Who Has the Upper Hand in the Valley’s Office Market?

August 26, 2021

Real Estate Sign Showing Office Properties For Lease

Office space, as an asset class, will continue to be difficult to navigate for the foreseeable future and for every type of stakeholder. In recent blogs, we covered the challenges for office space in a WFH world as well as economic indicators such as the true vacancy rate and subleasing and direct leasing trends in office properties. Today, we’ll take a closer look at who has the upper hand in the current environment for landlords, tenants, buyers, and sellers.

Is Phoenix in a Landlord’s Market or a Tenant’s Market?

In many cases, tenants still have the upper hand in negotiations, including pandemic, force majeure and impossibility clauses. Notwithstanding, many landlords are holding firm, for now, with respect to rental rates, but are offering some concessions such as free rent, more tenant improvement (TI) allowances, etc. We believe that once lease renewals really hit (November and December 2021), tenants will have even more negotiability.

With vacancies still high, tenants can also afford to be choosier about the types of properties that make sense for them. As a result, Class A and B buildings are in a stronger position than older properties. Office amenities also rank high on the list, whether flexible meeting spaces, tricked-out technology setups, or enhanced indoor HVAC equipment to allay employee health concerns.

Nonetheless, some recent figures in the Phoenix market are trending in the favor of landlords, or at least showing signs of stabilization. In Q2 2021, office tenants committed to leasing about 2 million SF of space—that’s a 65% increase over Q2 2020, according to CoStar. While subleasing has increased dramatically over the past year, the pace has leveled off and should continue to do so.

Another factor in the favor of landlords is job growth, which could result in increased demand for office space. Although Arizona unemployment ticked up slightly to 6.8% in June, the state added nearly 38,000 seasonally adjusted jobs and could return to the pre-pandemic levels in October 2021. Owners targeting small businesses may be the biggest beneficiary, as Arizona led the nation in small business (under 50 employees) employment growth in July, up about 6%. https://www.bizjournals.com/phoenix/news/2021/08/04/arizona-tops-small-business-growth-in-july.html

Is It a Buyer’s Market or a Seller’s Market?

National investors perceive Phoenix as still offering relative value. Office cap rates have held stable, hovering near 7% over the past few years, and at 150-200 basis points above California markets, Golden State buyers looking for higher returns accounted for nearly one-quarter of deals over the past year. There have, however, been relatively few office investment transactions that have closed post-pandemic in the Greater Phoenix area. Looking forward, the trend towards shorter-term leases may also have a negative impact on office valuations and cap rates. 

Owner-occupant buyers are experiencing tough competition for now, as many business owners have not made decisions as to how they will occupy their buildings going forward. As a result, the inventory level for smaller, owner-occupied buildings is low, and these buildings are still commanding high prices.

Looking on the optimistic side, the first half of 2021 did see an increase in transactions in Phoenix, comparable to 2019 levels. Single tenant net-leased properties with high-quality tenants and medical offices (driven by population growth) have been the demand leaders.

A year ago, discussions often revolved around what the “new normal” was going to look like. With the arrival of vaccines and loosening of restrictions, many sectors have regained their footing. Office properties, which were among the hardest hit, still have a way to go before the prognosis is clear—particularly with uncertainties revolving around new COVID-19 variants. At a panel conducted by Trepp in June, the consensus was that “the pendulum may swing back to neutral” by January 2022. 

Contact R.O.I. Properties

R.O.I. Properties represent investors, owner-occupants, lenders, and fiduciaries in buying, selling, and leasing commercial real estate throughout the Greater Phoenix market and the state of Arizona. Whether you need help investing in properties (mainstream or distressed properties), we are full-service real estate brokers who handle all commercial asset classes. In addition, we serve as Fiduciaries through court appointments as Real Estate Special Commissioner/Special Master and REO broker. To put an expert advocate on your side, contact us at [email protected] or 602-319-1326.

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