Valley office space struggling for tenants | Restaurants

Despite gloomy – and in some cases, alarming – forecasts of a meltdown in the commercial real estate market, the Valley is nowhere near Armageddon, according to a recent report by a major player in that arena.

But some signs of distress appeared in Transwestern Real Estate Services’ report on third quarter performance in the Valley’s office market.

“Buyers and sellers continue to be at odds on pricing, with neither side wanting to make concessions to get deals over the finish line,” Transwestern said. “With tighter lending and unfriendly interest rates, investment activity continued to be incredibly stifled in Q3.”

Deals are still being made for office buildings in the Valley – most recently last week in Scottsdale, where Providence Real Estate Group paid $26.5 million to New York Life Insurance for a 141,534-square-foot office building, according to Valley real estate tracker vizzda.com. The three-story property, on just under 7 acres, was built in 2004.

“The good news in Phoenix is that we are not yet seeing the distressed sales that every doomsday foreteller has been prognosticating for the past 18 months,” Transwestern said.

Doomsday predictions have flooded national media for the last six months as office space continues to take a beating because so many workers continue to work at home – and resist their employers’ requests to return.

However, commercial real estate investment company CRBE reported in August that “Two-thirds of all U.S. office buildings were more than 90% leased as of Q2 2023 – not far off from the 71% of all office buildings in pre-pandemic Q1 2020.

“While the overall U.S. office vacancy rate hit a 30-year-high of 18.2% in Q2, it is not indicative of the performance of most buildings,” it said. “Only 10% of all U.S. office buildings account for 80% of the occupancy losses between Q1 2020 and Q4 2022… These tend to be older buildings in downtown submarkets with relatively high crime rates and few surrounding amenities.”

Just after that report was released, John Fish, the head of a New York City area construction firm and former board chairman of the Federal Reserve Bank of Boston, told Fortune magazine the nation was seeing “almost 100 million square feet of vacant office spaces.

“It’s staggering,” he said. 

The bankruptcy filing earlier this month by WeWork, a coworking space provider,  was characterized as a major blow to office building owners.

“This is going to be a bloodbath” for the office sector,  George Schultze, founder of distressed asset investor Schultze Asset Management LLP, told Chief Investment Officer, a website that providing investment advice to large financial and other institutions.

That site said WeWork will be able to terminate dozens of leases in struggling cities especially on the West Coast, where vacancy rates like 34% in San Francisco are not uncommon.

Transwestern bases its quarterly reports on office and industrial space in the Valley by examining single tenant, multi-tenant and owner-user properties that are at least 10,000 square feet, excluding condo and medical office facilities and those properties owned and occupied by a government entity.

“Vacancy rates remain high, at 19.5% across the market, down a bit from last quarter,” it said of Valley office buildings, adding that “net absorption” fell precipitously from the third quarter of 2022 to the thirds quarter of this year.

Net absorption is the sum of square feet that became physically occupied, minus the sum of square feet that became physically vacant during a specific period.  

In the third quarter of 2022, Trans-western’s data showed that meant 90,500 square feet of office space in the Valley remained vacant. That number soared to 426,900 square feet in the third quarter of 2023, Transwestern’s data showed.

The report attributed the massive amount of empty space to a single major project in Tempe.

“Two large blocks of space totaling just under 390,000 square feet at Tempe’s Fountainhead Heights building park hit the market in Q3,” it said. “These spaces are currently under renovation and targeting Q1 2024 occupancy for incoming tenants.”

Transwestern said the Valley is home to 135,776,110 million square feet of office space in buildings with at least 10,000 square feet. Of the total, about a third is considered Class A space.

The report also took note of the third quarter’s economy overall, stating it “seems to have continued resistance to the recession rumors, so far” and suggesting that the Valley’s commercial real estate market has a bright future.

“FY 2023 was a record-breaking year for new international business prospects,” it said. “Much of the interest in Phoenix has been in the form of advanced manufacturing, but it will positively impact office demand down the road. 

“We expect that Phoenix will continue to command interest from international companies moving forward due to big corporate investments made over the past couple of years coupled with relatively low environmental risk, and a stable economy.”

But more immediately, the report said, new construction is taking a hit.

“Upheaval remained in the Q3 lending world, which seriously influenced the start of new construction,” Transwestern said. 

“The unpredictable nature of interest rates and tighter lending rules have made it challenging for office projects to move from the drawing board to actual construction. Additionally, continued resistance to traditional office structure means we’re in a bit of a stalemate. Everyone’s on the edge, waiting to see where the chips will fall in terms of compromising.”

Among nine key Valley submarkets, downtown Phoenix showed the highest vacancy, with over 4.6 million square feet of empty office space, followed by Scottsdale (3.5 million), Tempe (3.2 million), the Camelback Corridor (2.3 million). 

The overall vacancy rate was in Tempe, with 24.6%, the report said. Scottsdale’s vacancy rate of 17.4% was below the Valley-wide vacancy rate of 19.5%, according to Transwestern.

The vacancy rates were far higher for Class A space in the Valley – located in prestige buildings with prime locations and above-average rent.

Valley-wide, Transwestern said, the vacancy rate for that kind of space was 29.6% last quarter and the area around Phoenix Sky Harbor Airport led all Valley submarkets with a 50% vacancy rate.

Scottsdale’s vacancy rate for Class A space was 21% – lower than the 27.9% vacancy rate in Tempe and the 26.8% for the rest of the East Valley.