Phoenix’s Office Market Tanks Amid Multifamily, Industrial Overbuild

Despite the record-breaking heat, things are not all that sunny in Phoenix. 

The Valley of the Sun saw its office market collapse in the second quarter of the year, while its once-thriving industrial market faces a risk of overbuilding as the absorption rate for industrial space fell 80 percent in the last three months, according to a new report from Transwestern Real Estate Services.   

Moreover, while the fundamentals of Phoenix’s multifamily sector remain strong, monthly rents have stalled at an average asking price of $1,570, after rising almost quarterly between 2014 and 2021, a troubling sign for multifamily owners. 

“It’s instability, and just as every other market is trying to find their footing right now, Phoenix is no different,” Jennifer Barili, senior research analyst at Transwestern and author of the report, told Commercial Observer. “We have a lot of the same negative energy in our office market that every other major market does, but we have some really good things that will help insulate some of the damage to the [overall] Phoenix market in the next few quarters.”  

No sector of Phoenix’s commercial real estate market has experienced a worst shift in 2023 than office. Net absorption fell deeply into the negative in the second quarter, reaching minus 1.2 million square feet, with more than two-thirds of Phoenix’s negative net absorption residing in Class A office buildings. 

To make things worse for investors and sponsors, new construction has all but collapsed, as the amount of new office construction reached its lowest levels in 10 years: Just over 700,000 square feet of new office is currently under construction, compared to nearly 3.8 million square feet in 2018 and nearly 4.5 million square feet in 2015. New construction reached 3 million square feet even as recently as the fourth quarter 2020, according to the TransWestern data.  

Barili emphasized that the common flight-to-quality trend has teamed with a number of companies choosing to scale back their physical space to make even many Class A buildings increasingly obsolete in a Phoenix economy that isn’t exactly sure where its strong point is. 

“We’re trying to find our footing. You have San Francisco, which is a technology market, and Phoenix is kind of a melting pot of a lot of different things,” she said. “We have professional services, business services, and we have national companies that have national footprints as well, but the national companies are not coming back to the office as quickly as our local companies.” 

As construction and absorption rates for office have trended downward, vacancy rates have concomitantly increased this year. Phoenix’s Class A vacancy rate reached 25 percent in the second quarter, while its Class B vacancy rate crested slightly to 17 percent. The city’s overall office vacancy rate of 20 percent is substantially higher than the overall U.S. vacancy rate of 12.9 percent. 

And, with the increase in vacancies, it should be of no surprise that investment sales in the valley have also fallen off the map. 

“Another quarter of instability in the lending environment, in conjunction with shrinking office footprints, has been a continued paralyzing force for office product,” the Transwestern report concluded. “Prices have dropped substantially and are showing no signs of rebounding in the near term.” 

After reaching more than $1.2 billion in investment sales in fourth quarter 2017 – and hitting more than $1 billion as recently as fourth quarter 2021 – the Phoenix investment sales market collapsed to less than $200 million in both the first and second quarters of 2023. 

Notable downtown and midtown office sales in the last year include 4520 North Central Avenue, a six-story, 88,000-square-foot office building that sold for $9.5 million, and 45 West Jefferson Street, a 67,000-square-foot, 14-story Art Deco office building that sold for $6.9 million.  

“It’s really, really hard to value the buildings,” Barili said. “How do you tell someone who is going to lend money that this building – that might have creditworthy tenants – will keep those creditworthy tenants? No one is going to take that leap of faith right now.”  

If the Phoenix office is melting under changing economic conditions, then the valley’s industrial sector now has to seek shade from its own risky environment. With absorption slowing and vacancies rising, the city’s industrial market could experience a downturn associated with overbuilding in upcoming quarters, despite strong sector fundamentals, according to the Transwestern report. 

Phoenix’s industrial sector currently has 57.6 million square feet of space under construction, while 59.1 million square feet of available space sits on the open market. An additional 120 million square feet of industrial space has been proposed. 

To this end, overbuilding has now become a concern, as under-construction numbers in the city’s industrial sector have risen every quarter since fourth quarter of 2020, jumping from just over 10 million square feet in fourth quarter 2020 to nearly 60 million square feet this past quarter. 

“Absolutely, the threat of overbuilding is there,” said Barili. “I’ve been holding my breath every quarter, not wanting to know what the numbers are, because at some point we need to find an equilibrium, but we haven’t found it yet.” 

Finally, despite temperatures hovering around 115 degrees every day in July, Phoenicians can breathe easy when examining the city’s multifamily sector. That is, at least in some cases. 

First, consumers can exhale a bit when it comes to the high rents that have plagued Phoenix and other cities in recent years. The first and second quarters of 2023 saw asking rents finally dip compared to 2021 and 2022, which saw multiple quarters post year-over-year asking rent increases higher than 10 percent, peaking at a 20.2 percent year-over-year increase in the third quarter of 2021.  

The current average asking rent in Phoenix stands at $1,570, after peaking at $1,600 in second quarter 2021. The city saw its average asking rent rise from a pre-pandemic point of $1,200 in the second quarter of 2019, according to Transwestern. That leveling off is good news for renters and bad news for landlords. 

But there’s also a demand problem. Overall vacancies in Phoenix’s multifamily market reached 9.3 percent in the second quarter of 2023, far higher than the national average of just over 6 percent. 

The city currently has 39,538 available units, while 37,532 are under construction; sales volume has plummeted to less than $1 billion in the previous two quarters, after having reached a high of more than $6 billion in the fourth quarter of 2021 alone, and a near high of $5.5 billion in the second quarter of 2022.    

“The story’s the same: Money is not cheap right now. Everyone is going to pause,” said Barili. “Multifamily is still the safer bet, but it’s still not a safe bet. Everyone wants to wait it out and see what happens with the Fed.”  

Brian Pascus can be reached at [email protected] 

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