Office Space: Road to Recovery
February 20, 2015
By Dennis Desmond
The year 2014 marked one of the first years since the recession in which the term “recovery” was spoken with confidence, and looming doubt hanging over the nation had finally begun to fade away. What seemed like years of a U.S. economy simply spinning its wheels gave way to a new commercial environment with the traction needed to move forward. Employers across the nation added 3.0 million new jobs to the economy in 2014, pushing the unemployment rate to its lowest point since 2008. Consumer confidence also reached its highest level since the crash, and continues to rise as low interest rates and marginal inflation fuel additional activity. Despite the domestic and international challenges that still exist, such as global economic instability fueled by the Eurozone’s recession, slowing growth across China and the recent turmoil caused by depressed energy prices, a positive outlook has permeated to the local level – as evidenced by Phoenix metro’s recent growth.
As one of the fastest growing metro economies in the country, Phoenix has exhibited similar characteristics to trends seen on the national level. The Valley is still 40,000 jobs shy of recovering all of its 300,000 jobs that were lost in the recession, but mostly due to the lagging construction and manufacturing sectors. Fortunately, many of the office using sectors such as professional and business services, financial activities and education and healthcare have surpassed their respective peaks and are fueling higher demand for expansion space across office buildings. Many companies with a Phoenix presence such as Infusionsoft, Aetna, Avnet, General Motors and The CORE Institute that have expanded and taken additional office space, whether it was into current availabilities or into newly constructed facilities. The Valley also remains an attractive location to tenants outside of the state. Asurion, Shutterfly, Weebly, Zenefits, Cognizant and Lockheed Martin are just a handful of companies that have chosen to locate in Phoenix and take advantage of the competitive business environment. The growth exhibited by these and many other companies has resulted in more than 2.4 million square feet of positive net absorption in 2014, the highest level seen in Phoenix since 2006.
The significant absorption recorded in 2014 has driven vacancy 210 basis points lower than it was 12 months ago, to end the year at 21.4 percent. Although the overall Phoenix office market still exhibits a relatively high vacancy rate, the real story lies within the subset of more modern Class A space, which is currently 18.7 percent vacant. The Valley has seen a noteworthy flight-to-quality phenomenon as 60 percent of total net absorption in 2014 has happened in Class A properties. Tenants are looking to locate in modern spaces that satisfy their needs for a strong workforce, proximity to amenities and high parking ratios. Tempe is just one example of a submarket that can check all of these boxes and, as a result, is enjoying
significant interest from growing companies. In fact, Tempe has seen such unprecedented growth in 2014 that it has become a catalyst for growth in the Valley – a force that began when State Farm announced their new regional headquarters on Tempe Town Lake last year and that continues today. At 11.3 percent, this submarket boasts not only the Valley’s lowest vacancy rate but also its fastest rent growth, a 30 percent increase in the last 12 months.
Strong demand, falling vacancy rates and rising rental rates have all helped reinvigorate investor interest in Phoenix. Based on properties and portfolios valued at $5 million or greater, total sales volume exceeded $1.7 billion in 2014, up 47 percent over 2013. Just some of the buyers returning to Phoenix metro in force include ARCP, Cole Capital, Regent Properties, ScanlanKemperBard and LBA Realty. All of these entities have purchased at least one property in the last 24 months, with notable transactions including LBA Realty’s purchase of Kierland II for $211 per square foot and Palisades Capital Realty Advisors’ purchase of 4141 N. Scottsdale for approximately $235 per square foot. Both of these transactions are examples of the steady rise in Phoenix metro office values. As of the end of 2014, Phoenix metro’s average price per square foot had climbed to $170 – a 46 percent year-over-year increase and more than 100 percent above the values seen in 2010 and 2011, during the trough of the recession. Given the strong economic and real estate conditions in Phoenix metro and the country, values are expected to rise even higher in 2015.
With the exception of a stagnant construction sector, Phoenix metro’s economy is firing on all cylinders. Employment continues to outpace national growth, population gains are returning to pre-recessionary levels and the Valley remains attractive with cost advantages relative to regional peers. Add in the steady rebound of the residential housing sector and you have an overall market slated for continued rapid improvement and what we expect to be another strong year of growth within the Phoenix metro office market.