In January 2020 (which, in some respects, seems like a century ago), the Arizona commercial real estate (CRE) market forecasts for the year were enthusiastic, if not downright bullish. Many predictions were on a par with one from Roland Murphy, director of research at ABI Multifamily, a brokerage and advisory services firm in Tempe.
“At this point in the market and cycle, Phoenix, literally, has everything,” Murphy noted at the beginning of the year. “We’re still highly affordable, have massive success in economic development across a range of job levels and industries, and are consistently modernizing and adapting our quality of life for the better.”
Murphy’s first-quarter assessment echoed what experts were then saying across the country: In general, the 2020 commercial real estate market was looking rosy. As Steve Larsen, Managing Director at the international brokerage firm JLL, put it, “People are optimistic about the current state of the industry and what appears to be a lot of runway ahead. I expect we’ll see more manufacturing and logistics requirements landing here, which will continue to keep us well balanced.”
A few weeks later, however, everything went dark. The global pandemic fell over the world like a shroud and everything changed. All bets were off. Any predictions—be they economic, cultural or otherwise—were forever altered.
"With 2020 having turned out better than expected here in Arizona, I think we’re in a position to build upon what we consider to be a fairly strong current market."
– Andrea Davis, Owner Andrea Davis Commercial Real Estate
In the turmoil that the pandemic has caused, a focus on commercial real estate is an important one, many economists agree. Commercial real estate, because it’s based in so many other components of the general economy—small business, retail, manufacturing, technology, tourism and residential—is often seen as a bellwether for the economy in general. If commercial real estate is predictably strong, it often bodes well for the economy.
And, interestingly, as time wore on last year, the commercial real estate situation in Arizona didn’t appear to be as dire as it was in other parts of the country. Several factors helped cushion the state from complete collapse.
For one thing, because of the first-quarter momentum the state had built up, Arizona’s economic downturn wasn’t nearly as severe as other states were registering. In fact, by early summer, some economic analysts were expressing cautious optimism.
Andrea Davis, a 20-year veteran of Arizona commercial real estate, noted that although tourism and the entertainment industries were hit hard, the state’s diversification in other business segments was helping keep Arizona commercial real estate investment afloat.
“Vacancy rates in all commercial real estate sectors were at an all-time low prior to pandemic,” she says. For comparison of the downturn, she notes that office vacancy rates across the greater Phoenix metro area were between 10 and 12 percent during the last economic downturn in 2008, and subsequently rose to 30 percent. Speaking in June, she said, “…amid the pandemic, my company projects office vacancy rates between 11 and 15 percent.”
Road to recovery
That cautiously optimistic view of Arizona commercial real estate—current and future—is shared by real estate commercial portfolio manager Jeff Melsek, who works nearly exclusively in underwriting and managing loans for the real estate banking group at National Bank of Arizona.
“We’re still positive about commercial real estate in Arizona,” he says. “There are a few sectors of the market—namely the hospitality and retail industries—that took a big hit in March through May, and they’re still struggling a bit to recover. Because of the lack of travel at that time, our hospitality and tourism industries took a pretty sizeable hit.
“The good news is that Arizona’s tourism and hospitality industries are recovering far more quickly than those in a lot of other states and municipalities across the country,” Melsek continues. One factor in that recovery is that Arizona is a drive-to destination.
“Because people from California, New Mexico, Utah or Colorado can get in their cars and drive here, we’ve recovered more rapidly than some of these other places that are predominantly air travel destinations,” he says.
“Our proximity to southern California and some of these major hubs, combined with the lower cost of doing business in Arizona, has helped significantly."
– Jeff Melsek, Real Estate Commercial Portfolio Manager, National Bank of Arizona
One commercial real estate segment that hasn’t appeared to struggle thus far has been Arizona’s industrial sector. It’s remained surprisingly strong throughout the year, Melsek notes.
“Our proximity to southern California and some of these major hubs, combined with the lower cost of doing business in Arizona, has helped significantly,” he says. “We have a lot of companies that are coming here as startups or relocations, mostly from southern California. The idea of setting themselves up in an industrial location right off Interstate 10, say, and being within a six to seven-hour drive to L.A. is an appealing scenario for a lot of these companies. The upshot, I would say, is that the pandemic did not affect this segment at all.”
Office culture shift
Another key commercial real estate market segment, office space, is a different entity and more difficult to gauge, Melsek admits.
“It’s a strange one,” he says. “I think right now we’re still waiting to measure how this pandemic affected the office market. Again, we’re cautiously optimistic, but the fact is that the pandemic has created an environment in which most everyone is working from home. So, what we’re trying to figure out is how the pandemic has changed the office culture.”
Melsek’s sense is that many companies will be downsizing—not in terms of their workforce, he explains, but rather their real estate footprint.
“I think we’re going to see renewed construction in office product, but it’s going to be smaller in dimension,” he predicts, adding that the renewal will occur with building projects on the outskirts of urban areas, rather than downtown in city centers. “I also think the days of projects involving 60-floor office buildings housing multiple companies are numbered. I believe that the idea of social distancing isn’t going away in the near future and, as such, it’s going to impact the nature of office construction, sales and leasing.”
Preparation is key
Business owners—especially those involved in these larger projects—are very astute people, Melsek says. And, as such, they realize that if a pandemic occurred once, it could do so again.
“I think we’re going to be seeing a lot of businesses preparing for this eventuality in the future, and they’re going to do that by reducing the size of their footprint and curtailing expenses in these big projects,” he notes.
Hitting precisely the same chord, Davis summarizes her own predictions for the short- and mid-term commercial real estate in the state.
“I suspect Arizona will come out of the pandemic above other major [areas] for reasons that include our geographic location, our ‘dry heat,’ [the] plethora of land for development, low building footprints, and nationwide stats that show we managed the outbreak well.
“Even so,” she cautions, “it’s important that companies use this time to focus on the next pandemic. Those companies that create a plan now with workspace, renegotiated rent terms and a readiness plan will come out ahead down the road.”
We don’t project to have a horrible 2021, Melsek adds. “With 2020 having turned out better than expected here in Arizona, I think we’re in a position to build upon what we consider to be a fairly strong current market. There’s still a lot of uncertainty, but right now we’re holding firm, and predicting a continuation of that strength into the new year.”
Story: Bruce Farr