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A Time Machine Real Estate Tour

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During a meeting last week, one of our team members brought out a copy of The Real State newsletter from June 2014. It was like pulling the lever on a time machine to a decade ago—and an excellent reminder that, in every market, there will be challenges working through the system. In the current environment, inflation, interest rates, and low supply are the dominant themes in Phoenix housing.

Looking back to 2014, the pain from the Great Recession a few years earlier had started to fade, but housing demand was still weak and buyers had a slight negotiation edge after a balanced market earlier in the year. Median home prices had risen almost 78% since the lows of the housing crisis.

In 2014…

  • Mortgage rates were around 4%; currently, they remain at around 7%.
  • There were 22,000 active listings in Greater Phoenix; currently, there are about 16,000—and that represents an increase of 56% since last June. 
  • The monthly median sales price was $195,350; today, that number is $455,000.

Locked-in Homeowners, for Different Reasons

Oddly enough, like the current market, there was a sense that homeowners were locked in place. June 2014 had the lowest new listings since 2001. The reasons back in 2014, however, included: 1) a high percentage of homes being rented and providing cash flow to their investor-owners, who had no desire to sell and 2) homeowners who were waiting to sell because they were underwater—they owed more on their houses than they were worth. About 20.6% of homeowners were underwater at this point in 2014.

That’s a far cry from why homeowners are staying put now: persistent high interest rates and historic appreciation levels. According to real estate data firm Attom, more than half of Arizona homes are considered “equity rich,” meaning the owner holds at least 50% equity. That is significantly higher than the national average of 44%. In addition, the Attom report found the portion of mortgaged homes that were “seriously underwater” (i.e., loan balances are at least 25% more than estimated market value of the home) in Arizona is just 1.6%.

Midyear Pulse Check

Halfway through the year, the Greater Phoenix market has maintained balance, with demand 23% below normal and supply 25% below normal. It seems clear that rates still need to move closer to 6.5% for demand to improve in any meaningful way—although the Federal Reserve remains cagey about whether a rate cut might happen in September. 

If history is a guide, we should see supply begin to rise again in September. In the meantime, the number of price reductions is up 81%. More than 61% of supply listed between $300K-$1 million posted a price reduction over the past 4 weeks; last year that measure was 52% in June. 41% of active listings over $1 million included price cuts, up from 33% last year.

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Blast from the Past: CRE in 2014 vs. 2024

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During a recent meeting, one of our team members brought along the June 2014 issue of The Real State—and it served as a reminder as to how much change can occur in commercial real estate in the span of a decade. Today’s biggest concerns in CRE revolve around inflation, interest rates, and pressures on the office and multifamily markets. Back in 2014, however, memories were still fresh about the financial devastation of the Great Recession. The acute pains had mostly faded. Nationally, job numbers had rebounded, although Phoenix lagged the pack, recovering just over 60% of its lost jobs by then—sitting at 7.8% unemployment compared to the US average of 6.3%. The Federal Reserve had kept the Fed Funds Rate at zero since 2008, and the first 25 basis point increase wouldn’t occur till 2015. 

The headline story in our June 2014 newsletter was “Robust Activity in the Commercial Market! The commercial market is showing strong signs of stabilization, across all property classes …Investor activity/interest is robust.” While that was the 30,000-foot view of the market, a closer look at the details shows an interesting compare and contrast with today’s performance.

CRE Sector by Sector: 2014 vs. 2024

Office: At around 20%, office vacancy rates were technically not too different in 2014 from today. The push then, however, was to get numbers to hold below 20% with disciplined development, focusing on build-to-suit activity/development. The plan worked, with vacancies dropping to 12% by 2019…and then we all remember what happened in 2020 and the uncertainty that lies ahead. The average verified sales price for office sales in Q2 2014 was $143/SF, compared to today, at $162/SF. 

Retail: Five years after the 2008-2009 downturn, retail was still having a tough go, with vacancies around 10% and concerns about how online sales would impact brick-and-mortar locations. Few new developments hit the market during the next two years, other than infill redevelopments/repurposed projects. Aside from an upward blip during the pandemic, retail vacancies have been on a steady decline ever since—now at about 5%, making retail a surprise success story. The average verified sales price for retail sales in Q2 2014 was $138/SF, compared to today, at $213/SF.

Industrial: In 2014, the Greater Phoenix industrial market was described as “relatively strong” with vacancies at levels comparable to today, around 12%. The major difference between then and now, however, is the amount of new development that has surged into the market to meet demand. Whereas less than 8 million SF of industrial space was completed in 2014, developers have been exceeding 10 million SF a quarter for almost a year—with Phoenix ranking #1 in the nation for the largest active industrial pipeline. The average verified sales price for industrial sales in Q2 2014 was $69/SF, compared to today, at $154/SF.

Multifamily: As with the case in the other sectors, vacancies in multifamily were suppressed in 2014 due to relatively subdued development (about 5,000 units completed) and tight lending standards that kept would-be homeowners in the rental pool. As a cursory look around the Valley will confirm, the surge in development that began in 2020-2021 has continued—and as anticipated, driven vacancies higher to around 11%. The average price per unit for multifamily sales in Q2 2014 was $62,377 per unit, compared to today, at $279,492 per unit, which is down from market peak in early 2022.

There’s no such thing as a crystal ball in CRE. Looking at the perspective of a decade’s worth of economic ups and downs illustrates how the market evolves—with plenty of surprises and sometimes counterintuitive results.

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The Inflation Tail Wagging the Phoenix Housing Dog

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Much like the rest of the country, the residential housing market in Greater Phoenix is focused on where interest rates are headed. For the foreseeable future, it appears that inflation will be the tail wagging the Phoenix housing dog. 

In their May meeting, Federal Reserve officials remained concerned about persistently high levels of inflation in an economy that’s chugging along—with monthly data indicating goods and services prices are increasing at a pace well above the Fed’s 2% target. The result? The benchmark rate remains at a 23-year high—and the expectations from last year of multiple rate decreases now seem overly optimistic. The next Fed meeting occurs on June 12, and then they meet again on July 31. 

Until we experience a rate cut, you can plan on staying in our now-familiar pattern. Single family owners are locked into their current mortgages and properties, and buyers who need to buy will figure out a way to do so. The $2M-plus range is still seeing an astonishing number of all-cash transactions. Even with small increases in inventory, Phoenix remains short on the supply of homes, which is keeping pricing fairly steady. 

In many cases, deals require some level of creativity. When available, assumable loans are playing an interesting role in the market, since they may be far below current rates. One of our recent listings, for example, had an assumable VA loan at a rate of 2.25% on a $1.6 million property—which would be close to $5,000 monthly payments at today’s 7% rates. Of course, a VA loan has strict requirements: The owner of a VA property would lose their eligibility to get a VA loan on their next property if they sold to a non-veteran buyer. In any case the dramatic difference between rates illustrates how powerful assumption is within the single-family residential space, along with other creative solutions such as seller carryback financing and wraparound mortgages.

Phoenix Housing Market Overview

The Phoenix market’s current low levels of transactions make it tricky to extrapolate statistics, particularly in less populated areas of the Valley. With relatively few data points to draw on, each sale, purchase, or new listing may have an outsized effect on the metrics.

That said, for the third time in two years, the Greater Phoenix housing market has shifted into balance. April to May 2024, the supply-demand index dropped from 111.1 to 108.7, with supply up and demand essentially flat. The most affected properties in this type of market are the fixer-uppers: homes with extensive wear and tear, deferred maintenance, or in outdated condition. In Q1 2022, the market was so hot that these homes would fly off the market with little to no effort by the seller. By 2023 the market had cooled, so these homes would still sell, but their owners would take hits on price, repairs, and concessions to the buyer. As of May 2024, buyers had gained the advantage as supply continues to rise. Fixer-uppers should be priced to sell to investors, or have all necessary repairs and updates done prior to being listed—not to achieve a higher price but just to sell at all.

Some of the key Phoenix housing market statistics we’re watching as we head into summer:

  • Supply is up 48% over this time last year and continues to rise.
  • With 41,207 total new listings year-to-date, we are up 16.6% over last year—but that is still the second lowest count historically going back to 2001 (behind only 2023).
  • Total sales year-to-date are down 4.3% from last year and this May was 13.8% lower than last May.
  • The luxury market over $1.5M has outperformed, with the best April and May ever for sales volume: up 30% over last year and up 3% over the previous high of 2021.

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Monitoring the Market Signals in Phoenix Multifamily

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In March, we observed as one of our three CRE trends in Greater Phoenix that notices of trustees sales were starting to hit the market, after many months of speculation about inevitable distress. The newest data points from Real Capital Analytics confirm the reasons for concern. US apartment transactions have hit their lowest level since the pandemic: “Nearly 1,040 apartment properties changed hands at a value of $20.6 billion during 1st quarter 2024. The overall sales volume during the quarter was down 25% from 1st quarter 2023, while the number of properties trading hands was down 26% during the same period.”

Obviously, those are national figures, and Phoenix has its own dynamic. In fact, the largest multifamily transaction of the year just closed: Carter, a 365-unit luxury apartment community in downtown Scottsdale, sold for $161.4 million in cash. Our local observations are that properties are selling at a reasonable if slow pace, but at a 19-20% discount from where they were in late 2021 or early 2022, including Class A, B and C properties.

Inflation and Other Pressures on the Multifamily Market

Like all commercial classes, multifamily is also suffering some drag from persistently high interest rates. Higher rates not only increase what investors are paying on loans, they make it more difficult to generate cash flow and overall returns and can exert downward pressure on valuations. The Federal Reserve’s benchmark rate remains at a 23-year high—and the earlier statements of multiple rate decreases now appear overly optimistic, given that we remain well above the Fed’s 2% inflation target. 

On a related note, Starwood Real Estate Income Trust recently announced that it would be limiting investors’ monthly withdrawals to 0.33% of net asset value. (The previous limit was 2%.) About 48% of the REIT’s holdings are in market rate apartments—which is part of their reason for a “cash crunch.” In a shareholder letter in May, the company said, “We cannot recommend being an aggressive seller of real estate assets today given what we believe to be a near-bottom market with limited transaction volumes, and our belief that the real estate markets will improve.” More recently, Starwood Capital Group chairman and CEO Barry Sternlicht told CNBC that he expects the restrictions to last about six months—and, while criticizing Fed policy, noted that “The spreads are coming in, which means the markets are healing, the future’s getting clearer.”

Sternlicht also asserted that the move was designed to protect the 80% of investors who have never redeemed shares. Above all, it is an interesting signal that a significant number of investors would be unwilling to stick it out at the current point in time—and it will be instructive to see if other multifamily-heavy REITs follow suit.

Is It Time to Look for Multifamily Opportunities?

For multifamily investors seeking a silver lining, the current environment in the Valley presents an interesting time to buy quality assets—with the knowledge that we are likely not done with distress on the multifamily side. Contact the R.O.I. Properties team to learn more about multifamily investments: [email protected] or 602-319-1326.

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Are Residential Conversions the Answer to a Stagnant Office Market?

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About $820 billion in CRE loans are coming due in 2024 according to MSCI—about 20% of that linked to office properties. As noted in last month’s coverage of commercial real estate trends in Greater Phoenix, concerns about defaults are rising, but we are not yet seeing them in any significant number. (Indeed, in highly amenitized properties in the Camelback Corridor, we are seeing price improvement—a stark contrast, for example, to the weakness in the Central Avenue corridor.) While loans are coming due, lenders seem to be frozen, reminiscent of the “extend and pretend” days of the Great Recession that hit around 2010-2012 for CRE.

The office market in Greater Phoenix continues in a holding pattern, with everyone from property owners to investors waiting for the next shoe to drop. There is an understandable undercurrent of concern related to commercial office space and discussions about what can be done to reuse or repurpose these buildings, including converting offices to multifamily housing. This is not a local issue or conversation—it’s happening across the nation.

Making a Push for Office-to-Residential Conversions

Nationally, the number of office-to-residential conversions is up more than 350%, according to data from RentCafe. While that seems like a huge increase, it represents a tiny fraction of the overall multifamily market: just 55,300 units across the country. Phoenix ranked at #10 in the country as far as conversions, with 1,377 units projected in 2024. The highest-visibility project is Kierland Sky, which will add 420 units to the market.

Still, it is a trend in the early going—one that governments are supporting at a variety of levels. For example:

The Challenges of Converting Commercial to Residential Adaptive re-use has been a familiar strategy for years within the retail sector and even hotels. Converting commercial buildings to residential ones, however, comes with an array of challenges, including changes to structures, ventilation, plumbing and floor plans—not to mention the unknowns of rezoning. Add to those the recent issues at the One Camelback property, including the bankruptcy of the subcontractor and construction delays. Moreover, any developer who wants to ride the adaptive reuse trend in Phoenix will be facing serious competition, with a record supply of multifamily product going live in the coming months.

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Phoenix, Arizona Supply-Driven Housing Market Still Short on Supply

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Overview of the Arizona Home Supply in Phoenix

The Greater Phoenix residential market continues its snail’s pace. We remain short on supply, and occasional downward blips in interest rates have not moved demand—as noted last month, the Phoenix housing market is stuck in a loop. The anticipated interest rate reductions projected by the Federal Reserve may help, although mortgage companies have already built some of that expectation into their current interest rates. In addition, there is some speculation that we will be see only two rate cuts rather than three during the remainder of 2024.

With additional rate decreases, it should become easier for current homeowners to make a lateral move or a move up, which has been unappealing in the past year or so. With lower interest rates, more buyers may enter the market as well—although that could also affect prices. 

It is a supply-driven market, and until we see more homes on the market, we will experience more of the same. The lack of inventory gives buyers too few choices—unless they want to step up and pay the price. We are starting to see some pockets where buyers have more negotiability, such as Avondale, El Mirage, and portions of the East Valley, especially areas like Queen Creek where there are new builds. In the overall market, demand is strongest in the $1 million plus bracket, and even more above $2 million, because the buyers don’t necessarily need to borrow to purchase. Arcadia, Paradise Valley, and portions of Scottsdale and North Central remain in high demand and low supply. 

What’s the Impact of the NAR Settlement? Too Soon to Tell

We have been getting quite a few questions about the impact of the recent National Association of Realtors (NAR) settlement that has been all over the headlines. The short answer is that the settlement just came out, and no one really knows. In addition to the NAR, the various real estate associations are going to provide different types of guidance for agents, sellers, and buyers. 

As initially filed, the lawsuit was going to require that buyers have and pay their own broker. The fact of the matter is that sellers are going to be willing to pay a buyer’s broker to have the exposure on the AZ Multiple Listing Service and to make sure that their property gets shown. In addition, if a buyer needs to pay a commission, it may price them out of the market, particularly in entry-level and move-up housing. 

For the time being, we anticipate a lot more discussions about commissions and how they are allocated, and there is likely to be more negotiability. As you can imagine, this is a hot topic. Stay tuned for more details as the situation evolves, and follow the R.O.I. Properties Facebook page for the latest news on the Phoenix housing market.

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