2011 was a year in which more of the region’s landlords, prospective sellers and lenders reset their expectations, coming to terms with the protracted timeline for economic recovery. Pricing–both for sale and for lease–followed suit, adjusting to current market conditions.
With a reliance on jobs and services, recovery in the office sector is expected to lag other types of commercial real estate. On a positive note, University of Arizona economic researchers report Tucson employment grew year-over-year. The leading sector for job growth was professional and business services including biotech, contributing to 2011 overall absorption exceeding 287,000 square feet (sf).
Migration and mobility have been constrained nationally by deflated home prices. Population mobility in 2011 was at its lowest level since tracking began in 1948. Lack of mobility has been evident in the Tucson office sector, as well.
Although market metrics improved only incrementally during 2011, consensus supports the belief that better days are ahead.
STABILITY IN STORE
Although fairly flat for the year, overall vacancy ticked down again and ended 2011 at 11.8%, 0.2% ahead of year-end 2010. While the downtown office market lost traction over the year (vacancy increased from 7.1% to 9.3%), positive absorption in the larger suburban market brought vacancy down to 12.4% from 13.0%. Significant absorption occurred in the midtown Williams Centre as the year closed.
Effective transaction rates, while significantly lower than quoted lease rates, have stabilized for most classes of office product, as landlords gradually capitulated to the reality brought on by multiple years of anemic demand. Interestingly, asking rates have only decreased 2% in the past year to an average of $18.60 per sf and are down 7.6% from their peak in 1Q 2008. Leases are effectively being written at 25% below peak asking rates.
As a positive glimmer, lease activity increased in the final months of the year, albeit at depressed rental rates with significant concessions invested to achieve stabilized occupancy or to justify a market lease rate. For-profit higher education and engineering firms have accounted for a share of new lease activity late in 2011, balancing some of the attrition experienced by the decimated not-for-profit office sector.
SALE MARKET CONTINUES TO LIMP
Except for distressed sales, pure investment transactions remain out of the realm of the current market. With an uptick in short sales and note sales, the transaction volume is more balanced between investor and user sales than in recent quarters. With lenders working hard not to take bad loans into inventory, fewer distressed sales have occurred than in other regions of the country, and the market clearing price continues to soften the comparables for the office market.
In the user market, we have identified numerous partially-completed development projects that are at a standstill given current conditions. Except for specialty uses, new construction cannot compete with rents in the existing inventory of for-lease projects. Despite these challenges, the depth of Tucson’s condo office development scenario pales in comparison to Greater Phoenix’s overbuilt market.
The medical office market remains stable, with momentum fueled by technology advances and the federal mandate for creation of Accountable Care Organizations (ACOs). Shifts to electronic medical records and other operating efficiencies create demand for newer, more efficient space and desire to co-locate with related practices and services.
EXPECTATIONS FOR 2012
With the Modern Streetcar infrastructure underway and the opening of Unisource’s 170,000 sf downtown headquarters, the future looks increasingly brighter for downtown Tucson.
Technology and other factors have pointed toward a shrinking office footprint nationally. Accordingly, speculative office demand will remain low to non-existent locally. Going forward, floor plans may have fewer square feet per office worker as libraries, paper files and private offices are phased out. That being said, demand for space to meet, gather and work collaboratively within the office environment is on the rise.
Where are the opportunities? We see pent up demand for interior space remodeling, given long-term deferral of capital improvements and upgrades to space. The multi-year, multi-mile Grant Road widening project will cause relocations and redevelopment opportunities. Finally, the charter school sector remains active, well-funded, and a continued source of demand, including new construction.
Photo credit: DowntownTucson.org