Megan Creecy-Herman: Why does the Tempe submarket appear to be so hot right now?
Molly Carson: Tempe has done a wonderful job of positioning itself for success within the development realm. The abundance of amenities (restaurants, the Tempe Center for the Arts, Tempe Town Lake) within this walkable community are desirable from a work-and-live standpoint. Arizona State University remains a valuable draw from an employment standpoint. Simply put, Tempe has done an impeccable job of building a strong foundation and was ready to take advantage of the uptick in the market.
Tom Johnston: The confluence of our freeway system and the center of Metro Phoenix is in Tempe. Proximity to ASU, the airport and light rail make it advantageous for employers. It has become a real urban core where you can live, work and play.
Chuck Vogel: Tech companies want to locate in areas that are attractive to younger, tech-savvy workers. Arizona State University and recreational, cultural and retail amenities are draws for this cohort as is easy access via the Loops 101 and 202, Highway 60 and Interstate 10. Somewhat central locations (are ideal), especially for the east Valley and the nearby Phoenix Sky Harbor.
Megan Creecy-Herman: Tempe doesn’t “appear to be hot” it is hot. There are numerous reasons why tenants want to be in Tempe, one of which is its central location and the fact that it allows employers to pull talent from across the metro-plex considering that 60 percent of Phoenix Metro residents live within a 20-minute commute of Tempe. Also, its proximity and access to Sky Harbor Airport and proximity to the largest public university in the United States are substantial contributing factors.
Megan Creecy-Herman: There’s a lot of buzz around adaptive reuse and redevelopment of downtown spaces, particularly in Phoenix. What significance does this development have to the industry? What have been some of the most important projects?
Tom Johnston: As someone who grew up here and now lives downtown, it is refreshing to see all the redevelopment in our central core. As evidenced by housing price increases in central Phoenix, people want to be in an urban environment. They no longer want to drive 30 to 45 minutes to get somewhere. We have seen tremendous success with retail (particularly restaurants) and multi-family redevelopment. There is a lot of opportunity with infill sites for office redevelopment as well. Important projects include 7th Avenue and McDowell Road, 7th Street and Osborn Road, Central Avenue and Colter Street, and the Roosevelt Arts District.
Bob Mulhern: Phoenix is in the early stages of the adaptive reuse and redevelopment phase, in part because Phoenix is a newer city and in part because the area does not have as developed a downtown as some other markets. That is not to say that the city does not have opportunities for adaptive reuse, either with outdated inventory in the downtown/midtown area or some large blocks of vacant retail space. Education has been a driver of redevelopment in the downtown portion of Phoenix, and further expansion by Arizona State University and University of Arizona could be a source of future activity.
The pace of population growth is the wild card for adaptive reuse downtown. First, a larger residential presence would fuel development of retail properties to serve the population. Chef-driven restaurants, where properties are purchased, rehabbed and then re-opened would be an example of this. Also, an increase in the local population would make transit oriented development increasingly feasible and alleviate some of the strain associated with office parking ratios that are lower than the current market standard.
Megan Creecy-Herman: What is the current state of our Metro Phoenix industrial market?
Anthony Lydon: Metro Phoenix typically absorbs 3.5MSF to 4MSF of space annually. As we move through Q2 Metro Phoenix’s industrial market remains in flux. Larger, national/regional employers like Living Spaces, Winco Foods, Pepsi and others have selected Metro Phoenix to be their “West Coast solution” through the design-build process. These requirements tend to be larger and/or sophisticated “process” facilities that mandate signature construction. In fact, Metro Phoenix has almost 3MSF of industrial facilities currently under construction. In fact, almost two-thirds of “net” absorption is due to corporate design-build projects.
Conversely, the smaller (less than 50KSF) and larger (more than 200KSF) “existing building stock has yet to see a clear, sustained level of occupant demand.” The mid-sized (75KSF to 200KSF) market does show significant activity with several leases and user sales pending. Leading vertical sectors include high-technology, food and beverage, e-commerce and regional retail fulfillment. With a metro industrial vacancy rate at +/-12 percent versus the national average at 8 percent, the Valley has significant product runway to accommodate most occupant requirements.
Chuck Vogel: The Phoenix industrial market is very strong. Demand has been booming, fueled by e-commerce (Amazon), as well as traditional retailers and third-part logistics firms attracted by the area’s low costs, proximity to southern California ports and expanding local economy. Construction has picked up more quickly than we would have expected and led to an increase in warehouse vacancies last year despite robust demand. It is expected that demand will continue to accelerate, putting vacancies back on a downward path.
Megan Creecy-Herman: NAIOP conducted the industry’s first in depth look at e-commerce and its effect on industrial. Where does Arizona stand in preparedness for this shift, in existing and future developments?
Anthony Lydon: Due to the lack of sales tax consistency nationally, Metro Phoenix was an early winner in attracting e-commerce operations. In fact, Arizona contains almost 10MSF of e-commerce space with operators like Amazon, Target, Home Depot and others. Moving forward, facilities will provide a multichannel service: internet, store replenishment, catalog, etc. Older industrial properties will be hard-pressed to compete with higher clear heights, larger electrical services, higher auto parking needs, super flat floors and other building/site enhancements mandated by e-commerce employers.
Megan Creecy-Herman: What role does our proximity to the Inland Empire increasingly play in industrial development?
Anthony Lydon: Metro Phoenix offers an excellent location option for energy-centric, higher head count employers who seek a 25 to 40 percent operational cost saving while enjoying a deep, qualified workforce population at +/-4.5M. The +/-300MSF Inland Empire lies an hour from the ports of Long Beach and LA and is comprised of “West IE” and “East IE.” IE West has significant geographic and economic development barriers to entry. The IE East lies further from ports while being susceptible to California’s perceived over-regulated and cost environments. Accordingly, Metro Phoenix’s west Valley provides same-day access within the federal truck driving rules and regulations.
Bob Mulhern: In the short- to intermediate-term, proximity to the Inland Empire will play a minimal role in the Greater Phoenix industrial market. The Inland Empire’s status as a premier big-box industrial market is well-deserved, with approximately 70 percent of the market space in buildings of 100KSF and greater and 88 percent of its space built in the past 20 years. Current vacancy in the region is approximately 4 percent, which at first glance would suggest an opportunity to attract tenants that are unable to secure space in the Inland Empire, but developers have more than 15MSF of space under way to meet current and future demand. Tenant demand in Metro Phoenix is forecast to be fairly steady in 2014 and 2015, but tenant activity will likely stem from organic growth rather than spillover from the Inland Empire.
Megan Creecy-Herman: Is the Phoenix market ripe now for spec building? If so, where and what type of building?
Molly Carson: Yes, for responsible spec building. Tempe’s sub-5 percent, class-A vacancy and overall 10 percent office vacancy combined with very healthy activity in the class-B+ office product make for a market ripe for spec class-A office. The construction of Hayden Ferry Lakeside phase III allows Tempe to remain squarely competitive (with other markets such as Denver, Austin and California in general).
Keaton Merrell: For the right submarket and project, banks will finance spec buildings in the 60 to 65 percent of cost range.
Megan Creecy-Herman: There’s a lot of capital coming into the market right now. Where is this best invested? How is financing trending?
Molly Carson: Core assets in solid locations within primary and tertiary markets. The discipline to invest in core assets through upturns and downturns is almost always rewarded. As for financing, we are seeing institutions continue to be competing to invest/purchase/lend for the type of assets mentioned above. Lending for land is still challenging.
Steven Schwarz: Since we are selling a decent amount of office product right now, I would say that the best investments are in stabilized office. The reality is that there are certain office markets (certain pockets of north Scottsdale, like Chauncey, Tempe and Chandler) where rents are beginning to really move in a positive direction. We have sold some assets at sub-6 percent caps, but if full-service rents move from $20 to $25 that is really a 40 percent increase in net rents.
That cap rate becomes an 8.3 percent, which is a pretty
nice return on investment when interest rates are 4 to 5 percent. One of our strategies that applies to the local market is a focus on acquiring and developing general industrial in tightening markets. This asset type can take advantage of the current historically low interest rate environment, upside potential in rents and being bought at below replacement cost.
Chuck Vogel: There is no shortage of available debt and equity capital. Senior secured lenders still remain modestly levered. Projects with 30 to 40 percent equity work because there is plenty of capital available. If the 10-year treasuries tick up, there will be pressure for the senior secured lenders to take a bigger part of the capital stack if cap rates remain low.
Keaton Merrell: Financing is getting very aggressive. CMBS is back and quoting interest only for up to half of the loan term at 75 percent loan to value. Banks are getting aggressive as well.
Megan Creecy-Herman: What new trends are coming to our industry?
Steven Schwarz: In the short-term, the “densification” of office space and focus on creative space will continue. I love these companies saying they want their office to be a “home away from home.” If that’s the case, why are they cramming eight people in 400 SF? I doubt most people are sharing their bedroom with seven other people! The corporate world has realized that density saves the company money, so they have offset that negative by making the space fun and cool so people aren’t bothered by their lack of space. There are a lot of studies going on right now about productivity and morale related to office space. It’s still early, so I’m not sure anyone has the true answers at this point. Obviously, the continued adoption of technology such as the internet, smartphones and 3-D printing will change the supply chain and use of industrial space, as will the shifting energy landscape and globalization. These items will have a profound impact on the office environment on a rapid and constant basis for many years to come.
Anthony Lydon: The newest industrial trends include 3-D printing, robotics and open source hardware. 3-D printing deposits thin layers of plastics or metals atop the other fabricating a component part and/or finished good. This will have a profound impact on how companies manage their supply chains. For instance, half of typical pharmacy stock can be 3-D printed on-site. The cost of robotic equipment has dropped from +/-$250,000 per machine to $25,000 per machine. Amazon hopes to increase its pick-pack-ship robotics from 1,300 to 10,000 by end of 2014. Finally, open source hardware found in mechanical systems and networking equipment is available to all without reverse engineering need. This will compress the prototyping cycle time and move machine tools to the production line sooner, quicker and faster.
Chuck Vogel: It is becoming easier for the small investor to invest in institutional quality real estate through non-traded and exchange traded REITs. More investment products are coming available for investors that may offer liquidity and yield in the product types they are looking for. I expect you will see these kinds of investment vehicles continuing to grow. There is also an increasing disparity between credit and non-credit cap rates as the investor appetite continues to grow for credit opportunities, which is keeping the credit cap rates low