The Real Deal: On the Ground with Commercial Real Estate

Arizona’s real estate market has had a yo-yo cyclical nature for decades. Are we entering a time of more stability?

In Business Magazine has asked leading professionals in this market to share insights on what is happening now in the four real estate sectors of industrial, retail, office and multifamily plus how real estate is supporting the important economic sector of healthcare — and what influences may direct future development.

Quashing the Myth of ‘Secondary’ for CRE’s Industrial Sector

from Andy Markham of Cushman & Wakefield

One of the “myths” out there is the notion that the Phoenix Metro is still a secondary industrial market in the U.S. as opposed to a primary market. For several consecutive years — and particularly since the onset of the COVID-19 pandemic that abruptly accelerated the need for industrial space — the Phoenix market enjoyed a sustained period of profound occupancy and rental growth, driven by exponential demand from a robust pool of occupiers. Although perhaps not considered a true “gateway market,” Phoenix certainly now competes with some of the country’s most dominant markets, such as the Southern California Inland Empire, and is now definitely on the front page of surveys for our national clients seeking a solid distribution location option.

Although there has been some recent adjusting in the industrial sector, the market has now reported a phenomenal 48 consecutive quarters of positive net absorption through Q1-2024 amounting to nearly 130 million square feet of occupancy growth. Complete annual totals include 12,348,043 square feet in 2023; 21,726,765 square feet in 2022; 22,824,154 square feet in 2021; 14,783,343 square feet in 2020; and 4,904,147 square feet in 2019.

How is this playing out around the Valley?

• Deer Valley remains one of the most in-demand submarkets in Metro Phoenix. Investors and occupiers remain very attracted to this submarket given its access to key logistical freeways and abundance of labor, and increasingly paramount is the recent development plus future planned expansion from Taiwan Semiconductor Manufacturing Company Limited in the area. Investors as well as relevant occupiers continue to look to capitalize on the prolific growth the surrounding area has experienced overall driven by TSMC.
• Light industrial and high-bay properties have remained in high demand by small to mid-size occupiers given their flexibility to accommodate a variety of industries. This has, in turn, also captured greater investor interest for these types of assets in the Phoenix market.
• And as one of the most robust and strongest performing industrial areas in Metro Phoenix, the Sky Harbor submarket is well-known and desired due to its proximity to several key freeways and logistical routes. This submarket also has a limited amount of land left for new Class A industrial development.
• Phoenix’s West Valley housed a handful of major new industrial leases in the first quarter of 2024, including a trio of significant leases from a major ecommerce company (±3.5 million square feet), SOLogistics (±519,000 square feet) and USPS (±450,000 square feet).

Q1 Market Snapshot

According to Cushman & Wakefield’s latest first quarter of 2024 Industrial report, the Phoenix market registered an overall vacancy rate of 10.6%, a quarterly increase of 170 basis points (bps). As with previous quarters, the vacancy rate has continued to rise due to continued supply growth and an increase in sublease availability. The vacancy rate climbed in all five of the macro submarkets; the Southeast Valley had the most substantial increase in vacancy in the fourth quarter as the vacancy rate swelled 320 bps to 13.9%, followed by the Northwest Valley where the vacancy rate rose 150 bps to 5.9%.

Phoenix’s construction pipeline remains the highest in the U.S., with 42.2 million square feet underway. The warehouse/distribution sector in Phoenix dominates the development pipeline with approximately 28.8 million square feet or 68% of all product types under construction. While supply chain issues, elevated construction costs and build-out delays have slowed construction activity dramatically, Phoenix industrial inventory has increased 28.8% in the past five years.

Phoenix’s inventory continued to grow as 7.9 million square feet of new industrial product was added to the market in the first quarter. The Southeast Valley and Southwest Valley remain the most active submarkets, recording the highest level of completions, with 3.7 million square feet and 3.6 million square feet, respectively. Speculative projects accounted for 97% of new projects (7.6 million square feet) of which 24.7% (1.9 million square feet) was delivered pre-leased.

In the first quarter of 2024, according to the Bureau of Labor Statistics, the Phoenix market recorded an employment level of 2.4 million jobs and the unemployment rate decreased slightly quarter-over-quarter (QOQ) from 3.7% to 3.6% in Q1 2024. The metro area continues to experience tremendous growth, as the number of households increased by 1.9% year-over-year (YOY) to 1.94 million. Wage growth continues to bring jobseekers back into the labor market, as the median household income reached $89,400 in Q1 2024, a rise of 2.9% YOY. (Q1 data is based on the U.S. Bureau of Labor Statistics, All Employees: Total Nonfarm in Phoenix-Mesa-Scottsdale, AZ (MSA) – seasonally adjusted.)

Notable for the Coming Year

Leasing activity increased to 7.7 million square feet in the first quarter of 2024, improving on just 4.7 million square feet and 5.3 million square feet in the third and fourth quarters of 2023, respectively. Although four high-profile leases accounted for nearly 4.0 million square feet of leasing activity in the first quarter, the market is primed to improve upon a lower 2023 year-end total of 20.8 million square feet. Tenant demand remained strong in the warehouse/distribution sector, accounting for 85% (6.5 million square feet) of new leasing in the first quarter.

The Southwest Valley submarket posted the highest amount of new leasing activity, representing 65.9% (5.1 million square feet) of total new leasing due to the proximity to the Ports of Los Angeles and Long Beach and the large population base in Southern California.

Of note, the substantial amount of leasing signed in the first quarter will not factor into our net absorption stats until occupancy, meaning there is already significant baked-in-growth that will be anticipated ahead once these companies move into these spaces.

Additionally, Cushman & Wakefield is currently tracking more than 28.8 million square feet of active Industrial Tenant Requirements or Tenants in the Market. This is a very solid level helping to feed potential future absorption in the Greater Phoenix Metro industrial sector even at a time when there is an expected slowdown of industrial activity across the broader U.S. looking ahead. We fully anticipate Phoenix to remain as one of the “winners” in the industrial marketplace and we don’t expect it will experience any real deep swings in the long-term even through any headwinds that may arise; rather, the region should remain steadfast and resilient through the foreseeable future. We will look for the Phoenix Metro industrial market to maintain between 15 and 20 million square feet of occupancy growth per year ahead — which, although not the skyrocketing levels seen in recent years, is still an impressive level historically.

Industrial construction starts will be limited in 2024 as the market works through the surplus of new supply and projected deliveries that will be introduced with limited preleasing. New projects are set to pause, potentially being pushed back to late 2024 or 2025.

As tenant demand for warehouse space continues to normalize and speculative development slows down, the Phoenix metro industrial market will remain one of the most resilient real estate sectors nationally, with activity remaining strong in general manufacturing and warehouse industries. Although net absorption dropped QOQ, it is difficult to pinpoint the state of the market based on first quarter absorption alone, especially with a quarterly leasing activity rebound.

Driving Forces in Industrial

The Phoenix market has experienced a considerable uptick in manufacturing as there has been more than $60 billion in private investment in the semiconductor, battery production and energy storage emerging technologies sectors. Significant manufacturing announcements include Taiwan Semiconductor Manufacturing Co. locating their first manufacturing facility in the U.S. in north Phoenix, the continued Intel expansion of their Ocotillo campus in Chandler and LG Energy Solution’s capital investment of $6.9 billion.

The vacancy rate is expected to continue its steady rise in 2024 as under construction projects are scheduled to deliver with available vacant space, likely pushing rents further downward and providing tenants with increased options.

Tenant demand will continue to be fueled by 3PLs, retail/apparel, e-commerce, general manufacturing and semiconductor chip-related manufacturers.

Of note, in March 2024, the current administration announced that the U.S. Department of Commerce and Intel Corporation have reached a non-binding preliminary memorandum of terms to provide up to $8.5 billion in direct funding under the CHIPS and Science Act to strengthen the U.S. supply chain and re-establish American leadership in semiconductor manufacturing.

According to the announcement, over the course of the next five years, Intel expects its investments in the United States to exceed $100 billion, as it expands capacity and capabilities in Arizona, New Mexico, Ohio and Oregon. Leading-edge chips power the most sophisticated technology on the planet, including developing AI and building critical military capabilities.

In Chandler, Arizona, construction of two new leading-edge logic fabs and modernization of one existing fab is significantly increasing leading-edge logic capacity, including high-volume domestic production of Intel 18A. The company will produce the first Intel 18A product, called Clearwater Forest, at its Arizona facilities. In 2022, Intel partnered with Maricopa County Community Colleges to launch a first-of-its-kind program with Intel employee-instructors to provide students an entry point into semiconductor technician careers. This investment will support 3,000 manufacturing jobs and 6,000 construction jobs.

Another key area for Phoenix’s industrial sector is around data centers. According to Cushman & Wakefield’s latest “America’s Data Center Update,” the second half of 2023 shows the Phoenix metro area continues to maintain its national leadership position in the industry sector. With tight vacancy and many options where it comes to providers, Phoenix has quickly become the central data center hub along the West Coast. After absorbing 411 megawatts of capacity in 2022, the Phoenix area jumped considerably last year, absorbing nearly 600 megawatts in 2023. Phoenix has joined the rarified air of gigawatt-plus markets, and it has shown no sign of slowing, as hyperscalers and colocation providers alike have evaluated land sites across Mesa, Chandler, Goodyear, Glendale and Avondale. All major hyperscale data center providers now either have a foothold in Phoenix or plan to grow in the area.

The Cushman & Wakefield market recap shows 12 major operators have 17 total projects in the works in metro Phoenix for a total build area of slightly more than 16.3 million square feet. Six of the developments are listed as “under construction” (2.8 million square feet), with the remaining 11 shown as “in planning” (13.4 million square feet).

It should be mentioned that we continue to encourage some of our industrial clients to move forward with construction plans given that the number of competitive projects under construction is slowing.

Phoenix remains one of the fastest-growing markets the U.S. (some sources even say the fastest, depending on the period). The Phoenix-Mesa-Scottsdale MSA has continued to see solid population growth, averaging 1.2% annual growth over the past five years (2019–2023). According to Moody’s Analytics, the population in this region is anticipated to grow at an even higher pace of 1.5% or above each of the next five years (2024–2028). This population increase should continue to help fuel the region’s commercial and overall economic growth.

While still a concern, inflation in the Phoenix metropolitan area has cooled a bit, as of February 2024 Consumer Price Index data. Inflation in metro Phoenix over the past 12 months (2.2%) remained below the national average (3.2%). Inflation was at very high levels in the metropolitan area in 2022. “Inflation in the Greater Phoenix area remains below the national rate — a welcome change from 2022 and early 2023, when we were among the fastest growing regions in the country in terms of prices,” Glenn Farley, Common Sense Institute Arizona’s director of policy and research, said in a statement to The Center Square.

And Watch Out for …

I don’t know if I would categorize it as a worry per se, but Phoenix’s East Valley has nearly as much new industrial supply delivering as we are tracking in the West Valley. However, the size of the occupiers in the East Valley area tends to be smaller, which may cause some uneasiness from a supply/demand balance standpoint. That said, the East Valley is still growing at a strong clip, being driven by companies like LG, Intel, solar farms and an array of other companies and industries.

Another trend that we continue to monitor and that may impact the market is interest rates. If interest rates don’t descend as fast as predicted, this could cause some stress in the Capital Markets sector.

Despite growing solar developments in surrounding areas, power — as with many markets — is becoming more constricted as competition grows for larger data center deals in the Phoenix area. Per C&W’s Data Center report, water usage has also become a critical issue for the market, as high ambient temperatures and demand for more intensive AI/HPC workloads have generally increased the requirements for more intensive water-cooling technologies. State and local governments have begun to ask data center operators to limit their water usage and have incentivized the deployment of air-cooling technologies. The confluence of these factors will likely lead to fewer high rack-density deployments in the Phoenix market as compared to others, though this will likely do little to dampen the overall positive momentum of the market, the report finds.

Andy Markham, SIOR, is executive vice chair at Cushman & Wakefield, a leading global commercial real estate services firm for property owners and occupiers with approximately 52,000 employees in nearly 400 offices and 60 countries. In 2023, the firm reported revenue of $9.5 billion across its core services of property, facilities and project management; leasing; capital markets; valuation; and other services.

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Significant Shifts Ahead in CRE’s Multifamily Sector

from John Carlson of Mark-Taylor Companies

The current state of commercial real estate presents a mixed outlook — characterized by cautious investor sentiment and economic adjustments, as evidenced by the notable decline in transaction activity within the multifamily sector.

According to CBRE Economic Advisors, “The biggest wave of new apartment supply in decades will temper rent growth and improve affordability for renters in 2024. With delivery of 440,000 new units expected in 2024 and more than 900,000 currently under construction, the overall vacancy rate is expected to rise and rent growth to decelerate,” highlighting significant shifts in the multifamily sector.

Despite these challenges, multifamily real estate is playing a more important role in alleviating a severe shortage of single-family homes. CBRE also noted that “the premium for an average monthly mortgage payment of a newly purchased home vs. average monthly rent is expected to remain above 35% in 2024 versus 52% in 2023.” This reaffirms the essential role and viability of multifamily communities among evolving market dynamics.

Notable for the Coming Year

Amidst the transactional freeze being experienced in the multifamily market, positive influences are evident through broader macroeconomic data and consumer sentiment trends. All of this underscores the potential for continued supply-side pressures to be met with strong absorption and potentially less negative rent growth than first anticipated.

Looking specifically at the Phoenix Metro area, Mark-Taylor forecasts an upcoming peak in excess inventory — which is expected to reach its highest point in the summer of 2024. Expanding nationally, out of the 69 markets tracked by CBRE, 17 are slated to grow their inventories by more than 7% in 2024 and 2025.

As operational headwinds continue, it is imperative for property managers to prioritize the delivery of 5-star service to attract and retain residents who are contemplating their housing options. Demand for value remains elevated.

But Watch Out for …

The multifamily sector is facing several significant challenges that are cause for concern among property owners and operators.

• Anti-housing/landlord legislation: A surge in legislation aims to regulate the multifamily industry to include debilitating proposals such as rent control, housing fees and screening measures. As of April 2024, hundreds of state bills, related to multifamily and rental housing, are being considered nationwide.

According to the National Apartment Association’s State Legislative Tracker, there are 213 active bills related to rent control across the country. Such bills could directly impact operations and require property managers to adjust their standards.

• Rising insurance rates: Insurance costs for multifamily property owners have been on the rise since 2020 and increased significantly last year. This poses a challenging situation for all involved, especially landlords. An NMHC study conducted in June 2023 found that respondents reported their property insurance costs had risen by an average of 26% over the past year, with some experiencing increases as high as 120% year over year. In response to inflated premiums, many property owners have been forced to raise deductibles, accept new policy limitations or face reductions in coverage amounts.
• Historic increase in supply: Rent growth in 2024 is expected to trend negatively while vacancy loss is set to increase; this is the result of a continued high rate of new supply scheduled to enter the market. Per Census Bureau data, multifamily completions nationally rose by 22.1% in 2023 to 438,500 units, marking the highest number of annual deliveries since 1987. The multifamily construction pipeline remains robust with just under 1 million units under construction — most of which are expected to be completed in 2024 and 2025.
• Elevated expenses compared to consumer price index: In addition to recent rent softening, multifamily properties’ net operating income continues to decline due to ongoing expense pressures since the pandemic began in 2020. According to Freddie Mac, during the third quarter of 2023, national expenses grew by 7.2% — more than double the rate of inflation. Taxes and payroll expenses increased the most, with taxes rising by 10.5% and payroll expenses by 8.4% over the past year.

Stakeholders must navigate each of these challenges strategically to adapt to evolving market conditions and regulatory environments, while optimizing property operations and financial outcomes.

John Carlson is president of Mark-Taylor Companies, a privately held, Arizona-based developer, owner and investment manager of multifamily communities in Arizona and Nevada. Since its establishment in 1985, Mark-Taylor has grown to become the region’s longest-standing investment manager, developer and owner of Class-A multifamily real estate on behalf of numerous third-party owners.

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Resiliency and Challenges in CRE’s Retail Sector

from Todd Folger of CBRE

Retail continues to be a bright spot in today’s economy, showing resiliency since COVID with consistent expansion and absorption of space. The main challenge in the current market is supply, as vacancy rates are at their lowest in over two decades (sub 5%), causing rents to rise across most submarkets. While new supply in the west, northwest and southeast submarkets has alleviated some supply constraints, other dense areas with low inventory and difficulties in redeveloping underutilized properties still face challenges.

In some of the denser parts of the market that are still highly desirable, one of the main constraints is the ability to redevelop due to higher land costs; there are properties that could and should be redeveloped, such as older office buildings and aging strip centers, to name a couple. Given the underlying land values, developers need to increase density by going vertical or finding another way to add density. However, doing so makes the development more complex and more costly.

Given some of the challenges we are seeing in the office and multifamily sector for new development, it makes these redevelopments all the riskier. As market fundamentals start to normalize and inflation and interest rates start to adjust, it will become easier for these projects to come to market.

Notable for the Coming Year

While grocery-anchored centers lead the charge post-pandemic, there is a shift toward community and power centers, a trend not seen in almost two decades. The change is, simply, being driven by demand. As the larger format retailers still need to grow and add stores, we will continue to see more of this type of development — so long as it is driven by sound fundamentals in the housing market.

At least four Target-anchored developments are underway across the Valley, adding significant square footage to the market. The last Target store built was the smaller format store at 16th Street and Camelback Road. This was previously a Sports Authority that was approximately 50,000 square feet in a center that was originally a grocery-anchored center. The new developments they are looking at are slated to be closer to 150,000-square-foot stores with more than 250,000,000 square feet and up of additional retail.

And Watch Out for …

Phoenix has seen 13 consecutive quarters of positive net absorption since the pandemic, and this trend is expected to continue despite new supply.

What we saw post-pandemic was a resurgence in the consumer shopping in person. They had been relegated to their homes and social distancing for so long that, as the pandemic subsided, the consumer was anxious to get back to in-person shopping.

Retailers did and still must adapt by making shopping experiences more personal and interactive, so they are engaging the consumer and making them want to come back. While online shopping will continue to increase, the in-person shopping experience will continue to thrive — and those retailers and restaurateurs that do the best job of engaging the consumer will see the best results.

Challenges still exist in the market, such as increasing land values and construction prices, although those costs are showing signs of leveling off and returning to more normal costs. In the food and beverage sector, food and labor cost concerns continue to persist as operators try to find a careful balance between raising prices while maintaining affordable yet meaningful dining experiences.

Overall, optimism remains high in Arizona’s retail sector, and it is expected to thrive as consumers continue to shop and dine despite inflation driving up prices.

Todd Folger is first vice president at CBRE in Phoenix. Dallas-based CBRE Group, Inc. is the world’s largest commercial real estate services and investment firm (based on 2023 revenue) and serves a diverse range of clients in more than 100 countries with an integrated suite of services that includes facilities, transaction and project management; property management; investment management; appraisal and valuation; property leasing; strategic consulting; property sales; mortgage services and development services.

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Modern Office Space Bolsters Phoenix CRE Market

from Trevor Pratt of JLL

Metro Phoenix office vacancy rates continue to rise, now sitting at almost 26% according to the latest JLL data, but there is a silver lining to the lingering clouds. Modern office space, for example, is thriving as companies continue to reimagine their workspaces and better define their size needs.

Whether an organization chooses to return to the office, embrace a hybrid work model or transition a portion of its operations to fully remote, clarity and strategy are emerging. For those who maintain an office presence, one thing is certain: Employees want amenities.

Notable for the Coming Year

As a broker focusing on tenant representation, I’m seeing this flight-to-quality play out particularly among spec suites. Company after company are finding the ease and convenience of this kind of move-in-ready, design-forward, highly flexible space something that’s hard to pass up. Landlords have picked up on this shift and are transitioning their vacant square footage into spec suites at an unprecedented rate.

As demand for all types of Class A space continues, rental rates for the Class A product type are also pushing upward. The current direct asking rent for metro Phoenix office space is $29.87 per square foot. This compares to rents at an average of $33.98 per square foot for Class A space, and rental rates for best-of-the-best Valley office space leasing into the mid-$50s per square foot. Overall office rent growth in metro Phoenix has increased 1.1% year-to-date, offset somewhat by attractive concession packages that are often being offered to offset higher financing costs.

And Watch Out for …

The persistence of vacant office sublease space and older office inventory scattered throughout the Valley remain points of concern, with the potential to continue to negatively impact vacancy and absorption rates. According to JLL’s Q1 2024 Phoenix Office Report, almost 60% of local office vacancy is concentrated in 10% of the market’s buildings (many of these older). Vacant sublease space also remains substantial, though new sublease additions have started to subside from their peak in 2023, even recording some positive absorption earlier this year. What remains to be seen is how much negative absorption is ahead as pre-pandemic leases expire in the coming months and years.

The hope — and expectation — is that the metro Phoenix office market continues to find balance. Tenant requirements are on the rise, particularly in the Camelback Corridor and downtown Tempe submarkets for buildings with on-site or close access to amenities. There is no specific industry or company type dominating demand, but rather a steady desire among those looking to upgrade their space to attract employees back to the office.

Much like the rest of the nation, which is experiencing significantly reduced levels of new development, new construction in metro Phoenix remains metered, with just 322,610 square feet of space under construction during Q1 2023. If demand persists for Class A space and new construction levels remain low, it should help drive activity to Class B product. That would bring us closer to pre-pandemic conditions and further Phoenix’s position as a cost-effective, inventory-rich market of opportunity for companies looking to relocate and expand in the West.

Trevor Pratt is managing director at JLL. JLL is a leading global commercial real estate and investment management company that, for more than 200 years, has helped clients in more than 80 countries buy, build, occupy, manage and invest in a variety of commercial, industrial, hotel, residential and retail properties.

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Partnerships Driving Growth of CRE for Healthcare & Biosciences

from Sharon Harper of Chairman and Co-founder, Plaza Companies

The current state of commercial real estate in Arizona is strong, particularly around healthcare and bioscience. The healthcare sector is the second-highest growth sector in Greater Phoenix, according to the Greater Phoenix Economic Council. Arizona has long been a healthcare destination because of its quality of life, leading healthcare providers and world-famous centers of excellence. An innovative healthcare and biomedical industry is a legacy for Phoenix and has been forged by organizations such as Barrow Neurological Institute, the AZBio Association, our major hospital groups and innovation districts such as the Phoenix Medical Quarter, the Discovery Oasis, Phoenix Bioscience Core, Scottsdale Cure Corridor and other R&D areas. This has been bolstered by educational institutions such as Creighton University, the University of Arizona, Arizona State University, Grand Canyon University, Midwestern University and others.

Plaza Companies is a highly regarded full-service firm with roots in the healthcare and bioscience industries and has seen first-hand how public-private and public-private-university partnerships can drive economic growth. Along with healthcare and bioscience, we’re seeing success in mixed-use projects throughout the Valley that are reimagining old uses and revitalizing key areas of the community, such as what we have seen at our SkySong and Park Central projects. Other projects are poised to have a similar impact on the Valley. And we’re seeing a great deal of excitement around the technology industry, particularly around the semiconductor industry and in the investment being made in the Valley. This investment is creating high-paying jobs that are expanding our overall economy and encouraging new development in the office, retail and residential sectors.

Notable for the Coming Year

We’re seeing a great deal of forward thinking and planning around key sectors and industries that will fuel growth in the commercial real estate sector. Our leadership is working on execution of a number of new initiatives as a result. As mentioned, the healthcare and biosciences sectors are leading the way along with the renewed investment in the technology sector. This is creating a ripple effect that is fueling growth across the board in many parts of the community and in many sectors of commercial real estate. We’re seeing significant growth in downtown, north Phoenix, Scottsdale, the West Valley, the East Valley — just about everywhere in the market is seeing some increase in investment and development, particularly in the medical and bioscience sectors.

And Watch Out for …

We don’t really see a cause for “worry” as much as a need for a heightened focus and forward thinking. There are many opportunities ahead for Arizona and it is important for our communities to be prepared to make the most of the growth that is occurring in our state. The focus at Plaza Companies is on continuing to support market growth in healthcare, bioscience, mixed-use development, office, retail and hospitality and multifamily housing, and we’re seeing that across sectors throughout the Arizona market.

As CEO, chairman and co-founder of Plaza Companies, Sharon Harper oversees all facets of company operations, including ownership, development, leasing or management of nearly 13 million square feet of Arizona projects, medical healthcare companies, senior living communities and bioscience centers.