As vacancy tightens, spec construction pipeline fills

The Greater Phoenix office market got off to a healthy start to 2018 during the first quarter. Market conditions strengthened, with vacancy dipping to its lowest point in nearly a decade.

Some of the strongest improvement is occurring in the Southeast Valley, with the Tempe, Chandler and Superstition Springs submarkets all recording significant year-over-year vacancy declines. These submarkets have also been areas that have been attracting employers in recent years.

Construction trends have begun to shift in the Greater Phoenix office market. With vacancy dipping into the 15-percent range and rents on the rise, developers are increasingly moving spec construction projects into the development pipeline.

Projects totaling more than 1.5 million square feet of spec space are currently under construction, nearly double the total that was under way one year ago.

After a very active close to 2017, the investment market for office properties slowed in the first few months of this year. Modest declines from the fourth quarter to the first quarter are common following periods of elevated activity as investors work to close transactions ahead of the end of the year. The median price dipped a bit in the first quarter and cap rates rose slightly.

Key Takeaways:

  • Net absorption in the Greater Phoenix office market began 2018 with more momentum than in recent years. Tenants moved into a net of approximately 679,000 square feet during the first few months of this year.
  • Net absorption did retreat somewhat from the total recorded in the fourth quarter of 2017.
  • Vacancy fell 30 basis points in the first quarter of 2018, dipping to 15.5 percent. The rate is now 90 basis points lower than one year ago. Vacancy has improved in each of the past four quarters.
  • Asking rents in Greater Phoenix reached $24.68 per square foot in the first quarter, rising 3.9 percent year over year. Rents are forecast to rise by approximately 4.5 percent in 2018.
  • The investment market had a slower start to the year, with fewer buildings changing hands, the median price dipping and cap rates inching higher. The decline in activity is largely seasonal, while the price and cap rate trends are likely the result of the mix of buildings transacting and rising interest rates.

Outlook:

The Greater Phoenix office market is forecast to post another year of improving conditions in 2018. The first quarter proved to be a good start to the year, with absorption off to a stronger start than in recent years, vacancies inching lower and rents rising.

The primary driver in the local office market remains the healthy job growth that is being recorded. The financial activities and professional and business services sectors continue to expand, combining to add more than 12,000 jobs during the past year. This will provide the fuel to the Greater Phoenix office market in the year ahead. The ongoing strengthening in the local housing market could be an additional source of demand in the office market, particularly in the Southeast Valley and Scottsdale submarkets.

The outlook for the investment market is mixed. The improvement in property fundamentals should support continued investor demand, but rising interest rates could put some upward pressure on cap rates. This trend began to take shape during the first quarter, when cap rates edged higher, particularly in the multi-tenant buildings that changed hands. With lending rates likely to rise in the coming quarters, cap rates may edge higher as well.