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Phoeniz AZ Commercial Real Estate: "Off A Cliff"

At the wrong end of the boom cycle

By John Collins Rudolf Mar 24 2010
Tags: office space, Phoenix, Leisure Writing

Perhaps it was just a matter of time, but three years after this city’s complex emotions of housing crisis distilled on a single street housing market collapsed in a spectacular fashion, commercial real estate has followed it off the cliff.

The average price paid for office space in the Phoenix metro area tumbled more than 50 per cent last year, from $205 a sq ft in 2008 to $102 a sq ft in 2009, according to data compiled by Kammrath & Associates, a local real estate analysis firm. Retail and industrial space underwent similar declines.

“Prices are falling like a stone,” said Bob Kammrath, who has studied the commercial market in Phoenix since 1981. “I see them going lower.”

In a mirror image of the housing bubble, relaxed lending standards and a boom mentality prompted the construction of hundreds of offices, shopping centres, industrial buildings, hotels and apartments from 2005 to 2009 — about 86.5 million sq ft of new commercial space in all, according to research by CB Richard Ellis.

In 2006, when growth peaked, about 30 per cent of the Phoenix area’s economic output was tied to real estate and construction. So it was not long after the once white-hot housing market fell apart, in 2007, that the rest of the city’s economy stumbled, and hard. As jobs in construction and real estate dried up, and stock market losses curbed the relocation of retirees from the north, in-migration to the city radically slowed.

Commercial brokers blame a confluence of factors for the worst downturn in memory: rampant overbuilding, a national economic crisis, spiking unemployment and a near halt in population growth. The result is visible all over the city in the form of empty storefronts and “for lease” signs affixed to office buildings.

The worst-off of these projects were built in marginal locations on the outskirts of the metropolitan area, and stand completely empty months and even years after completion. “We’ve got some see-through shopping centres,” said David Wetta, senior vice president and managing director in the Phoenix office of the real estate brokerage Marcus & Millichap.

A handful of major developments throughout the metro area simply collapsed midconstruction and linger, half-built, as gloomy reminders of the sudden end of good times.

One such failure, the Hotel Monroe, sits in the heart of downtown Phoenix, just a few blocks from City Hall. Started in 2006, its plans were extravagant even by the bloated standards of the bubble era. The 144-room boutique hotel was to be housed in a rehabilitated 12-story Art Deco office building from the 1930s and would include opulent “Rock Star” suites, a five-star restaurant, a rooftop nightclub and 24-hour room service.

Construction began in 2007 but ground to a halt a year later when the project’s banker, Mortgages — for a short time, Arizona’s largest private lender — cut off financing, en route to its own bankruptcy. The hotel remains unfinished, with dark windows and a desolate mien; Grace Communities, its developer, was recently cited by the City of Phoenix for code violations including graffiti on exterior walls and trash and debris around the premises.

There, 13 investors will try to recoup $76.5 million in loans, though experts say the building is unlikely to fetch that amount.

Yet it is not just new commercial developments that are floundering. Older properties — in particular, those that sold at big premiums during the market run-up — are also struggling with rising vacancy rates, shrinking rent rolls and high debt loads.

A prime example is the Viad Corporate Center, a 24-story, 478,000-sq ft high-rise in midtown Phoenix, which was built in 1991 and bought for an estimated $105 million in 2006. Earlier this month, Bank of America filed a motion in court to appoint a receiver for the property, citing the failure of the building’s owner to stay current on a $65 million loan.

Commercial mortgages in Phoenix are souring at their highest rate in years: according to Foresight Analytics, a banking analysis firm, 5.3 per cent of commercial mortgages in the metro area were delinquent in the fourth quarter of 2009, up from 2.3 per cent at the same period in 2008.

“There’s more to go, just to get caught up with the current volume of defaulted loans,” said Matt Anderson, an analyst with Foresight Analytics.

High unemployment (over 9 per cent here in February), combined with continued weakness in housing and sluggish consumer spending, will most likely prolong the pain in Phoenix’s commercial market. Since the recession began nearly two years ago, many business owners here have dipped into savings and lines of credit in an effort to stay afloat. As these resources run out, more tenants are closing up shop.

Already, vacancies are at troubling levels: according to CB Richard Ellis, 25.4 per cent of office space in the Phoenix metro area is unoccupied. Retail has also deteriorated: vacancy rates for that sector have risen the last 11 quarters, to 11.4 per cent at the end of 2009. These rates may not reflect the full extent of the industry’s weakness, however, as some landlords appear disinclined to evict even seriously delinquent tenants because of the difficulty of attracting businesses to replace them.

Yet despite the avalanche of negative indicators, some in the public and private sector are keen to point out bright spots for commercial real estate in the Phoenix area. Desirable pockets in affluent cities like Scottsdale have little vacant space available at any price, while areas close to the downtown core and along established urban corridors are weathering the storm fairly well. CityScape, a $900 million commercial development in the heart of downtown Phoenix that includes shops, restaurants and a 27-story office tower, is at least 75 per cent leased months ahead of its scheduled opening this summer.

The mood of commercial real estate professionals is improving, said Kevin Calihan, senior vice president at CB Richard Ellis in Phoenix. “People are starting to feel the end is in sight,” he said.

But others are less optimistic. “We’re in the first or second inning,” said Wetta of Marcus & Millichap. “We haven’t seen the worst of it yet.”

http://www.mydigitalfc.com/leisure-writing/wrong-end-boom-cycle-531