Phoenix: Flight to Quality Office Space

Patrick Leiser's Avatar
By Patrick Leiser
On

Phoenix Unemployment Rate

2010
12.0%
2014
5.8%

By most metrics, the Greater Phoenix Area has rebounded from the latest recession. Four years ago, the unemployment rate in Phoenix peaked at 12%; by the end of 2014, it had fallen to 5.8%. In Scottsdale, where economic growth has been especially strong, the unemployment rate is just 4.4%. And with this growth, the city’s commercial real estate market has experienced an upswing.

According to Colliers of Greater Phoenix’s recent market report, this creation of jobs is “directly driving tenant demand for office space,” and has resulted in an office space price surge across the Greater Phoenix Area.

At 42Floors, we’ve collected data on this market, and have noticed some interesting trends. The price of office space is growing much faster in some parts of Phoenix than in others. Moreover, in this midst of this boom, some classes of office space are actually becoming less desirable, and thus less expensive.

In Phoenix, we’re seeing a “flight” to quality office space which is resulting in a booming Scottsdale commercial real estate market.

The Market

At the beginning of 2012, office space vacancy rates in the Phoenix metropolitan area and Scottsdale were nearly identical (about 22.5%). Today, thanks to the improving economy, vacancy rates in Phoenix have fallen to 18.8% — and in Scottsdale, these rates have fallen to 14.7%:

 

Commercial Real Estate Vacancy Rates in Scottsdale and Phoenix

In Scottsdale specifically, the low supply of vacant office space means that tenants need to pay top dollar for commercial real estate. While Scottsdale has traditionally been more expensive than the rest of the market, the city’s rent prices have increased at a much faster rate than the rest of Phoenix in the last two years:

Cost of Renting Scottsdale and Phoenix Office Space

We asked Pete O’Neil, the Research Manager at Colliers International in Greater Phoenix, why the Scottsdale commercial market in particular is surging so strongly. According to O’Neil:

“Phoenix has no true downtown, so it’s a question of which suburb you want to be in. In Scottsdale, especially Scottsdale South, we’ve seen it become a hotspot for businesses to relocate in the valley. Scottsdale has tremendous amenities, bars and restaurants, it’s really well located in the city. Businesses coming into town have said this is a great live/work play for their employees, so that has driven demand.”

But there is another important reason Scottsdale is leading the Phoenix commercial real estate market: during periods of economic growth, businesses upgrade their offices, and the nicest “Class A” buildings are predominantly in Scottsdale. Tenants are trading up — and that means moving to Scottsdale.

Scottsdale: Flight to Quality Office Space

Like all commercial real estate, Scottsdale office space is grouped into three categories by the Building Owners and Managers Association (BOMA): Class A, Class B, and Class C. As we will soon see, these different types of units are all faring differently in Scottsdale’s current market.

Class A units are typically large trophy buildings that offer more amenities than other buildings. According to BOMA, these units “have high quality standard finishes, state of the art systems, exceptional accessibility and a definite market presence.” Consequently, they also come with the highest rent prices.

Phoenix A Class Office Building
Phoenix A Class Office Building
Phoenix A Class Office Building
Phoenix A Class Office Building
Phoenix A Class Office Building

On the other end of the spectrum, Class C buildings are smaller and cheaper spaces (ie. converted warehouses, or buildings that are only a few stories tall). BOMA classifies these structures as “functional spaces at rents below the average for the area.” Often, they are 20 years or older, are situated in less desired locations, and in need of renovation work — and because of these traits, usually take the longest time to lease.

Phoenix C Class office building
Scottsdale C Class office space
Scottsdale C Class office space

Scottsdale Commercial Real Estate Vacancy Rates

In Scottsdale, the office space market is experiencing a rapid ‘flight to quality.’ This is reflected in our data: At the beginning of 2013, Class C (or the most affordable) spaces were in the highest demand, and nearly a quarter of Class A office space was empty. Today, Class A buildings are the most highly demanded spaces in the city:

Phoenix Rate Change
From Jan 2014 to Jan 2015

Class A
$0.96
/sqft/yr
Class C
$0.60
/sqft/yr

Since the economy has recovered, many companies have upgraded to better office spaces in Scottsdale, resulting in falling vacancy rates for the city’s top-of-the-line Class A buildings. Conversely, the demand for cheaper Class C space is on the decline, and more of these units are consequently becoming vacant.

As a result, Class A office space in Scottsdale has increased $0.96 per square foot in the last year, while Class C $/SF has dropped $0.60. That’s right: even as the real estate market heats up, economical Class C office space is getting cheaper.

 

Class A Office Space in Phoenix

Containing 34% of all Class A buildings in the Greater Phoenix Area, Scottsdale leads the region in high-end real estate:

Phoenix Class A Office Buildings

In 2013, the Phoenix metro constructed approximately 200,000 square feet of new Class A office space. The following year, Scottsdale alone added almost 200,000 square feet of Class A units, which amounted to nearly one-third of the total Class A supply added to the whole Phoenix metro in 2014.

This year (2015), Scottsdale already has 170,000 square feet of Class A product under construction. But, of the four Phoenix submarkets currently building Class A office towers, Scottsdale is practically tied for the least. Tempe has over one million square feet of new construction of Class A product — though not all of that will come to market, as a large swath of this is State Farm’s new office complex, Marina Heights.

Phoenix Class A Construction of Office Space

As more Class A supply is constructed in Tempe and Chandler, Scottsdale could face increased competition in the high-end office space market. But for now, things are looking rosy in the Scottsdale commercial real estate market.

Scottsdale’s real estate market is showing the signs of a full recovery from the crash it suffered in 2008. Tenants are coming to Scottsdale for the high-class buildings, live/work atmosphere, and all the amenities the area has to offer. And while Class C buildings are experiencing increased vacancy rates, the Class A buildings that Scottsdale is known for are booming.