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Tuesday, September 7, 2010 |
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| Third Quarter Tucson Industrial Market Update |
By Stephen Cohen, Principal, PICOR |
TREND REPORT, NOV 09 |
November 4, 2009
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The Tucson industrial real estate market has seen a downturn, but we should be thankful that several factors have kept this from being as catastrophic as seen in most other major markets in the U.S. Because of our proximity to Phoenix (where 75% of the state’s residents reside and the distribution center for the state is located) and size of our market, we did not see the depth of new development in the mid 2000’s that many markets experienced. The construction tap was turned off as soon as the market saw a downturn, as opposed to the continued new development in other cities that produced many large, unoccupied buildings on the market today. And with the I-10 reconstruction project and border development, public sector spending was disproportionately high in our area during the past two years, propping up some sectors of our industrial market. With Raytheon as our largest private manufacturing employer, and some depth to our defense supplier market, again, government spending has helped us weather this storm.
Make no mistake, the tenants in our industrial buildings have had a rough time, as the local homebuilding market and national and international economy suffered. But, unlike the late 1980’s and early 1990’s, owners of industrial property here are much better off than those of that earlier period. Between 1989 and 1994, 75% of the multi-tenant industrial buildings in Tucson were lost to lenders, and resold at $10 to $15 per square foot. We have not seen foreclosures in this market, and, while values have fallen due to lower occupancies, lower rents and the lack of available capital pushing required returns up, the drop is in the 15% to 20% range from the all-time high in valuations seen in the mid-2000’s. Even properties where owners were desperate to sell after a business failure offered discounts in ranges of value that were more than 50% of replacement cost.
While the third quarter appears to have ushered in a slight improvement in leasing activity, volume is still well below average or healthy standards. The most active industry sectors apparent in the lease market include logistics, health care, and education, with construction-related firms, specifically, and small businesses, generally, hit the hardest. Lease rates have continued to tick down in consecutive quarters, driven downward by decreased demand. Vacancy rates had been increasing steadily, and while up in the third quarter, absorption seems to have slowed the velocity considerably. Vacancies climbed the most this quarter in smaller bay spaces, due in large part to the toll the economy has taken on small businesses.
On the sale side of the market, activity for both user and investor sales has been anemic. Most sellers have significant equity in their holdings, and can weather the downturn in occupancy and rents. Current ownership is extremely responsive to tenants whose leases are expiring, making concessions (rent reductions, tenant improvements, etc.) not seen recently as leases renew. With current cap rates, these owners would rather weather this storm than take the reduced sale price that could be achieved if the property was sold today.
The market for industrial land in Tucson has changed significantly over the past 25 years. In the early 1980s, the sale of the 13,000 acre Howard Hughes estate changed the market in Tucson from a severe shortage to a severe oversupply in a short period of time. This redistribution of many large parcels near the Tucson International Airport put over 3,000 acres of zoned, served land on the market in the area bound by I-10, I-19 and Los Reales Road, including Rita Ranch. With absorption levels of 100 acres per year at that time, coupled with the downturn in the economy from 1987 through 1995, the industrial land market was in a severe oversupply position during that entire period. Land prices plummeted, and lots in finished business parks fell below $1.50 per square foot in most areas.
Tucson recovered in the late 1990s. Business park land prices in the northwest areas began to increase, from $2.75 per square foot in the early 2000s, to $4.00 per square foot by 2003, to $6.00 - $8.00 per square foot in the northwest areas today for interior business park lots between 2 and 10 acres. Land prices in the south areas remained stagnant during that period, as late as 2005 lots in quality business parks near Palo Verde and I-10 were still selling for $3.00 per square foot or less.
Since the third quarter of 2002 through the third quarter of 2007, we had positive net absorption of industrial space in Tucson measured each six month period, totaling almost 3 million square feet during that five years. The vacancy rate in all industrial buildings in Tucson at the end of the third quarter, 2007 was 5.1%, a very healthy market for new development.
A great deal of land in the south areas that was planned for industrial use was downzoned in the early 2000s, as land owners took advantage of the strength in the residential market. We began to realize that things were changing in 2006, when it was apparent that business park lot prices were increasing down south. The level of absorption was steady until 2008, when the downturn in the economy and availability of existing inventory increases made new construction a poor choice for space needs.
Prices of business park lots increased steadily during that period, from an average of $2.32 per square foot in 2005 to $4.10 per square foot in 2007. Land owners in the Tucson International Airport environs realized that the competition was limited, and began to raise asking prices during that period. Looking at the current supply, there are about 300 acres of business park lots in the four primary industrial areas in Tucson, which is a little over a one year supply when our economy returns to a level that will support new development. With a two to three year entitlement period, a shortage of industrial land could push prices significantly higher when our economy returns to its former health and prosperity.
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