What is happening in the office market? Is the pandemic over?
Remember the days when people went to work every day? Then we found ourselves in the world of the pandemic and it seemed the world was frozen. The workplace had to adjust in order to keep business moving. This meant that if a worker could do their job from their home then they did. Even in industries that had long been industries where everybody comes to office and worked from their desk all day, it HAD to adjust to keep productivity moving forward. Well the post-pandemic effects are still here. People discovered that work does get done at home, business owners realized that the line-item expense of office space was inflated or unnecessary all together. Businesses found efficiencies out of necessity…AND THEY LIKED IT.
We want to share some data from Costar to bring the office market into perspective. The Phoenix office sector has yet to find its footing as the adoption of hybrid work environments has upended traditional market dynamics. Companies are reevaluating their space needs, and many have opted to downsize their footprint or close offices altogether. This has led to a significant pullback in demand for office space with eight of the last 10 quarters recording negative net absorption and early numbers the first quarter of 2023 indicate this streak will extend. As a result, the metro wide vacancy rate has been on a steady upward march, climbing from 11.4% in the 4th quarter of 2019 to 15.2% in April of 2023.
Recent weakness is most evident in the sublease market. Local office users are putting unnecessary square footage back on the market causing sublease availabilities to surge from an average of 2.1 million SF in the decade leading up to the pandemic to 7.4 million SF. Sublease space now represents 3.8% of the total Phoenix office inventory, one of the highest rates in the country. Tech companies that were in expansion mode during the pandemic, but have since announced layoffs, have been the first to relinquish space. Tempe and Chandler are feeling the brunt of the recent wave of sublease activity.
Overall, the Phoenix market has 7.4 million SF of space on the sublease market with these two high-growth East Valley submarkets combining to account for about 3 million SF of that total. Tech companies like PayPal and GoDaddy have 188,700 SF and 180,500 SF available for sublease, respectively, in Chandler. Additionally, Carvana, the struggling online auto retailer, has over 90,000 SF available across two buildings at Tempe’s Rio West project in addition to 268,000 SF at the former Apollo Corporate HQ near Sky Harbor Airport. DoorDash is downsizing its presence at The Grand II, listing 211,500 SF up for sublease, after signing on for 338,100 SF in November 2019.
One positive factor for the market’s outlook is the lack of supply. Development has slowed considerably in the past 24 months and new construction starts are minimal. The amount of space under construction is at its lowest level since 2013, mitigating the risk of a further supply-driven imbalance. About 1.3 million SF of office space is currently underway, accounting for just 0.7% of inventory, a fraction of the 1.6% seen at the national level.
Demand is strongest in the Camelback Corridor and Scottsdale Airpark submarkets. These areas are more expensive but also offer an attractive mix of restaurants, bars, and other retailers while being situated close to population centers. Additionally, the tenant base is more heavily weighted toward law, healthcare, real estate, and finance firms, which has kept it more insulated from the surge in sublease activity seen in other parts of the Valley. These types of companies are generally more reliant on their physical footprints and have been less willing to give up space. Additionally, the first phases of new ultra-high-end office parks opened their doors recently and have been met with strong tenant demand.
Healthy leasing activity at The Grove in Camelback Corridor and Cavasson in Scottsdale Airpark indicate that firms still value the physical office. Companies are willing to pay a premium to operate here in an effort to entice workers back to the office with an appealing workspace and amenity package in a desirable location. Additionally true throughout the valley is the fact that demand for smaller office suites remains higher. As people have become remote or hybrid workers, the average size that office users are seeking has become smaller.
Moving forward, the leasing environment will likely remain challenging over the near term. As leases for tenants who choose not to renew come due in the next 12 to 24 months, property owners will likely be met by a less accommodating climate. The modest construction pipeline will help avoid an exacerbation of current fundamentals, but higher vacancy is nevertheless expected in 2023.
