Tenants Reap Benefits of Sagging Office Market

15 Jul, 2008, Phoenix, AZ

Tenants in the Metro Phoenix office market are reaping the benefits of a sagging office market that's demonstrating the overall effects of a weak American economy, according to Cushman & Wakefield of Arizona, Inc.

"It's a great time to be an office tenant," says Tom Johnston, senior managing director of Cushman & Wakefield of Arizona, Inc. "We encourage businesses approaching lease expiration to hire a good real estate agent and strike a long-term lease now. Stable, strong credit tenants can strike fabulous 10-year deals during these times of higher vacancy."

According to Cushman & Wakefield's mid-year statistics, overall vacancy of office space in Metro Phoenix rose to 17.2 percent, up from mid-year 2007 when overall vacancy was 14.8 percent. "We're completing a wave of significant new construction in our market," says Johnston. "New buildings are being delivered with very little tenancy and that's driving up direct vacancy rates in landlord controlled spaces. In addition, we have job losses and companies downsizing. This creates growth in the sublease marketplace, further increasing overall vacancy."

At the end of June 2007, sublease space accounted for only 0.8 percent of the Valley office space inventory. Today, that figure has doubled with 1.6 percent of our office space inventory being available for sublease. "The increase in sublease space has occurred as a result of move-outs and downsizings in the 5,000 to 10,000-square-foot tenant sector," says Johnston. "We haven't experienced any large blocks go dark, but our commercial market is primarily comprised of these small to mid-sized, entrepreneurial and professional tenants. These small businesses make up a large portion of our commercial real estate market. Many of these companies relied on pulling equity out of their homes to fund expansion of their businesses. That funding is no longer available with the current lending environment."

Companies continue to lease space in the Metro Phoenix office market. Direct net absorption for the first half of this year remained positive at 61,583 square feet. However, the overall net absorption, which accounts for sublease space, put us in the negative zone of (279,752) square feet. "Essentially, any gains we make in leasing these new buildings are being eaten away by the growing sublease vacancies," says Johnston. "Statistically, our market is relatively flat, but we may not have fully felt the impact of the national economic troubles."

Several significant leases were signed during the last few months. Pulte Homes pre-leased approximately 96,000 square feet at Terra Verde Corporate Campus in North Scottsdale with completion scheduled for 2009. CDW has leased approximately 72,000 square feet in Chandler and Shamrock Foods has recently signed a pre-lease commitment for 46,000 square feet at the new Ryan Companies building on 39th Street and Camelback Road.

"Larger corporations are moving forward with their office space requirements," says Johnston. "However, it is taking increasingly longer for both lease and sale transactions to be completed. Uncertainty in the economy and within the tenants' specific industries is creating more hesitancy. While expiration dates on current leases may be looming, landlords are far more flexible about signing short term extensions to allow the process to play out."

Direct weighted average rental rates have increased, up to $26.09 per square foot from $25.87 per square foot just three months ago. "The market-wide increase is completely attributable to the amount of new construction coming online," reports Johnston. "New, Class A buildings are the most expensive and they are driving up the average rental rate across the board. Concession packages are being used to entice good tenants and the older buildings are reducing rates. It is a terrific time for tenants to strike a great deal on quality office space."

Since the beginning of 2008, approximately 2.3 million new square feet of office space have been completed in the Metro Phoenix market. Approximately two million square feet of that is situated in Scottsdale and the Southeast Valley. "These two areas are suffering the short-term effects of overbuilding," adds Johnston. "Both areas have posted overall vacancy rates in excess of 18 percent and each of the areas has at least another million square feet more of space under construction. Fortunately for Scottsdale, it is one of the office submarkets that historically benefits from very strong demand. The Southeast Valley office market has grown in popularity during the past 24 months and it will be interesting to see how quickly demand will absorb this new supply."

Not unexpectedly, sales of office buildings are scarce during these economic times. "We just completed the sale of Hayden Ferry Lakeside II at Tempe Town Lake, which was a significant transaction," says Johnston. "However, the capital markets activity has slowed dramatically. Not many assets are trading hands as the financial markets tighten and investors take a 'wait and see' attitude about the real estate environment."

Johnston remains optimistic about the long-term prognosis for the Metro Phoenix real estate market, but is cautious about the short-term landscape. "We expect the current market conditions to continue in the upcoming months and anticipate an upturn towards the end of 2009. Our expectation is that 2010 will be the year for signs of recovery to be evident."

Cushman & Wakefield is the world's largest privately held commercial real estate services firm. Founded in 1917, it has 221 offices in 58 countries and more than 15,000 employees. The firm represents a diverse customer base ranging from small businesses to Fortune 500 companies. It offers a complete range of services within four primary disciplines: Transaction Services, including tenant and landlord representation in office, industrial and retail real estate; Capital Markets, including property sales, investment management, valuation services, investment banking, debt and equity financing; Client Solutions, including integrated real estate strategies for large corporations and property owners, and Consulting Services, including business and real estate consulting. A recognized leader in global real estate research, the firm publishes a broad array of proprietary reports available on its online Knowledge Center at www.cushmanwakefield.com.

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