The Phoenix Industrial Market transitioned into 2013 with positive indicators giving an outlook to a sustainable future. After two years of steady rebuilding of the market, not without its pitfalls, Q4 12 comes out solid with a strong positive net absorption, declining vacancy rates, and increased construction. With election year uncertainty behind us, the Phoenix CRE market has the chance to maintain this ground, brightening the mindset towards recovery from the lowest points of the recent recession. Metro Phoenix helped lead the way by adding the fifth-highest number of construction jobs in the nation, over 5,400 new construction jobs year-over-year as of November. Combined with the rapidly recovering housing market, it is only a matter of time for the positive momentum to impact the commercial market.

While 2012 began with a negative net absorption, the market quickly recovered from this stumble, which turned out to be the only negative net absorption posted in 11 months. The second quarter finished with close to 2.5 million SF of positive absorption. Continuing the trend at 1,956,473 SF absorbed, Q4 helped end 2012 on a positive note. While the 2012 year-end total of 4,994,590 SF was down over 1.5 million SF from the previous year, 2013 appears to continue the momentum of positive net absorption occurring during the last 2 years. Each of the five industrial submarket clusters posted positive absorption numbers, with the Southeast Valley headlining with over a 1 million SF absorbed.

In addition to the prolonged positive absorption run, vacancy continues its steady decline. With a similar vacancy rate not seen in the Phoenix industrial sector since midyear 2008, Q4 12 ended the year with a rate of 12.7%, a long way down from the 17% vacancy rates seen at the beginning of 2010. The Northwest Valley led the Phoenix market with the lowest vacancy rate of 11.8%, while the Sky Harbor submarket showed the highest rate at 13.4%.

Industrial building completions for Q4 12 added just over 2 million SF, more than doubling the delivered square footage for the previous three quarters of the year. The year-end total of 2,894,298 SF is an approximate 1.8 million SF increase of delivered space over 2011. One of the most notable deliveries for the year occurred in the final quarter of 2012; 3740 S Signal Butte Rd, a 1,328,075 SF facility that is now over 45% occupied. In addition to delivered space, future deliveries look positive with 15 industrial projects totaling 5,375,404 SF under construction during the final quarter.

While these indicators show signs of the industrial market resurgence, areas for improvement remain. Rental rates held at $0.51 PSF for the third straight quarter. While overall more submarkets reversing their downward trend in rental rates, the Phoenix market still has hurdles to overcome until these rates return to pre-recession levels. While vacancy and absorption seem to show stamina, the rental rates remain stagnant.

As economic conditions settle throughout 2013, optimistic economic trends viewed in 2012 could begin to trickle down and show their effect on the CRE market. The largest lease transaction recorded in Q4 12 was a 164,486 SF lease at 2550 N Nevada St in Chandler for the i/o Data Center. The largest sale transactions for the quarter were all a part of larger portfolio sales; 7980-7990 W Buckeye was part of a $178 million, 13 state, 20 property portfolio sale to the Chicago based real estate investment firm Brennan Investment Group, while both 4201 N 45th Ave and 2555 N Nevada St were part of a $76 million, 3 property sale leaseback sold by the Hensley Beverage Company to Angelo, Gordon & Co., a privately-held registered investment advisor.

The Phoenix Industrial Market noticed moderate changes in the third quarter of 2012. There was a significant decrease in the square footage of absorbed space, still vacancy rates are heading in the right direction. With exports and manufacturing expanding throughout the US, there should be a continued increase in industrial space demand. In addition to this growth, there was a significant jump in new industrial construction starts this quarter. Construction and manufacturing jobs remained flat; the dismal level must make large strides to recover the more than 200,000 jobs lost during the crash.

644,000 SF of space was absorbed this quarter, down dramatically from the approximately 2.6 million square feet of space absorbed during the second quarter of 2012. Even though absorption decreased this quarter, it marks the tenth straight quarter of positive absorption. This decrease can be attributed to expected fluctuations as we pull out of the financial crisis. The largest increase in absorption was observed in the Northwest Valley submarket, which includes Glendale and Deer Valley, increasing by 24% to nearly 390,000 SF. Distribution related facilities noticed the largest declines; third quarter absorption for distribution industrial sites decreased from 915,100 SF to (221,787) SF. While the Southwest Valley lost traction this quarter recording (191,368) SF of absorbed space, the Southeast Valley showed improvement with a gain of approximately 450,000 SF.

In contrast to the decrease in absorbed space, vacancy rates showed signs of improvement. The vacancy rate for the third quarter inched down to 13.2% from 13.4% the previous quarter. Only distribution facilities showed an increase in vacancy rates, moving up 0.2% to 9.2% at the end of the third quarter. Across all submarkets, the vacancy rates maintained consistent levels. The lowest rate was noticed in the Northwest Valley submarket, with a 12.0% rate. Compared to the previous quarter, vacancy for manufacturing space declined .3% to 10.8%. This increased demand is likely affected by spending growth in the tech and defense sectors.

Lease transactions noticed a brief decline in square footage; activity was down 1.3 million SF compared to the previous quarter. On a year over year basis, the percent of occupancy increased from 86.9% to 88.2%. The two largest leasing transactions this quarter were both in the Tolleson market. A 276,336 SF lease at 10397 W Van Buren St signed by State Logistics Services, and a 238,450 SF lease signed by Communications Test Design Inc at 8602 W Buckeye Rd.

Rental rates in the Valley found minor increases, inching up to $.51 per SF ($6.17 annually), a 1.6% increase for the quarter. Landlords are hesitant to increase rates as the fiscal situation nationwide warrants risk adverse decisions from tenants looking to relocate.

There was no new space delivered in the third quarter but construction starts showed an increase. Projects undergoing construction increased this quarter to approximately 3.8 million SF, an increase of nearly 500,000 SF. The largest projects initiated were the First Solar Factory, a 1,200,000 SF building with 0% of its space pre-leased. Also started this quarter was FAB 42, an Intel Corp building with 1,000,000 SF that is 100% pre-leased.

Cap rates continued their descent, as rates trended down to 6.26%, from a previous 6.93%. That is significant improvement as the previous quarter saw rates drop 2%. The lower cap rates play to the theme of the quarter, positive but slight momentum. Across the nation, the results were mimicked, as cap rates trended down to 7.5% from 7.67% during the second quarter. There was a continuance of large scale industrial assets purchase. One such example was the 20-property industrial portfolio acquisition by Brennan Investment Group and Gatehouse Bank, acquired from AIC Ventures for $155 million. Increases in manufacturing activity and the continued expansion of our defense needs poise the industrial sector for heightened demand.

The Phoenix Industrial Market showed modest improvement over the previous quarter’s relatively weak progress. The figures pointing to positive momentum in the industrial sector evolve around the large amount of space that was absorbed, as well as the downward trend in vacancy. However, it should be noted that the vacancy rate for the second quarter of 2012 is still approximately 4% above historical norms. Phoenix metro employment growth is expected to sustain advances during the remainder of 2012, yet levels will be down 50% of pre-crisis levels, according to data from Moody’s Analytics.

Absorption figures through the second quarter marked a significant turnaround for the industrial market. Nearly 2.3 million square feet of space was absorbed this quarter compared to approximately 280,000 square feet absorbed in the first quarter of 2012. The strong activity this quarter sets the stage for achieving the improved forecast for the industrial sector in early 2012. Both distribution and warehouse properties experienced absorptioin growth with nearly 1 million square feet absorbed in each property type.

Lease transactions noticed a slight increase in square footage, bringing total square footage to 3.65 million during second quarter 2012, an addition of nearly 400,000 square feet. The three largest leasing transactions this quarter were all in the Southwest Sub-Market. Total Warehousing a provider of third party logistics, signed a 358,830 square foot lease at 435 S 59th Avenue in Phoenix, MiTek, a supplier of engineered products, entered into a 259,200 square foot lease at 7890 W Lincoln Street in Tolleson, and Exel, a supply chain and solutions provider, signed a 237,176 square foot lease at 7210 W Van Buren Street in Phoenix.

The Phoenix industrial vacancy rate decreased slightly dropping to 13.4% compared to 14.2% in the first quarter of 2012. Flex building space continues to have the highest vacancy rates, with vacancies at 21.5%. Warehouse space posted the lowest levels at approximately 12.5%. Forecasts suggest vacancy levels for warehouse space will continue diminishing through 2014. Manufacturing space had low, though improving, absorption numbers. We expect continued increases in demand for manufacturing space. Advances in technology are fueling spending for both the aerospace and defense industries, suggesting further investment in manufacturing space. One such example is the $5 billion investment by Intel to expand their facility in Chandler.

The analysis of the industrial market shows positive trends and modest growth prospects, albeit slow, identified by the increases in absorption across all property types, and the downward movement in vacancy rates. This improvement is not yet strong enough to support higher rents. Rental rates increased 0.8% over the previous quarter from an average of $.50 per square foot ($6.01 annually) to $.51 per square foot ($6.06 annually). As economic conditions continue to fluctuate and fuel uncertainty, landlords are choosing to maintain lower rental rates to attract tenants and fill their vacant space. Vacancy needs to drop significantly for the pricing power scales to shift from tenants to landlords.

Construction faced a mild compression. Delivered space decreased this quarter to approximately 327,000 square feet down from approximately 560,000 square feet delivered in the first quarter of 2012. There were no new construction starts in the second quarter however the start of the third quarter gave rise to approximately 3.3 million square feet of space under construction. According to Phoenix Business Journal, third quarter 2012 should yield construction of approximately 1,190,000 square feet of speculative building projects. The first project, Coldwater Depot will be developed as a cross dock distribution warehouse space. The 56-acre site is in the city Avondale, along Interstate 10 and 127th Ave. The first phase will build out around 600,000 square feet. The second project, Estrella Logistics Center, will be a 592,000 square foot distribution center. The 38.4-acre site is located in the city of Phoenix, serving as a speculative distribution center.

Cap rates trended down two percentage points this quarter, to 6.93% from 8.66%. This decrease suggests that there is an excess of capital to be deployed, a growing interest in industrial sector properties, and a limited supply of industrial space. Nationwide, significant industrial purchases totaled $1.9 billion, a 17% increase on a year-on-year basis, according to Real Capital Analytics. Large REIT’s increased their holding of industrial properties. Blackstone Real Estate Partners purchased a portfolio consisting of 65 industrial properties in the central US for $770 million. Large scale purchases such as this outline our perspective that the industrial market will continue to press forward with positive momentum, ultimately playing a major part in the recovery of Arizona’s economic health.