Office Vacancy Below 15 Percent for First Time Since 2007

August 2, 2018

The Greater Phoenix office market has posted a strong second quarter, continuing a robust trend in net absorption and declining vacancy.  Net absorption for the second quarter exceeded 1.1 million square feet and year to date net absorption is up more than 60 percent over the first half of 2017.

 

Vacancy fell below 15 percent to just 14.7 percent at the end of June.  The rate is 140 basis points lower than a year ago and the lowest it has been since 2007.  Tenant demand is being fueled by a healthy pace of hiring, both by existing companies expanding in the Greater Phoenix market and those relocating or initiating new operations here.  Vacancy declines have been strongest in the Class B segment of the market, which accounts for more than half the total inventory. 

 

Tempe continues attracting substantial tenant activity, even as the submarket’s vacancy rate dipped into single digits.  Net absorption in Tempe totaled approximately 180,000 square feet in second quarter and more than 540,000 square feet for 2018 thus far. 

 

Rental rates for office space continue to rise, but at a relatively modest pace.  Asking rents at the end of second quarter averaged $24.69 per square foot, which is 2.8 percent higher than a year ago.  Rental rate increases have been particularly strong in the Camelback Corridor, where asking rates have risen 5.2 percent in the past year to $30.71 per square foot.  Class A properties in the area are commanding up to nearly $35 per square foot.

 

“The pace of rent increases appears to be lagging a bit, considering our impressive drops in vacancy,” says Pete O’Neil, research director for Colliers International in Greater Phoenix.  “This will not persist, as we anticipate delivery of some new spec projects in the coming quarters.  The average asking rents in those properties will be approximately 20 percent higher than current average asking rates in existing Class A buildings.”

 

Approximately 220,000 square feet of new product was completed in the second quarter, bringing the 2018 year to date total of new inventory to approximately 600,000 square feet.  This is a steep decline from last year, when nearly 1.5 million square feet was delivered in the first six months of 2017.  This will be just a short-term lull, as more than 2.9 million square feet of new office space is currently under construction. 

 

Investment activity heated up during the second quarter, with median prices rising and cap rates dipping slightly during the past three months.  Investors have witnessed improvement in market conditions and are responding with increased demand for properties.  The number of office sector sales transactions rose approximately 10 percent in the first half of 2018, as compared to the first half of 2017.  Prices are also trending higher. The median price for an office property sale rose to $195 per square foot during the past three months, bringing the year-to-date average price to $166 per square foot.  Cap rates averaged 6.9 percent during second quarter, just below the average for first quarter 2018.   Improving property fundamentals in the office sector are outweighing any drag in the investment market created by rising interest rates.

 

The momentum built in Greater Phoenix during second quarter is expected to extend throughout the second half of the year.  Net absorption is forecast to hit approximately three million square feet during 2018, fueled by continued job creation across a wide variety of office business sectors.  Several prominent corporate announcements heralded job growth ranging from Deloitte opening an operations center in Gilbert, to Nationwide Insurance building a regional headquarters in Scottsdale.  Each of these facilities is expected to create as many as 2,500 new jobs.  Vacancy in Greater Phoenix is expected to complete the year in the 14.4 percent range, which is 90 basis points below year-end 2017.  This would mark the eighth consecutive year of vacancy improvement. Rental rates will likely rise to above $25 per square foot by year-end, demonstrating a rise of more than 3.5 percent during 2018.

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