A Nuanced Analysis of Phoenix’s Industrial Market Boom

With the metro boasting dynamic speculative industrial development, Lee & Associates Arizona Principal Chris McClurg explains why developers favor certain submarkets of the city.

The industrial market in the U.S. is going through a boom period, as recent research from Lee & Associates shows. Core markets that dominate the industrial sector are seeing new Class A product being delivered at a fast pace, as demand for high-quality warehouse space is partly fueled by the rise of e-commerce, among other factors. There is currently about 325 million square feet of industrial space being developed nationwide. Strong demand is enabling more construction, while vacancy rates are hovering around 4.7 percent in the country, a much lower figure than a year ago. 

At the same time, smaller markets such as Phoenix, are experiencing a resurgence of investment in industrial product. The metro currently has 4.8 million square feet of industrial space under construction. The largest is TEN, a 1.1 million-square-foot distribution warehouse which broke ground in January. Among other developers, Prologis is also expanding its footprint with the I-17 Logistics Center, a 900,000-square-foot facility built on the site of a former concrete batch plant in the Sky Harbor market.

Chris McClurg, principal, Lee & Associates Arizona
Chris McClurg, principal, Lee & Associates Arizona

The same Lee & Associates report shows that over the course of a year, vacancies dropped from 9.4 percent to 7.3 percent across the metro, while asking rates slowly increased to an average of $7.2 per square foot. Some of the most coveted areas in Phoenix are Mesa, Chandler, Sky Harbour and the southeast part of the metro, where almost 3 million square feet of new industrial space has come online since the beginning of this year. Moreover, more than 3 million square feet of new industrial space is currently under construction in these areas combined. Commercial Property Executive reached out to Chris McClurg, principal at Lee & Associates Arizona, to touch on the particularities of Phoenix’s industrial market. 

Why are some submarkets seeing much more activity compared to others in metro Phoenix?

McClurg: The two submarkets of Chandler and Mesa, Ariz., continue to see new speculative construction based on user demand, abundant skilled labor and employment and the fact that this part of metro Phoenix has land available to develop. Most companies are aware that the employees prefer to live and work close by. Also, these two market areas have buildings that were constructed in the ‘80s and ‘90s, which have lower clear heights, inferior truck courts and less power. The new speculative construction has created a “flight to quality” effect for the tenants.

With most of the upcoming product being speculative construction, why are developers showing such confidence regarding these markets?

McClurg: Developers in the greater Phoenix market, in particular the Chandler and Mesa markets, are bullish with speculative construction. The vacancy rates are in the five percent range while absorption is strong in the industrial sector. The current market trends over the last eight to 10 quarters show absorption in the southeast valley—Chandler and Mesa—averaging around 300,000-400,000 square feet annually, with this last quarter boasting 900,000 square feet, including two large build-to-suit projects.

Rent has remained relatively stable throughout the second quarter of 2018, with only a very slight increase. Do you expect rates to rise once more product comes online and supply starts to catch up with demand?

McClurg: It is possible to see an increase in the rental rates. A few factors are involved in a possible rise in rental rates: Land cost continues to rise for developers as well as an increased cost in tenant improvements as developers build out from shell condition. We have experienced a gentle rise in rents over the last few years, but have not seen a “spike”.

The near-future forecast looks good. What about the long-term outlook? 

McClurg: The overall Phoenix market is very healthy with a vacancy factor of 7.3 percent—valley wide—with absorption over the last two quarters at 3.9 million square feet. In particular the Southeast valley—Tempe, Gilbert, Chandler and Mesa—vacancy for warehouse and general industrial is 6.9 percent vacant, with absorption over the last two quarters totaling 750,000 square feet. This being said, the current outlook is very bright for the market.

The long-term forecast also looks very bright for the Greater Phoenix market as well as the Chandler and Mesa markets specifically. The tenants’ appetite in last mile users, manufacturing, distribution, aerospace and tech, defense work and nutraceutical and medical create the market activity. The fact that Phoenix is a very desirable place to live and multiple universities provide abundant skilled labor continues to keep Phoenix on many developers’ radar.

Lastly, while some perceive Phoenix as having endless land opportunities, the fact is, especially in the Southeast valley, great sites are hard to find. Therefore, the developments that are planned or underway will have good lease-up activity with local, regional and national tenants. Our next assignment will be to repurpose or rebrand the older inferior product and locate a second tier of tenants to occupy those facilities.

Images courtesy of Lee & Associates Arizona