Drew Sampson on Phoenix's CRE market
Housing costs are the primary driver of inflation in Phoenix, said Sampson. Image courtesy of Avison Young

In the heart of the desert Southwest, Phoenix’s CRE market stands out due to its vibrant economy and burgeoning demographics. The recent influx of employment giants that promise significant job additions is further enticing in-migration from other parts of the country. But amidst this boom, opportunities and challenges converge, so understanding the local economic conditions is paramount to navigating the market’s complexities.

With more than 15 years of experience in the medical office, office and industrial sectors, Avison Young Vice President Drew Sampson knows firsthand the intricate relationship between Phoenix’s economic landscape and its commercial real estate investment dynamics. Here’s what he told Commercial Property Executive.

How are the local economic conditions today impacting Phoenix’s CRE market?

Sampson: The Phoenix economy is robust, boasting a low unemployment rate of 3.8 percent and a steady population growth of approximately 4.0 percent annually, with the latest U.S. Census in 2020 recording a population of 1.6 million. While national interest rates are high, their impact is primarily felt in the Phoenix housing market. With minimal anticipated cuts until the summer of 2024, investors are waiting for opportunities to enter the Phoenix market. Moreover, the recent entry of market giants such as TSMC and Amazon is expected to fuel significant job market growth, attracting further migration into the Valley.

However, the current housing rates are leading to heightened competition for rental apartments, exerting upward pressure on the multifamily market amid a shortage of supply. Despite challenges in the office market, other real estate sectors and industries in Phoenix are thriving.

Which sectors are growing exactly? Are there any particular trends you’ve noticed in the market?  

Sampson: The retail sector is experiencing rapid growth, a shortage of supply and high demand. The result is the lowest historic vacancy rate in 40 years recorded at 4.9 percent for direct spaces in our Q4 2023 Avison Young retail market report.

The industrial sector is witnessing extensive construction and deliveries, with a notable presence of warehouse/data centers and increased interest in entering the market. Medical offices are emerging as a bright spot in the office sector.

READ ALSO: How AI is Boosting the Data Center Market

A Yardi Matrix report from last year noted that inflation in Phoenix rose faster than at the national level. How has inflation evolved? Tell us a bit about its effects on CRE investment.

Sampson: According to a recent Bloomberg report, inflation in Phoenix has decreased from 13 percent in August 2022 to 2.2 percent last month, attributed to a moderation in housing costs. This creates an opportune moment for investment and attracts new movers into the market, especially with the influx of major players in the AI industry. Compared to other major cities, Phoenix offers a more affordable cost of living while providing abundant opportunities, making it an appealing destination.

You previously mentioned some of the major moves in the Phoenix CRE market. For example, Amazon leased a combined 2.2 million square feet across two facilities in Buckeye and Glendale. What signal does the presence of big brands in the metro send to the market?

Sampson: The commitment of large users absolutely signals confidence for the future in Phoenix not only on their behalf, but for other occupiers and related industries looking to move or expand in Phoenix. This level of activity/absorption also helps justify the amount of speculative development that has taken place in this market. The West Valley marketplace continues to be the beneficiary of companies comparing operational and logistics costs between California and the overall Phoenix industrial market.

The semiconductor sector is also growing in the metro. Among other investments, Amkor Technology recently received approval from the Peoria City Council to build a $2 billion advanced semiconductor packaging and test facility. Has Phoenix become a semiconductor hub?

Sampson: With the recent level of activity within the semiconductor sector, the Phoenix area has become a semiconductor hub. The challenge for these projects will be the availability of labor to construct and deliver these facilities. The TSMC project has already severely impacted access to various trades, specifically electrical, so general contractors and developers will need to figure out how to deal with the limited construction labor force and the impact it will have on the completion timelines for these projects.

Bolstered by government support and a growing 55+ population, the medical office sector has also been thriving. Can you expand on this demand surge?

Sampson: The growth of the medical office sector in Phoenix is fueled by several factors, including population growth, strong demographics and shifts in health-care delivery methods. Phoenix’s population has increased by over 200,000 residents since 2020, driven by job growth and migration. Additionally, the city has been known to be a retirement destination for aging populations, with retirees who require increasing medical care moving from colder weather states. Moreover, there’s a notable change in how medical care is administered, with more procedures being conducted on an outpatient basis. This shift is driving the demand for additional medical buildings beyond traditional hospitals, leading to an increased need for medical office building space.

The increase in medical office contrasts with the decline in traditional office. What should we expect in this direction?

Sampson: While traditional office building development has stalled due to declining leasing activity and rising vacancy rates exceeding 25 percent, the medical office sector tells a different story. The construction of several new hospitals necessitates additional MOBs. Pre-leasing activity in the medical space is strong, making finding medical office space challenging, particularly in the burgeoning areas of metro Phoenix.

As suburban populations expand, there are opportunities for new ground-up developments, particularly evident in the west and southeast valley. Despite this growth, Arizona ranks 12th in the country for states with the highest percentage of residents aged 65 and older, at 18.5 percent. However, there’s also an influx of younger migrants, particularly from California, alongside the increasing demand for high-tech employment, shaping the evolving landscape.

READ ALSO: Phoenix Office Deal Volume Among Largest in the Nation

How does the CRE market in Phoenix compare to other major U.S. cities in terms of investment opportunities and returns?

Sampson: The CRE market in Phoenix offers promising investment opportunities compared to other major cities, particularly in the industrial sector, as it is not overly saturated yet ripe for entry. However, there is substantial ongoing development in this sector. Being part of the Sun Belt markets, Phoenix experiences significant cyclical pressure, especially in logistics and multifamily properties. Notably, Phoenix stands out in the forefront of data center development, presenting additional potential for investors seeking exposure to this rapidly expanding sector.

What are some other considerations for investors looking to enter the Phoenix commercial real estate market?

Sampson: Investors interested in Phoenix’s CRE market should focus on the rapidly growing data center sector. Ranking second in total colocation power nationwide, it has seen commissioned power double to over 1.4 GW in 2023. With 3 GW of planned power in the pipeline and the expansion of colocation providers and hyperscale users like AWS, Microsoft and Google, this sector offers significant growth potential.

Distressed multifamily assets also present a substantial opportunity due to cyclical macroeconomic headwinds. The Phoenix MSA continues to show positive population growth, twice the national average. Elevated interest rates have reduced the pool of prospective homeowners, increasing demand for multifamily housing. Debt maturities in the region don’t exceed $10 billion annually until 2028, limiting the number of non-distressed assets entering the market. Despite a 34 percent year-over-year decrease in investment volume, private investors dominated Phoenix acquisitions in 2023, indicating their strong interest in this market.

Where will investment opportunities lie going forward?

Sampson: Phoenix’s commercial real estate landscape offers promising investment opportunities in sectors like data centers, life sciences—particularly in R&D with health-care applications and medical office properties. Major institutional investors are attracted to the data center sector, demonstrated by Brookfield’s $775 million acquisition of Cyxtera, which added 40 facilities to their portfolio, including several in Phoenix.

Life sciences, fueled by private equity and venture capital, hold significant growth and innovation potential. Medical office properties are a substantial investment opportunity, given Phoenix’s large retiree population and its reputation as a health-care destination with top-ranked institutions like Mayo Clinic-Arizona. Despite entry barriers, health care offers potential for long-term growth and returns.

The opportunistic multifamily sector is another promising investment area. With many investors having overpaid for assets in 2021 and 2022, and rising capital costs, distress is anticipated, providing opportunities to acquire assets below replacement cost for potentially high returns. Among these sectors, current market dynamics highlight opportunistic multifamily as a standout investment choice.

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