2024 is off to a great start, with interest rates finally stabilizing and a positive outlook returning to several segments of commercial real estate, particularly in the Phoenix metro area, which has very different trends than much of the rest of the nation. Below is a brief update on each of the key commercial real estate sectors:

Office
Current Vacancy Rate: 15.9%
Time on market to lease: 6.8 months
Average Market Rent: $29.40 PSF
Average Sales price: $217 PSF
Average Cap Rate: 8.13%

Phoenix area office space continues to be the weakest segment of the commercial real estate market. The overall vacancy rate of 15.9% is the highest seen since 2015. The availability of sublease space has also spiked sharply over the last 36 months. The hardest hit portion of the office segment is higher end Class A office space, where large companies held regional or national headquarters. The impact on smaller office spaces has not been as severe, and as a result, the overall asking rates for office space have not declined to match the climbing vacancy rates. Instead, landlords have gotten more flexible in their terms, including a greater willingness to sign shorter leases. Sales have also slowed by about 50% in 2023, primarily due to increased interest rates and lack of availability of financing options.

On the office sales side, the sales volume decreased by approximately 50% in 2023. The average year over year sales price per square foot declined by approximately 4.5%, and the average cap rate grew to 8.13%. Forecasts estimate that the cap rates will continue to climb through 2024 along with a declining sales price per square foot, before reversing the trend in 2025.

Medical Office
Medical Office space continues to be the sector of office space that is staying strong. The increased vacancy rates experienced in the overall office space market have not trickled into medical, as medical office users tend to be less mobile and far less impacted by changing economic conditions. Rates have consistently remained higher than those seen in the general office space. As a results, landlords have shown a great deal of willingness to convert traditional office space into medical office space, often times offering substantial TI allowances.

Industrial
Current Vacancy Rate: 6.6%
Time on market to lease: 3.9 months
Average Market Rent: $13.20 PSF
Average Sales price: $174 PSF
Average Cap Rate: 6.30%

The Phoenix area industrial market has overall shown signs of weaking, but as with most segments of the commercial real estate industry, the data has to be broken down into larger and smaller properties. The overall vacancy rate started to climb over the last several quarters. Vacancy rates among spaces of 100,000 SF or more have been the most impacted. Vacancy rates for spaces under 20,000 SF continue to be critically low. The biggest driver is the construction pipeline, where new projects consist almost entirely of large footprint warehouses. Very little construction is happening to address the pent-up demand in the smaller industrial segment. The forecast for industrial vacancy rates shows continued increase rates, but also shows increasing asking lease rates for the foreseeable future.

Sales volume in the industrial sector has followed the trends of other commercial real estate segments, with a decline of almost 50% from the year prior. The drivers of the decline are as expected, increased interest rates and a challenging lending environment. Because the spread between interest and cap rates has been so compressed, especially on 5 star investment properties, investors have started seeking value-add industrial properties where there is an opportunity to purchase at a higher cap rate, and then improve property conditions and rental rates. Forecasts project higher cap rates and lower sales prices PSF through 2024 before the trends reverse in early 2025.

Retail
Current Vacancy Rate: 4.6%
Time on market to lease: 12.2 months
Average Market Rent: $24.11 PSF
Average Sales price: $249 PSF
Average Cap Rate: 6.50%
The Phoenix area retail market continues its brisk pace, with vacancy rates currently sitting at an all-time low of 4.6%. That rate makes Phoenix the top retail market in the United States. Rates are even lower in some of the newly developing areas such as Queen Creek and N. Phoenix. New, larger format retail spaces are being filled by grocers while older large retail spaces are being repurposed into experiential retail, including pickleball, indoor gyms and other recreational opportunities. Smaller format spaces are being filled by food and beverage users. The availability of second-generation space in the food and beverage (restaurant) segment continues to be painfully low.

Despite the robust leasing activity, the sales volume of retail buildings is down 50% year over year, again due largely to increased interest rates. The biggest pullback has been on deals in excess of $10M, as those deals tend to be more reliant on financing than smaller transactions. That said, investors have still been actively purchasing smaller properties with national credit tenants at cap rates as low as 4%.
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