Robust Blue-Collar Hiring Supporting Industrial Space Demand in Phoenix, Though Rents Decline

OVERVIEW

Phoenix, AZ – May 18, 2011 – (RealEstateRama) — In step with national economic growth, the outlook for the Phoenix industrial market continues to improve. Nationwide blue-collar sectors expanded by 1% over the past two quarters, the greatest six-month gain since mid-2006. Moreover, both manufacturing production and new factory orders increased for more than 21 consecutive months through March. The U.S. recovery has fueled a rebound in Phoenix blue-collar job growth and bolstered industrial space demand. Over the past six months, manual trades boosted head counts by 8,900 positions, or 2.7%. A measurable recovery remained absent only in the construction and the natural resources sectors, where job levels in these segments held steady rather than retreated during that time. The metro’s manufacturing and transportation and utilities sectors, in contrast, added 5,200 jobs, or growth of 3%, in the last two quarters. The recovery will gain momentum as the year progresses, with total U.S. employment predicted to expand by 1.9 m illion jobs in 2011, a 1.5% gain. In Phoenix, overall employment will increase by 41,000 positions, or 2.4%, including 11,000 blue-collar workers, representing a 3.2% rise.

Although net absorption in the first three months of this year lagged recent quarters, the 6.6 million square feet of industrial space absorbed over the past 12 months was on par with pre-recession levels. Vacancy is receding as a result, but still-elevated space availability is maintaining downward pressure on rental rates. Marketwide asking rents declined an average of 1.9% in the first quarter. Furthermore, lease deals were executed 15% to 30% below original asking rates and included significant allowances for tenant improvements and several months of free rent. At the submarket level, trends vary markedly. In the Airport submarket, for example, the rise in warehouse leasing could not offset the upswing of tenants migrating out of the submarket. Nevertheless, industrial vacancy is a metro-low 14.3% in the Sky Harbor area and rent declines were insufficient to whittle down the overall face rate from the $0.51 per square foot posted in the fourth quarter of 2010. Meanwhile, operational trends reversed in the Southwest submarket as owners aggressively reduced rents in order to secure quality tenants. Area wide occupancy, consequently, surged in the first quarter. Marketwide space demand will improve going forward, with vacancy anticipated to decline 140 basis points to 14% in 2011. Face rents will dip 3.8% to $0.50 per square foot this year, while ongoing use of leasing incentives will further depress effective rents.

Industrial price fluctuations will persist over the remainder of 2011, but the steepest decreases have already occurred. Local industrial property values peaked in mid 2007, in tandem with banks’ first efforts to tighten underwriting criteria, and the median price has since regressed 52% to $55 per square foot during the first quarter of this year. While the price is down 14% compared to the end of 2010, the drop is likely exaggerated due to steady distress acquisitions and fewer investment-grade and user sales. Additionally, a preliminary look at per-square-foot prices of industrial properties under contract at the end of March points to steadier values in the coming quarter.

ABSORPTION & EMPLOYMENT
Blue-collar and service industry job creation drove economic growth in the Phoenix metro over the past six months. Buoyed by 3,600 wholesale trade hires and 3,200 new transportation and utilities workers, manual trade fields expanded by a total of 8,900 positions, or 2.7%. Above-average working-class employment growth supported positive industrial net absorption of 2.2 million square feet over the past two quarters, including 789,200 square feet over the most recent three-month span. Hiring efforts will accelerate into the second half, pushing metro blue-collar employment to increase by a projected 11,000 jobs in 2011, a 3.2% rise. Consequently, industrial space users will augment leasing activity, leading to positive net absorption of more than 4.8 million square feet.

VACANCY
Healthy working-class hiring contributed to the fourth consecutive quarterly decline in metro vacancy, with the average rate falling 10 basis points during the first three months of 2011 to 15.3%. Although fewer lease deals underpinned a milder vacancy decrease compared to the second half of 2010, the rate is well below the year-ago peak of 17.1%. Operators in the Southwest submarket recorded a 60 basis point decrease in vacancy to 17.5% in the first quarter, led by stronger warehouse leasing activity in the Goodyear and Southwest North of Buckeye Road micromarkets. Elsewhere, vacancy fell 50 basis points to 14.5% in the Northeast submarket, with leasing of Scottsdale-area flex space accounting for more than 77,000 square feet of net absorption. In step with expectations for rising absorption, metrowide vacancy will retreat 140 basis points in 2011 to 14%.

RENTS
Despite falling vacancy, industrial space availability remains elevated in Phoenix. As a result, average asking rents declined 1.9% to $0.51 per square foot in the first quarter. Flex asking rents, meanwhile, fell 2.2% to $0.91 square foot. Annualized warehouse asking rents declined, but when averaged and converted to monthly rates, rents held at $0.46 per square foot. Rent cuts were pronounced in the Southwest submarket, however, despite a metro-leading 470,800 square feet of positive net absorption in the first quarter. This disconnect in trends is attributable to the number of regional and national tenants seeking area space. As prospective space users consider several properties and draw out lease negotiations, owners are accelerating rent reductions in order to lock down quality tenants. The building recovery will mitigate downward pressure on rates going forward, though asking rents will fall 3.8% in 2011 to $0.50 per square foot.

SALES & INVESTMENTS
Deal flow remained steady from the final quarter of last year through the early months of 2011, although the number of sales was roughly 45% below the peak levels recorded during late 2007. Price declines are generating interest from prospective buyers. So far this year, the median price for warehouse properties has regressed nearly 14% to $55 per square foot. Values for flex space also are falling, though the small number of sales makes quarter-over-quarter comparisons difficult. Nevertheless, first quarter flex sales prices hovered in the low-$60 per square foot to mid-$70 per square foot range. Industrial cap rates differ considerably based on location, size and asset quality. Initial yields for top-tier industrial product, for instance, have compressed to the 7% range, though the marketwide average is approximately 9.4%.

About Lee & Associates Arizona Research Division
In addition to celebrating 20 years of leadership excellence in commercial real estate in the Phoenix market, Lee & Associates is one of the largest national commercial real estate providers with regional expertise. Lee & Associates currently has more than 40 offices located throughout the nation. Clients of Lee & Associates Arizona enjoy a comprehensive range of specialized commercial real estate services including: industrial, office, retail property sales and leasing; real estate investment consulting, property acquisition and disposition; tenant representation and relocation, land assemblage. The Phoenix office of Lee & Associates was established in 1991 as the first office to open outside of California. The Lee & Associates model – empowering agents as o wners of the company – attracts industry-best real estate agents and has fueled the Phoenix office’s growth from 12 brokers in 1991 to nearly 40 brokers today.