Commercial Real Estate: Is Multifamily Moving the Market?

by RaeAnne Marsh


What’s most visible of commercial real estate in metropolitan Phoenix is the multifamily market. Dennis Desmond, senior managing director of JLL in Phoenix, puts the number of units currently under construction at 6,000. This strength has been a trend as we’ve recovered from the recession. “Multifamily, as a segment of commercial real estate, is the No. 1 driver of growth for the past four or five years,” says Chris Loeffler, CEO of Caliber Companies.

The impetus for multifamily “going up like crazy,” observes Jon Rosenberg, managing partner of LevRose Commercial Real Estate, is the convergence of forces from two directions creating “the greatest demographic in history for multifamily.” Baby boomers are reaching retirement age in significant numbers, and many are choosing to trade large homes for an apartment or condo lifestyle. Even more impact is coming from the millennial generation, which is following a very different life pattern that impacts the housing market: In 1960, 65 percent of 18- to 32-year-olds were married; today, that’s less than 25 percent. So, rather than jumping into home ownership, millennials are choosing the flexibility of apartment living. But amenities and convenience are the important factors. As Rosenberg expresses it, “‘Live, work, play’ is a big thing.”

Biomed and tech are the main employing drivers, observes Bryan Fasulo, regional property manager for national multifamily management company Pinnacle, which manages Residences at Fountainhead, a development at Tempe Town Lake, and Proxy 333 in Downtown Phoenix — and these fields bring in a demographic that’s looking to live where they have the most amenities and the most convenient location. “And that tends to be multifamily.”

Their employers look at those factors as well. Says Rosenberg, “The businesses coming here are more vocal about what they want — locations that are easy to get to, and good residences for employees.” What makes a “good residence”? “Millennials want to be able to walk home, and to have restaurants and nightlife right there.”

Visibility is somewhat misleading, for those who may be concerned about another real estate bubble. Explains Desmond, “It seems like a lot because it’s so visible, but it’s 2 percent of the overall marketplace in the multifamily arena.” Noting the supply and demand figures are in equilibrium, he says, “The market is strong — it’s about 92 percent occupied.”

“There are apartments all over the Valley, including the periphery — along the I-17, the Southwest Valley, the Southeast Valley — as well as inner-city,” says Howard Weiner, president and Maricopa County manager with Lawyers Title of Arizona. And Mark Stapp, executive director of the Master of Real Estate Development program and Fred E. Taylor Professor in Real Estate at ASU’s W. P. Carey School of Business, notes that P.B. Bell is doing a first-build in the West Valley.

But it is the downtown areas that are seeing a lot of multifamily development, unlike a decade ago when the activity was more with housing developments in suburban areas. In fact, according to Desmond, the vast majority of this development is in Old Town Scottsdale, Downtown Phoenix, Downtown Tempe and along Central Avenue. In Old Town Scottsdale alone, “thousands of units are under construction or planned.”

And Downtown Phoenix is big because of the growth of the Downtown District and ASU, observes Weiner. In fact, Downtown is the fastest-growing market in Phoenix, according to Fasulo, who shares that rental prices are competing with Scottsdale and the Biltmore area.

This is a recent phenomenon that has its roots about 10 years ago when ASU created a Downtown campus that brought thousands of students plus staff and faculty to the area. Then the Light Rail opened. “It opened in 2008 when the economy was soft, but now it’s ramped up. So there wasn’t much development until about three years ago,” explains Brian Cassidy, president of CCBG Architects, Inc. and chair of the Warehouse District Council, which is working to create the cool, urban environment sought after by tech companies through a lot of adaptive reuse of the area’s older buildings. Multifamily projects in the area serve not only those companies but the big employment base of the biotech campus and medical research companies while also sharing the area with big venues, the convention center, hotels and government seats.

Specifically, Roosevelt and 3rd Street is densest intersection in all of Phoenix, Loeffler says, noting four different projects are going up there at this time. And there’s a ripple effect. “The density is driving the growth of other businesses — restaurants, a record store — in an area where, a couple of years ago, there was nothing happening.”

“Multifamily has driven forward all other segments of commercial real estate,” Loeffler affirms, for the segment in general. And the effect is to increase the sense of community, as putting more people into the areas is a huge driver to local businesses. “Investors made a profit in multifamily, and then put their money into other types of assets, such as hotels, office and retail.”

What is making high density the driving force that it is? Says Cassidy, “Downtown development is increasing property value, which is spurring more people to start to develop their land.” We’re seeing a lot of infill projects on land that was ignored for years but is now of interest to developers because it is in the heart of the city and near transit. “Land is more expensive, so they need to get a higher yield — so multifamily is the strongest use.”

Multifamily is attractive to tenants, Fasulo explains, because “people are looking for the ‘50s sense of neighborhood, but in a big, urban setting.” They want to interact with their neighbors, share events in common, hang out in a sports bar that might be on the property or do yoga — and meet people who want to do similar things. “That is easier to find in high-density projects.”

The Valley is a leader in this urban development, and Fasulo says he expects it to trend out to Flagstaff and Tucson as success is seen in Phoenix. “Even homebuilders like Toll Brothers are getting into more multifamily than single-family projects.”

CRE Is Slow but Sound

“Commercial real estate is very healthy,” says Weiner, who shares that he has seen the market activity up significantly from last year.

However, Phoenix does lag in recovery compared to the rest of the country. Explains Desmond, “Because of our dependence on the homebuilding industry, we were the poster child for the recession.” Our slower recovery, though, he believes is not necessarily a bad thing and will be good in the long-term. Not as dependent on construction as we were 15–20 years ago, we have an economy now whose strength is spread over a wider base of skill sets, particularly education and health services. And pointing to housing starts — often looked at as an economic indicator — he notes that in the early 2000s, we had 40,000–50,000 new starts per year. “Now, we’re thrilled to have 18 or 19 thousand — so that’s very sustainable.”

Cassidy believes metropolitan Phoenix is the slowest of the country’s major metropolitan areas to urbanize. But he adds, “We’re one of most sprawling, therefore Phoenix has more room to urbanize than any other major metropolitan area in the U.S.”

Architect David Hovey Jr., vice president of Optima, Inc., views the real estate market here with “cautious optimism.” “Before,” he says, “people were just building because the banks were lending. Now, new development has a more focused approach because projects are more targeted — for instance, if tech companies want to come to Scottsdale, then multifamily [there] is important.”

In spite of its growth, Phoenix is still a second- or even third-tier city compared to cities in Texas, and even to Denver, says Stapp. He, too, cites as a positive the fact that we are not growing the way we were but are rather exhibiting a more sustainable, mature growth. “But,” he adds, “we will have to resolve public policy and infrastructure issues.”

The biggest market is infill housing projects — high-end, high-rent, denser multifamily projects with structured parking. Cassidy cites more than 1,500 apartments and condos under construction now in the Roosevelt District, plus product in Central Phoenix, North Phoenix, midtown, uptown, with another wave of 1,200–1,500 units in the development pipeline that have not yet broken ground but are ready to. “There will be a project opening every six to eight weeks for the next two-and-a-half years.”

Weiner cites, among other activity, the refinancing of major shopping centers that changed hands or brought on new partners and that brought new money into the market from outside Arizona. This is one sign, he says, that confidence in the Phoenix market has finally come back. Noting the significant increase in population over the past 24 months, the increase in home sales, and the fact that unemployment is down, Weiner says, “The only drawback to the market is attracting companies and high-wage employees who can afford to pay more.”

Retail, Industrial and Office Keeping Up

There’s plenty of activity in other segments of Metro Phoenix’s commercial real estate market. Weiner points to the major development core along Rio Salado, from Liberty Center just west of Priest Drive, down past the ASU stadium to the State Farm building. Noting this “big boom” has taken place in just the past two years, he says projects like these bring “the kind of good employment that really helps the economy.”

Another hot area Weiner names is around Phoenix-Mesa Gateway Airport in the Southeast Valley, particularly Eastmark. A hotel and conference center will be coming to the corner of I-17 and Camelback Road. And Grand Canyon University is, he says, “making a huge difference in the West Valley,” buying and developing property to expand its 3300 W. Camelback campus in all directions. This includes multi-million-dollar improvements to the Maryvale Golf Course on Indian School at 59th Avenue to make it the home golf course for the university’s golf team.

“Development patterns have changed,” Stapp says. “Phoenix is acting like a mature metropolitan area.” We’re not seeing significant amounts of new-home building on the periphery like the big, master-planned communities of the past. Infill and adaptive reuse are important. “Development is turning inward,” Stapp says, noting that such developments are more sustainable and — because of their unique characteristics — more interesting, such as Sip Coffee on Indian School Road in Scottsdale that used to be a lube and oil change facility.

Especially hot for infill and adaptive reuse projects is the Warehouse District on the south side of Downtown Phoenix. In addition to housing Chase Field ballpark and the Phoenix Suns Arena, the area boasts many buildings built in the 1910s, ‘20s and ‘30s that served as wholesaling facilities for food and produce distribution for the Phoenix area. “There are a lot of unique buildings with great character,” Cassidy says. There are a lot that are empty and will need to go through considerable renovation in order to meet the safety requirements of today’s building codes, such as exits, handicap accessibility and sufficient power to run air conditioning, which buildings didn’t have in those days, but these are the kind of buildings that tech companies, software-writing companies and companies in the creative space — such as R&R Partners, an advertising, marketing, public relations firm that Cassidy, whose company renovated R&R’s new offices, calls “the poster child for adaptive reuse — are looking for. “It’s a unique character district that doesn’t exist anywhere else in Phoenix.”

Commercial real estate has also seen a phenomenal growth in locally owned, unique restaurant concepts. Weiner, in fact, says he’s seen more activity in boutique-type restaurants than anything else. Sam Fox, whom he names as big in this arena, is not the only one into redeveloping a small building or a house. Seventh Street in Phoenix now houses The Yard, a popular restaurant destination that was formerly a motorcycle garage and dealership, and Taco Guild, in a space converted from a church.

“And there’s some activity in office and retail — small, neighborhood centers,” Weiner says.

Retail, as the real estate truism goes, follows the rooftops. Rosenberg sees retail starting to fill up again, but — observing that a lot of big-box stores are going away to Amazon-type sales — he notes these are more service-type businesses such restaurants, salons and dry cleaners. Stapp points to redevelopment opportunities for retail around Scottsdale Fashion Square, and, in Central Phoenix, small, local, infill, “niche one-off projects” that, he says, “are geared mostly around food.”

A factor not to be overlooked is Valley Metro Light Rail. Says Fasulo, “Everywhere within one mile of the Light Rail are new, fun, hip urban businesses.” He notes Spectrum Mall (formerly Christown) is seeing a huge rise in new stores “because people are parking there and using the rail to get downtown.”

Industrial is showing a lot of development in big box and other multi-tenant projects “because there’s not a lot available,” Weiner says. Many parts of Metro Phoenix are experiencing this; areas named include the Southeast Valley, Southwest Valley, Deer Valley Airport area, Chandler’s Price Corridor and Gilbert.

Pointing to the strength of big-box construction and e-fulfillment sites in the West Valley, Desmond says he expects this type of activity to stay strong for the next 24–36 months. Amazon, alone, is a big driver of this, with 15–17 million square feet now and still growing. “Amazon will be the largest seller of clothing in the U.S. in the next 12 months, and it will need a place to store all that merchandise,” he says. Part of the West Valley’s attraction for this kind of occupant is its proximity to the freeway and Southern California. “In the Southeast Valley, there’s good activity but smaller users,” he says, noting 77 percent of leases in the first quarter of 2016 were less than 5,000 square feet. He sees industrial development as popular with lenders, “more so than spec office.”

But some office is hot, according to Rosenberg. “The difference is, it’s more call centers, needing more open space.” Observing that availability is getting tight, he expects to start seeing more development.

“Most new construction in Phoenix over the past few years is along Loop 101, from South Scottsdale into Tempe, beyond the 60 to the south loop of 202,” Desmond says. Vacancy overall, since the height of the recession in 2011, is down from 28.1 percent to 20.9 percent. Citing those figures, Desmond explains that, while that may still seem high, inventory has grown almost 5.5 percent, from 78.5 million to 82.7 million square feet. Plus, tenants are using space more densely, with per-person square footage dropping from 250 to 175 over the past 10–15 years. He points to SkySong as a great example of this construction, along with the Hayden Ferry area where the State Farm building dominates. “New construction is being absorbed, but older product is falling victim to that because new tenants want ‘creative space’ that, instead of having drop ceilings, is open to the vent work.”

Finding Funding

Thanks to the Light Rail, funding for construction is coming in from New York, Chicago, Seattle — “places that are major metros, and don’t consider you to be a major metropolitan area if you don’t have some sort of mass transportation system,” Fasulo says. In fact, he adds, “Bankers have been asking how close you are to light rail, bus stops — it’s a huge driver.” After all, people want it to be easy to get places. Which brings the discussion back to the impact of multifamily increasing the population density.

“Multifamily is the darling of the debt world,” Desmond says, noting these projects — and some types of industrial — seem to be the easiest to finance. “Fannie, Freddie, banks — loan-to-cost was 65 percent; now it’s down to 60 percent because absorption is so high.” Compared to industrial, office and retail properties, where leases are a minimum of three years and, for new construction, may be five to 10 years, apartment leases are six, nine, maybe 12 months. “So if there’s an uptick in rates, it’s easier for the owners to capture those increases,” he explains, also acknowledging the flip side of this, should the market stumble. But funding, he notes, is being done by entities such as Trammell Crowe and Alliance, which are knowledgeable about the Phoenix market but, being national in scope, are not solely reliant on what’s happening in Phoenix.

Cassidy, who’s seen strong funding for multifamily for the past three years, observes that lenders on new projects are getting more conservative, “to make sure multifamily is not hitting a bump.” He expects the current volume to taper off, retail and fill-in older office to pick up, and then multifamily to again have a growth spurt.

As far as availability of funding, Loeffler says, “There are so many funds full of money to invest in commercial real estate and so many people interested in investing in commercial real estate, I don’t see investment activity and growth slowing down in foreseeable future.” And that promising look holds for every element of the state’s commercial real estate market, as the population — a driver of growth — continues to increase.

There are many different ways to invest in real estate. Institutional investment is one, and Loeffler, observing that the stock market is not as attractive as it used to be, says, “Institutions are looking for a place to invest that is safe and has a better return, so there’s a huge rush of private equity funds and firms looking to invest in real estate.”

And millennials are having an impact in this arena. Currently the generation with the highest savings rate, they are beginning to be on the receiving end of the greatest transfer of wealth in history — and, when they inherit commercial real estate property, “they sell the building and invest in zero-energy condos or green condos, et cetera, that drive the economy forward.” Although they may keep their money in real estate, Loeffler explains, “changing the type [of real estate] is an activity that tends to have a positive effect on the economy.”

Buying a building, however, is not the only way to own a piece of the real estate market, Loeffler notes. The Jumpstart Our Business Startups (JOBS) Act, passed in 2012, opened the field to smaller investors. “It’s always been a major-investor game,” he says, “but now someone can invest $25,000–$50,000 in a hotel and have a great return and limited amount of risk.” And he believes this helps enable significant local real estate development.

Additionally, Loeffler notes, 1031s are at an all-time high. This is the section of the U.S. Internal Revenue Code that allows capital gains taxes to be deferred in certain specified real estate transactions. “One of the great things, from an economic driver standpoint, about 1031s is that money gets reinvested in new projects.” Emphasizing again that economic activity is created by the movement of money, he offers as illustration the situation of an owner selling a building he has had for 20 years and buying into a new one that he will improve. “Just that economic activity of money moving from one sector to another and allowing the owner to roll the money forward without having to pay taxes improves the community and creates jobs and builds the wealth of local investors.”

Where’s the Driver?

“Commercial real estate is not an economic driver,” Desmond states, explaining, “Commercial real estate is a reflection of all the other economic drivers we have here — population growth, employment growth, housing starts.” For example, as people move here, there’s an increased need for new houses, and then for more fulfillment centers for industry and office space for financial services. Sharing, “Our business impacts once all those things start to move in the right direction,” he notes that Maricopa Association of Governments predicts a 5-percent population growth annually over the next 20 years — more than doubling today’s population.

Cassidy cautions that there is a need to diversify Arizona’s economy, that we can’t rely solely on real estate growth. “But good real estate growth attracts a more diverse economy — they work together.”

Diversifying the economy, however, is not as simple as just identifying what businesses to woo. “The world today is in competition for employees, not for businesses,” Stapp says. So businesses are looking for places that are highly desirable for employees. Citing better schools, quality of life, social and physical health and wellness, and a robust arts and culture sector — much the same concerns driving multifamily development — he says, “These are what will dictate how fast we grow.”


A Sampling of Multifamily Developments

Fountainhead Residences at Fountainhead
Alameda Dr. & Priest Rd.

Ten years ago, multifamily developments were huge, sprawling complexes, and people never knew their neighbors, says Bryan Fasulo, who manages the property. Also, people tended to get a roommate to help afford a two-bedroom apartment. “Now, smaller is more desirable because they’re not doing double occupancy.” Residences at Fountainhead is designed with energy efficiency and green landscaping, which he says are “big with millennials” — as well as a lot of natural light while still being in an urban setting.

Optima Sonoran Village
Camelback Rd. & 68th St.

“The key is to create a 5-star resort setting and usable outdoor spaces,” says architect David Hovey Jr., vice president of Optima, Inc., attributing part of his projects’ success to residents being able to use their outdoor space as another room. “Shading devices and vertical landscaping creates shade and lowers the ambient temperature, and creates privacy for residents.” Hovey has been involved in Scottsdale’s adoption of the International Green Construction Code instead of LEED, which, he explains, “allows cities to pick the specifics that make the most sense and provide the most benefit.” Plus, the cities can then use their own inspectors, thus making the process more efficient.

Proxy 333
McKinley St. & 4th St.

“What’s most important to people in urban infill is time — they want everything close at hand, connect to the arts district, near lots of jobs,” says Dan Tilton, founder of Tilton Development Company, co-developer of Proxy 333. A code amendment allowed the two-level parking structure to not be submerged, thus putting the residential units at a better height to enjoy spectacular views of the area. Floorplans are designed to especially appeal to singles; the average square footage of all units (studios and two-bedroom/two-baths) is 623.

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