Office rent growth has slowed across most major U.S. markets in 2018, and Phoenix has not been an exception.
At the end of the third quarter of 2018, the average year-over-year rent growth for the Phoenix office market was about 3 percent. At the same point last year, year-over-year gains were around 4.6 percent, or 160 basis points higher. This marks the eighth time in the past nine quarters that year-over-year gains in office rent slowed from the previous quarter.
Despite the deceleration in office rent growth, Phoenix has more than tripled its own historical average for office rent growth and far outpaced the national average of 1.9 percent.
Nevertheless, the recent performance is a far cry from peak levels in 2015 to 2016, when average rents in the Phoenix office market were increasing by an average of more than 7 percent year-over-year.
This pattern is typical of an economic cycle entering its final stages. In most cycles, high-occupancy rates and slowing rent growth reflect an aging expansion. With more than 2.6 million square feet of net office absorption this year, Phoenix office occupancies stood at about 87 percent, or more than 200 basis points above their historical average, at the end of the third quarter of 2018.
At the same time, office rents in Phoenix still have some ground to make up before making a full recovery and reach the market levels from before the Great Recession. The average asking office rent in Phoenix is still more than 5 percent below its prerecession peak, not accounting for inflation, making it still attractive as an affordable office location.
Newer, high-end office space has largely driven metropolitan Phoenix’s string of robust rent growth since 2013. In that time, average rents in the higher-quality 4- and 5-Star buildings surged by more than 35 percent, compared to an average growth rate of about 23 percent in 3-Star properties.
Much of the demand for high-end space has come from corporate tenants searching for affordable options offering access to the region's large, talented workforce. The average office rent in Phoenix is roughly 30 percent less than the National Index, but the discount is even greater relative to West Coast markets.
Office rents in San Francisco are nearly triple those in Phoenix, and those in Los Angeles are about 50 percent higher.
Phoenix has continued to attract a number of corporate tenants this year. In June, financial firm Deloitte announced a lease of 102,000 square feet in Gilbert, Arizona, where it plans to eventually hire 2,500 employees as part of its expansion.
In September, India-based tech company Infosys announced plans to open a technology and innovation hub and create 1,000 jobs in Phoenix over the next five years. Infosys is still in the process of selecting a location for the new office.
Meanwhile, office development is on pace to slow for the third-consecutive year in Phoenix and net absorption is on track to outpace deliveries for the eighth consecutive year.
If those trends remain in place and corporations continue to drive demand for new, top-tier space, office landlords for this class of space may well be in position to push office rent growth higher compared to lower-quality, less-expensive office options in the market.
CoStar Market Insights provides a snapshot of recent real estate trends. The CoStar Market Analytics team monitors commercial and multifamily real estate across 390 metro areas, with a granular understanding of the projects, players and economic trends that move these markets. |