Sporadic White-Collar Hiring Dampens Office Fundamentals, but Existing Tenant Base Steadying, Giving Back Less Space

Economy

Phoenix, AZ – November 16, 2011 – (RealEstateRama) — Although Phoenix office market fundamentals remain soft, improvements in other industries and property types will continue to seep into white-collar sectors and stimulate leasing. So far this year, metrowide employment levels have risen by 26,700 jobs through the end of the third quarter. Hiring within the blue-collar and education and health services sectors accounted for 14,700 positions. Layoffs in the professional and business services industries, however, drove overall office-using losses of 4,300 positions during that stretch. Despite the net loss of jobs, white-collar employers added workers during the second quarter and Phoenix’s business-friendly climate will further encourage relocations similar to Wal-Mart’s regional consolidation and AT Security Service’s complete move from California. While an immediate broad-based local recovery remains unlikely, incremental economic improvements will persists through year end. In 2011, total nonfarm employment levels will grow by 35,500 jobs, a 2.1% gain. Expectation for modest hiring in office-using segments during the fourth quarter will limit white-collar layoffs to 2,700 workers this year, a drop of 1%.

Fundamentals

Despite a recent dip in leasing, the third quarter marked the first period of positive net absorption since late 2010. The recent surge in absorption, a four-year high, is especially unique, given the mild decline in leasing activity during that span, as local tenants relinquished less space. Such resiliency lends optimism to the near-term outlook, yet a full-fledged up-turn in white-collar hiring remains necessary for continued positive absorption. Metrowide vacancy fell 40 basis points in the third quarter to 27.2%; however, asking rents dipped 1.3% to $21.26 per square foot. Fundamentals should steady over the remainder of the year. Vacancy is projected to slide 30 basis points to 26.9% in the fourth quarter, while quarterly rent reductions will ease to 0.6%, ending the year at $21.13 per square foot.

Sales

The local office investment market is the clearest indicator of normalizing office demand. Office sales have rebounded in each of the past two years, and institutional buyers are aggressively watching the market. While most of the major lease announcements are occurring in the Downtown and North Scottsdale submarkets and the Camelback and San Tan corridors, banner purchases by REITs year to date have focused on the Tempe/I-10 and Deer Valley/I-17 areas. Sales of properties occupied by top-notch tenants are closing with cap rates in the 6% to 7% range, though metrowide initial yields currently average 8.9%.

Employment & Absorption

A lack of confidence by local employers in the recovery has caused wide fluctuations across office-using job sectors and impeded space absorption. Despite the addition of jobs in the second quarter, white-collar payrolls have declined by 4,300 positions, or 1%, so far in 2011. Unsteady hiring caused a rise in vacancy during the first half of the year; however, positive net absorption of 318,000 square feet in the third quarter reduced year-to-date negative net absorption to 30,500 square feet. Employers’ outlooks are expected to improve modestly in the final months of 2011, which will maintain leasing and offset some early year layoffs. Net absorption will reach approximately 208,000 square feet for the year, and office-using employment sectors will contract by 2,700 jobs in 2011, a 0.6% loss.

Vacancy

Vacancy rates, like absorption and white-collar hiring, have fluctuated in recent quarters. Leasing has recovered measurably since the onset of the recession, yet much of the activity has been driven by large tenant relocations. While tenant shuffling is benefiting owners of Class A space, metrowide vacancy has been relatively unchanged, as leasing activity has barely outpaced tenant downsizing. The Phoenix office vacancy rate improved 40 basis points to 27.2% in the third quarter, but is down 10 basis points on a year-over-year basis. Class A vacancy receded 90 basis points from July to September to 27.5%, and is 220 basis points below year-ago levels. Steadier late-year hiring will cause fourth quarter vacancy to fall to 26.9%, 20 basis points under the average rate at the close of 2010.

Asking Rents

The wide availability of office space is maintaining downward pressure on rents, and free rent and tenant incentives remain significant tools for landlords to entice prospective tenants. Asking rents regressed 1.4% in the past six months to $21.26 per square foot and are now on par with rents last recorded in the third quarter of 2005. Operators of middle-tier space have been particularly aggressive in their efforts to attract space users; Class B rents have dipped 1.4% in the past two quarters to $19.24 per square foot, compared with a 1.1% decline to $21.26 per square foot among Class A properties. This year, Phoenix asking rents will recede a total of 3% to $21.13 per square foot.

Sales & Investment

Office sales and investment activity remain below historical levels, although it is clear that buyers are confident in the viability of the Phoenix office market. Sales velocity was mired in a prolonged trough for 2009 and the first half of 2010, but deal flow has since reignited, with both institutional and aggressive value-add investors deploying capital. The number of office sales surged 56% in the 12-month period ending in the third quarter, supported by plunging prices. During the same stretch, the median price declined approximately 15% to $92 per square foot. Although acquisition activity from REITs and large buyers will slow price declines, values will fluctuate for the foreseeable future due to elevated vacancy rates and soft revenues.

The Lee & Associates Arizona Research Division provides all facets of support to the Lee brokerage team. The Lee Research Division also regularly publishes quarterly research reports regarding national and local real estate and economic trends. For questions about publications, press releases or commercial real estate and economic data and trends, please contact David Delich at (602) 474-9512 or ddelich (at) leearizona (dot) com.

About Lee & Associates Arizona
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, multi-family, office and 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 owners 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