Employment growth fueling tenant demand
In the third quarter, the Greater Phoenix office market sustained the momentum built during the first half of the year. Net absorption was positive, although it did not match the more than 1.1 million square feet recorded during the second quarter of this year. One reason for the dip in net absorption is the shrinking number of large blocks of available space in desirable submarkets. This will be somewhat alleviated in the coming quarters, as a handful of spec projects are scheduled to come online in the fourth quarter, with still more deliveries anticipated in 2019.
The local office market is being supported by a robust pace of employment growth. During the past 12 months, employers have added more than 75,000 net new jobs, an increase of 3.7 percent. This marks the strongest annual job growth in Greater Phoenix since late-2006, and places Phoenix among the top-10 markets in the country for new job growth. Gains in office-using sectors have been a bit more modest, with more than 18,000 white-collar positions having been added in the past year, representing growth of 3.2 percent.
Sales of office buildings dipped slightly during the third quarter, but transaction activity is up when compared to the same period in 2017. Pricing has also pushed higher year to date, although the median price during the third quarter was down from a recent peak in the preceding quarter. Cap rates have remained low, even as interest rates have pushed higher. Cap rates have averaged in the high-6 percent to low-7 percent range for much of 2018, reflecting the elevated investor interest in quality office assets.
- The Greater Phoenix office market had a strong third quarter, although net absorption trailed off from the robust levels recorded during the preceding three months. Employers continue to add workers at a very active pace, fueling tenant demand for office space and prompting new development.
- While net absorption moderated in the third quarter, tenant move-ins still far outpaced new construction. This drove vacancy down to 14.2 percent, 170 basis points lower than one year ago.
- Continued vacancy declines are supporting rent growth, although gains thus far in 2018 have been more modest than in earlier years. Asking rents ended the third quarter at $24.81 per square foot, up 2.6 percent from one year ago.
- Investment activity posted a minimal decline from the second quarter, but more properties have traded thus far in 2018 than changed hands during the first nine months of last year. The median price year to date is $168 per square foot, and cap rates have averaged 6.9 percent thus far in 2018.
The outlook for the Greater Phoenix office market remains bright, as local businesses continue to expand and new companies are bringing operations to the Valley. During the third quarter, approximately one dozen companies announced plans to add workers in Greater Phoenix, highlighted by IT consulting company Infosys’s plan to more than double the company’s workforce in Arizona by adding 1,000 white-collar workers over the next five years. This followed second-quarter announcements from Nationwide Insurance and Deloitte for thousands of new jobs.
Strong job growth is supporting demand for office space, and with the overall vacancy rate tightening, new development is gaining momentum. Projects totaling more than 3 million are under way, up more than 75 percent from the amount of space under construction one year ago. Development of new projects, or additional phases or current projects will likely enter the construction pipeline in the coming quarters.
The strong operating fundamentals will continue to support the investment market. The fourth quarter is typically an active period for building sales, and some recent high-dollar sales could prompt additional transactions in the coming months. Rising interest rates could theoretically act as a drag on prices, but to this point in the cycle, investor demand has been strong enough to offset any rises in borrowing costs.