Retailer expansion fuels another vacancy dip

The strong start to the year in the Greater Phoenix retail market continued into the second quarter. In each of the first two quarters of 2018, net absorption has topped 500,000 square feet, and total net absorption for the first half of the year is up nearly 10 percent when compared to the first half of 2017. This tenant demand is driving the local vacancy rate lower.

Retail real estate fundamentals have been improving across the Greater Phoenix market. Vacancy has declined year over year in each of the submarket clusters in the market, with the East Valley and Scottsdale recording some of the most significant improvements.

Investment activity cooled off in the second quarter, with fewer shopping centers changing hands at lower prices. While the total number of property transactions slowed, there was an increase in properties priced at $5 million and higher during the second quarter. This was a continuation of the trend that emerged in 2017, when nearly half of the total transactions in the market were priced at $5 million or above.

With larger properties changing hands, cap rates are generally lower than they were a few years ago. Cap rates have averaged approximately 7.3 percent year to date, nearly identical to one year ago.

Key Takeaways:

  • The Greater Phoenix retail market continued to improve during the second quarter. Vacancy tightened and rents rose.
  • Development of new retail space has been modest; so as tenant demand expands, businesses are backfilling previously vacant space.
  • Retail vacancy dipped to 7.6 percent in the second quarter, and the rate has been trending lower for the past 18 months. Year over year, vacancy is down 130 basis points.
  • Rents continue to push higher. Asking rents rose to $14.99 per square foot in the second quarter, up 3 percent during the past 12 months.
  • Investment conditions softened a bit during the second quarter, with fewer properties selling and the median price dipping by nearly 25 percent from the first quarter.
  • The median price year to date is $160 per square foot, up from 2017, while the average cap rate is approximately 7.3 percent.

Outlook:

The Greater Phoenix retail market had a strong first half of 2018, supporting the outlook for the remainder of the year. Traditionally, the Greater Phoenix retail market has posted its strongest expansions during the second halves of years and that trend repeated itself in 2017.

In the second half of this year, current forecasts call for a steadier pace of expansion. In 2017, net absorption in the second half of the year totaled nearly 1.9 million square feet, but that figure was amplified a bit by the delivery of pre-leased new construction. Development in the second half of this year will likely be more modest.

The continued strengthening in the economy and the health of the local housing market are expected to continue to fuel consumer spending and support the local retail real estate investment market.

Cap rates have remained relatively flat even as interest rates have inched higher, in part because of rising rental rates and tightening vacancy throughout the market. These conditions are forecast to continue in the year ahead, which should support ongoing investor demand and transaction volume for shopping centers and keep cap rates from rising significantly.