Office Winners and Losers - One Broker's Perspective
I am tired of the request for advice columns and maybe had a couple of hazy IPAs so you all get me your friendly Arizona Broker wanting to talk about where office is going to go over the next 3-5 years in Arizona assuming the economy does not get slapped down. For those of you that made it through that run-on sentence, I commend you. 

Here is what I am seeing in the Arizona market in general:

1) Multitenant Office space in general is stable. New core developments are getting consistent activity. Tenants are diverse and willing to sign long term leases as long as the space is as the kids would say Gucci. Are kids still saying that phrase? I do not know. It may be cheugy to say Gucci, but I digress.  The take away is prime and new space is getting rate and term. 

2) Functionally obsolete spaces are getting redeveloped. All of those call centers with all of that parking are getting turned to multifamily. The shitbox space in crummy parts of town are also getting turned into multifamily. If it is not getting turned to multifamily, it is turning to industrial. If it is not changing to something else, then the seller is unrealistic and will lose their shorts. 

3) Tenant improvement costs are brutal. Owners have underwritten their properties with a certain TIA package and with construction costing what it does not everyone can compete. Those with the capital are or have done spec suites and these have leased. Those that do not believe in the market are selling. For those of you that are still with me, 2019 construction prices had shell space in class A building at about $50/SF. These prices are now $75/SF or higher. 

4) Subleases are leasing. Subleases are moving 60% faster than the rest of the market. This holds true for spaces about 50K on down. For decent Class A space, most places are at a 5-10% discount and have furniture included on a shorter term.  This fits perfectly with what the majority of the market is looking for at this time. 

5) Construction of new office space is limited for various reasons, but there is very limited supply planned and coming on-line for one of the largest metro areas that is primed for significant growth over the next several years

Crystal Ball Time: Suburban Arizona Multitenant Office will do very well and see significant rental rate increases over the next cycle. The caveat is the buildings need to have some investment common areas to make them look like something from this century and there needs to be a decent conference room that can hold 50 people. 

But AZCREBROKER bro, the Arizona market is one of boom and bust and surely the groups holding the bag will lose everything yet again. First of all do not call me Shirley, and second of all the tenant diversity in the market is substantially different than previous cycles. The tenant mix prior to the great recession was primarily homebuilders, title, and call centers. Not seeing that this time around. The growth this time around is in the finance, healthcare, semiconductor, and start-ups. These groups are both local and new to market. 

There are two things I consider primary in what is attracting these groups to Arizona. The first is ASU which provides young talent available for companies to hire in a hyper competitive labor market. There are multiple internship programs and business externships where companies are effectively able to design their own courses which students take for credit. I am not saying that I would bet on an ASU student over an Ivy for pure horsepower but for a sales/support role or engineering role then why pay for one when you can get 2 or 3? The second primary reason is Arizona's infrastructure especially when it comes to data is rock solid. Arizona is one of the top 3 or 5 data center markets in the US because of the position of disaster recovery and cheap dirt. While water will always be a concern because it is a desert. What most people do not know is that other states come to us to learn water management. Hey California!  

Office in Phoenix is not dead. It is changing for certain, but groups are doing hybrid options which requires office space. Groups have shed space so hence the reference to common areas and conference rooms, but companies are still leasing space in quality areas and assets. To this point, sever of the Class A buildings I lease the occupancy has gone up and the usage has also gone up especially in the past quarter. I personally think that everyone got the latest version of Omicron at the Phoenix Open. To herd immunity!

So I guess what I am asking is: Do you all have any multi-tenent office buildings you want to sell in AZ? I got groups looking.
[{"id": "i2j2k4i", "text": "Thanks for the write up. One thing where I am at is that most tenants have opted for shorter term deals, kicking the can until things are clearer and they get a better idea of longer term space needs. Are you still seeing that or are companies more willing to take longer term leases. \n\nAnd if class a is where it is at, have rents for b and c space just plummeted or are those landlords in denial?", "replies": [{"id": "i2j6zmv", "text": "Class A space is seeing term. Class B is seeing activity on 2nd \"gem\" space and spec suites. Class c space is a crap shoot. All rents at least in my market are stable with class a rising. \n\nTenants are opting for shorter term deals when practical. Throw in a ton of expensive furniture and the numbers make a ton of sense. \n\nTenants I work with and other larger Fortune 500 groups look only for 3 year deals. Only in certain conditions will they consider longer deals and even then they need termination options. \n\nArizona may be more unique in that the average lease term is only about 4 years so the turn allows for a rapid market adjustment.", "replies": [], "depth": 2}], "depth": 1}, {"id": "i2jubp5", "text": "What do you think of what City Office REIT owns / has bought recently in Phoenix? Average, below average?\n\nhttps://cioreit.com/property-location/phoenix/", "replies": [{"id": "i2kzhqt", "text": "Generally their assets are rock solid. \n\nI personally like the Quad and 6991. The new amenity package they put in there is very well done for the project and the location. \n\nI do like Block 23 and 5090 for different reasons. \n\nOverall their portfolio should do really well.", "replies": [], "depth": 2}], "depth": 1}, {"id": "i2jus62", "text": "Seeing the near exact same thing in tenant and asset trends across the Australian east coast markets - flight to quality wins.. or \u201cGucci\u201d assets. No one wants their staff coming back to the office in absolute shit no matter the price.", "replies": [], "depth": 1}, {"id": "i2k52os", "text": "So it looks like Phoenix is roughly the 75th most expensive office submarket in the US alone. Not really a major player. But the flight to quality is an important trend.", "replies": [{"id": "i2kwyzf", "text": "How are you defining the expensive? Are you looking at rent or sale comps? Part of the attraction of Phoenix is that rent for Class A space is cheaper.", "replies": [], "depth": 2}], "depth": 1}, {"id": "i2kielh", "text": "Office market is dead. The national average is Only 40% of workers have returned to work. Places like Austin and Houston are the highest at 50%. Go check out kastle systems return to work metrics. Every tenant coming up for renewal will downsize. Less demand\u2026. Lower rents. Inflation pressure on TIs\u2026.defaults and foreclosures.", "replies": [{"id": "i2kywtd", "text": "I am familiar with Kastle Systems and their numbers. What I have not been able to find is this spaces accessed so 4 out of 10 offices were accessed this week or simply the total occupancy of the office at one point as in the max number of people in seats at one point in time? I would like to also see a breakdown based on size. Large bomber 100K SF+ are going to skew the numbers. State Farm, Nationwide, USAA for example all have their spaces up for sublease.  If you have more info that breaks down, would love to see it. \n\nWill 100% agree with you that single tenant office buildings are in a very precarious position. I will also agree with you that some buildings are going back to the bank - Blackrock in Chicago for example. Big bomber buildings in flyover states are zombies. I do not know what can really happen there. \n\nI have done renewals from both sides and some groups are staying the same, some are growing. The ones that downsized or are 100% work from home have already done so in my market. The subleases that come on line in the smaller size less than 10K SF move quickly. The best evidence I have to support that is there was positive net absorption in Q4.", "replies": [], "depth": 2}, {"id": "i2nxfyt", "text": "You sir deserve this upvote. I heard that 1/3 of commercial office space is currently occupied. Major firms are seeing the benefits of WFH. And as for Wall Street, remember they are a tiny fraction and not Main Street.\n\nAlso, if you google this title, \u201cSigns of stress deepen in the office real estate market,\u201d you\u2019ll go to an Axios article that says 60% vacancy may be real.", "replies": [{"id": "i2oacm3", "text": "My \"hot take\" focuses in on Arizona multitenant suburban office performing well over the next 3-5 years due to population growth spurring local organic company formation as well as attracting national groups for a satellite office. \n\nI 100% agree that major single tenant office buildings will experience stress. Large office buildings that are not currently multitenant will suffer as the numbers simply do not pencil when you have to put in $100/SF to build it out and then wait 5+ years till you hit a payback period (maybe) as tenants are simply not reaching the same size prior to Covid. \n\nThe majority of tenants I am seeing right now are sub 10k SF so owners need to chop up a 50K SF floorplate to accommodate. These are mostly local groups so you get a diversity of tenants which is great for overall stability of the AZ market. They are a mix of professional services and tech. \n\nWFH does have significant benefits and companies will have different policies. Right now I am seeing the majority of groups (granted these are self-selecting groups as I will not see firms that have a 100% remote policy) adopting a hybrid work model. Come in for 2 days - you chose the days with your team as we need to you interface with other departments. \n\nWFH policies are pushing the development of a hub and spoke model where people can come in or not to local offices. These footprints are typically smaller as there are normally less offices. That being said I am seeing groups plan for the possibility of high utilization just in case.", "replies": [], "depth": 3}, {"id": "i2r1oxn", "text": "Phoenix went from Q419 of 1.7m sf of sublet space to now 5.6M sf, vacancy up 300 basis points since Q4 2019. Phoenix had negative 700k in absorption. These are all from costar.", "replies": [], "depth": 3}], "depth": 2}], "depth": 1}]