Office, Retail, Industrial & Multifamily: A Look at Commercial Real Estate as an Economic Measure

by RaeAnne Marsh

Marina-projectAs an economic indicator, commercial real estate touches those big indicators — money and employment. As the industry continues its comeback from the down days of the Great Recession, commercial real estate developers point to many positive factors supporting the current healthy slate of new projects.

Metro Phoenix is seeing some product types coming back more than others, of course. Tim Lawless, president of the Arizona chapter of commercial real estate trade association NAIOP, shares a view of the situation nationally that is impacting the growth we’re experiencing. “Interest rates and lending are less frozen now than five or six years ago,” he says. And commercial real estate has been able to move away from a reliance on just the REITs (real estate investment trusts), largely publicly traded companies that, a year ago, were the main sources of funding because “they would be able to self-fund rather than have to seek conventional funding.” Another industry challenge now left behind, Lawless says, is “the perception that large pension funds had red-lined Phoenix and were not going to invest in Class A buildings to the extent they had in the past.” Also improved in the past few years is employment, as business has absorbed losses “just north of 500,000 jobs.”

One of the strongest commercial segments is multifamily. Describing it as reactionary to job growth and population growth, John Cunningham, executive VP who heads the multifamily investment division for JLL in Phoenix, says multifamily has more than 93 percent occupancy. While there is still some single-family product being built in the suburbs, Cunningham says urban infill is the most abundant in the new construction pipeline. “The market is gravitating to urban-infill, higher-density, Class A projects that have parking attached,” he says. Broadstone, just east of the Esplanade on Camelback, was the first building in the new cycle of urban infill and high density. That was in 2013, and Cunningham says, “It exceeded expectations, including the developer’s.” But multifamily is not a market leader; rather, it is built where there is a true lifestyle component or lifestyle and jobs. This is why, he says, North Tempe — with significant job growth due to State Farm’s entrance to the community — and Old Town Scottsdale are getting higher-end product and achieving higher rents than ever before.

North Tempe and Old Town Scottsdale are also in demand for office — but there’s not much in the way of product, says John Pearson, a managing director and tenant rep expert with JLL. In fact, these areas are at record levels of low vacancy, which underscores the importance of not looking at broad average numbers. “All the submarkets have a completely different dynamic,” Pearson notes. “Phoenix is a 22-percent-vacant market, but there are pockets that are closer to 10 percent.”

Demand is for large square-footage that can house operations with a large work force of 300 to 1,000, such as call centers, and the development must also allow for parking at six spaces per 1,000 square feet. Liberty Trust’s 1-million-square-foot, Class A development on Rio Salado at Priest is “leasing as fast as Liberty can build it,” Pearson says. But it’s not the dense, urban environment that Millennials want, and, with the trending growth in technology and back office operations, Millennials is the work force these types of companies are particularly interested in. Parking is the issue holding back office development in the otherwise attractive environment of Old Town Scottsdale.

Submarkets

Marina Heights hits the sweet spot for urban, with a proximity to light rail that mitigates the need for extensive parking. Craig Henig, senior managing director of the CBRE Phoenix office, describes this project at Tempe Town Lake adjacent to ASU as “the catalyst for post-recession development in this urban submarket.” Phase I of the more than 2-million-square-foot, 20-acre project is expected to be completed in fall of this year, and its impact has also been building. Says Henig, “In addition to this major mixed-use development that will be home to a major regional headquarters for State Farm, development along and near Tempe Town Lake has exploded.” Liberty Center at Rio Salado is part of this. Other big projects include the neighboring Hayden Ferry III, which will deliver more than 250,000 square feet of Class A office product this September, and The Grand at Papago Park Center, which is proposed for 3.2 million square feet of mixed-use development and 1.8 million square feet of Class A office at Priest Drive and Washington Street.

Heidi Kimball, senior vice president with Sunbelt Holdings, which is a partner in the Marina Heights development, cites transit, transportation and utilities as important attributes of the infrastructure supporting the development. Also, she says, “The amenities of the lake have really caused Tempe to thrive in a big way.” And access to Arizona State University is another key element.

ASU, in fact, features large in the Valley’s commercial development picture. It is expected to come out soon with plans for The District, 330 acres in the middle of Tempe, that Kimball says “will drive development in Tempe for a long time.” She believes it will change the face of the community and bring new users, “especially in scenarios where we compete with other states.” Pluses will include prime location, work force and standard of living. But also critical, she notes, will be the state’s willingness to help court companies to come to Arizona.

Utilities and transportation infrastructure — providing good access to population centers and a highly educated work force — is also driving projects in the Southeast Valley and along the Loop 101, Kimball notes.

While beltways are attracting the Class A office, Lawless points out industrial follows a different pattern. “Industrial facilities want to be close to major highways on the way to major markets.” He sees the strength of warehouse and distribution operations continuing along the Long Beach connector Interstate 10 and good potential around Casa Grande when the proposed Interstate 8 to San Diego is built. However, he adds, “It depends on whether you transport by air or not.” The Goodyear and Mesa Gateway airports are drivers of industrial facilities, and he says, “It will be interesting to see who’s going to win 20 years from now.”

A seeming anomaly in terms of freeway convenience is the strength of office along the Camelback Corridor, from 23rd to 44th streets. In this area is clustered offices of developers, title companies and brokerage houses as well as significant multi-tenant buildings — much of the NAIOP membership representing commercial real estate for the entire state, Lawless notes. The determining factor here may be the ease of travel along east-west thoroughfares of Lincoln, Camelback and Indian School between this hub and affluent neighborhoods in Paradise Valley and Scottsdale. Current projects include a high-density development under construction at 44th Street and Camelback. “The Camelback Corridor is a prime place for a lot of activity,” Lawless says.

Light Rail

Light rail also drives a lot of location decisions. But developers tend to wait until there is certainty about the route, “until they see a clear funding source and construction on the way,” Kimball says. The certainty is the key factor, and it’s why developers see light rail as more significant than other types of public transportation. “Bus routes can change over time,” she says. “When you actually have hard infrastructure in the ground, that’s where you see value increasing and location decisions being made.”

The light rail has been helpful in Tempe and around the ballparks in downtown Phoenix, but it’s a different story in central and mid-Phoenix, Lawless points out. “It hasn’t saved some of those buildings because they’re not deemed as attractive.”

Other forces, however, are beginning to have an impact in that submarket. Christine Mackey, the City of Phoenix’s community and economic development director, has a vision for the area to be a tech hub. And, in fact, several local businesses are involved in that effort as some of the old warehouse buildings are undergoing adaptive reuse remodeling.

From a developer’s standpoint, though, it’s still a weak market for office. On the positive side, Lawless points out the relocation of Banner Health to that area provides an anchor to build around with potential for bio or healthcare synergy. But for now, Pearson says, “It hasn’t changed the dynamic that those are older buildings, not well parked, and pretty inefficient for today’s office users.”

Phoenix’s Central Avenue district has also not gained as much as expected from the light rail. Lawless notes there has been migration away from the central and midtown corridor, significant among the moves that of major law firm Fennemore Craig to the Camelback Corridor.

Out West

Demand for office product is picking up in the Northwest Valley after several years, according to Pearson. USAA, a major employer in the area that recently added to its own vast campus on Norterra north of Union Hills, will soon be breaking ground on the first phase of a 150,000-square-foot development. “It’s the first spec building in a long time,” Pearson notes.

The West Valley in general “does not have all the residential growth we’ve had in prior recoveries to drive ancillary office users,” Pearson says, explaining why it’s not a super-active market for office. But Kimball sees the West Valley’s potential in distribution space thanks to proximity to transportation services and a lower price of land. Over-flight, mostly due to Luke Air Force Base, limits the land use, and she notes this keeps down the cost of land. Pointing out that attraction depends on intended use, Kimball notes, “If you have great big land-use projects with relatively low density, you go out as far as you can.”

In fact, the West Valley is poised to see the next major wave of industrial and office/flex development, says CBRE’s Henig. Specifically, the newly opened interchange of Loop 303 and Interstate 10 is expected to be the site of major commercial development. Says Henig, “The combination of available land, existing labor and amenities made accessible by the new Loop 303 freeway have created the type of environment that will be the catalyst for explosive growth seen previously in other major transportation corridors, like North Scottsdale, Deer Valley and Chandler/Gilbert.”

Currently being developed in Goodyear is the PV303 Business Park, which Henig says “is expected to be ‘ground zero’ for that explosion of growth.” At build-out, the 1,600-acre master-planned business park will be one of the largest in the Southwest. Proposed buildings range in size from about 40,000 square feet to 2 million square feet. “Major corporate users have already started planting their flags,” Henig says, naming Dick’s Sporting Goods, SubZero, Bimbo Bakeries and REI.

The Story of the Basics: Food and Water

The Internet is having an impact on the retail segment of commercial real estate, according to John Reva, senior associate with the JLL-Phoenix retail team. The exception is the food industry, which saw $7.9 billion in sales last year. The driver in this market has shifted from fast food to quick-service restaurants (QSR), which, in turn, is being driven by the consumer. “It’s a better-informed consumer, wanting to know what’s in the food they eat and demanding better quality,” Reva explains. “But there’s a lack of adequate supply for these uses, and not many options open for the demand that’s out there.” Restauranteurs are turning to adaptive reuse, a hot trend Reva says was kicked off by Sam Fox’s creation of The Yard restaurant complex on 7th Street in mid-Phoenix. But noting an important factor, Reva says, “It’s driven by the uniqueness of the real estate.”

All development has an impact on water usage, and water is a resource that has lately been the center of a lot of attention. But it’s not a limiting factor for Metro Phoenix at the present time. Says Lawless, “We have a better water situation than other cities such Denver and Vegas.” The current allotment of Colorado River water was determined to support agrarian need, but Phoenix has been converting agrarian to red tile roofs, which, he points out, uses less water. Also crediting Arizona’s Department of Water Resources with doing a “phenomenal job of water banking,” he says, “We’re the envy of other cities.”

A big change in the marketplace has been investment in condos, notes Kimball. While a lot of multifamily projects are responding to the demand around the Tempe Town Lake development, Portland on the Park is the first condo project in downtown Phoenix. “All over town,” Kimball says, “a lot of commercial property is being developed as multifamily. It’s the highest and best use in a lot of cases.”

Speak Your Mind