In the May issue of The Real State, we discussed the overall potential impact of interest rates on commercial real estate, including increased building and borrowing costs, heightened competition to deploy capital, and cap rates. The caveat is that inflation also affects investor returns, which requires keeping an eye on which asset classes may offer the best safehaven opportunities—regardless of what the Federal Reserve does with rates. As we close out the first half of 2022, here’s an overview of the current performance and outlook in the Greater Phoenix market:
Multifamily has been overbuilt for a considerable time, but it has not been impacted as much as anticipated. Sales volumes and prices have remained strong, and many smart multifamily owners are selling and achieving excellent returns even after owning less than a year. We are starting to see some cracks, however, with more properties hitting the market this year and an even larger influx of deliveries in the first half of 2022. (Just under 38,000 units are under construction, and over 26,000 are in some stage of planning.) The multifamily market has benefited from higher interest rates keeping people in the rental pool. While many ex-California homebuyers have ample cash, that’s not necessarily the case for everyone moving into Arizona. Multifamily developers are counting on that in-migration to absorb the extra units.
Office reported vacancies are lower than anticipated, at about 20%, but a walk through many office buildings with professional and financial service tenants might yield a physical occupation rate significantly lower/higher physical vacancy. Business owners are still bound by their leases—even if they’re not sure what to do with the space. Last year, employers/tenants kicked the can down the road with 1-year extensions, and landlords accommodated them in lieu of an outright termination. This year, at lease renewal time, many will be seeking to shrink their footprint— especially with the possibility of recession. That is likely to lead to the repurposing of office spaces, and we’re already seeing a trend towards smaller office spaces, in better locations with more highly amenitized buildings, a.k.a., the “flight to quality.” Building owners are retrofitting to get their tenants to renew, while employers will do whatever it takes to get employees back to the office.
Industrial has eclipsed multifamily as the favored investor asset. While demand continues to be strong, plus major initiatives for Arizona as a logistics hub, there is a considerable amount of new space being built. About 36.5 million SF is under construction, representing about 9.2% of total inventory, and a significant amount is speculative. While the market has had no trouble as yet absorbing industrial property, it will be interesting to see how the influx plays out.
Retail was among the most troubled asset classes during the pandemic, so it’s good to see a bit of a revival. In particular, investor interest has increased in neighborhood retail/multitenant retail centers. Pricing has increased and cap rates have remained low, which creates a lot of good opportunity. It’s important to note the major shift on what’s successful: tenants providing services versus products—so-called internet-resistant tenants.
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