The Phoenix office sector entered 2012 with soft but positive indicators. The working theme for the real estate industry in the final quarters of 2011 was the strong reporting of absorption taking hold. The third quarter reported increases nearing 885,000 square feet of absorbed space; that number is down to 501,307 square feet at the end of Q1 2012. We’ve observed white-collar office job growth spurring positive net absorption, while unemployment in the Metro Phoenix area decreased slowly this quarter to 8.7%, helping push the outlook toward a favorable year for office space.

There were varied differences in absorption between class and submarket strata. The worst performing submarket was Sky Harbor Class B property with negative absorption of (-158,813) square feet. On the other hand, the best performing submarkets were Downtown Phoenix Class B, and Northwest Valley Class B space, both absorbing over 300,000 square feet of space. There was a decline in absorption for the suburban markets, as this quarter reported around 202,000 square feet, compared to roughly 615,000 square feet in fourth quarter 2011. Net absorption totals will likely continue with positive figures, but strict lending conditions and slow job growth restrain full acceleration.

Despite some job growth, and a feeling of economic optimism, vacancy rates increased slightly up to 20.8%. We attribute this excess available space to downsizing in underperforming businesses, as well as the downfall in the total space absorbed. Property type did play a large role in the vacancy rate, while Class A space trended up to 23.1% from 20.7%, Class C space trended down to 13.3% from 21.5% across all submarkets. Part of this reported downfall is due to tenants scaling back expenditures, and favoring lower quality, lower priced office space. As we should see with the overall rise in vacant space, rental rates declined this quarter to $20.13. Occupancy rates were trending up from second quarter 2011, however first quarter 2012 noticed a slight decline in this momentum; rates fell .2% to 78.2%.

Construction projects accelerated as a total for Metro Phoenix; new construction increased from approximately 35,000 square feet to over 140,000 square feet, current projects under construction total close to 265,000 square feet. While this will be a great boost for business expansion opportunity, we saw total sale activity maintain similar levels, with a slight decrease from 33 to 32 transactions totaling $222,350,000 in volume; the median price for transactions was $120.41 per square foot. At the same time, leasing activity gained momentum with nearly 590 transactions recorded over first quarter 2012. One of the largest leasing transactions was 80,158 square feet of space signed by Rancho Solano Private School at 9180 E Via De Ventura, as well as 70,000 square feet of space at 1500 N Priest Dr signed by IPOWER. The leading sale transaction was an $86,000,000 purchase by Parkway Properties of 299,540 square feet of space, the Hayden Ferry Lakeside II project.

Cap rates were seen trending down for the office sector to 7.91% from 8.89%. Office space gave way to a peak of 12% cap rates in 2011. The movement down supports the positive absorption data seen across both Class A and Class B space. As investors look to higher quality properties, and with interest rates remaining low, cap rates should remain at current levels through 2012.