With shrinking vacancy, rising rental rates and limited new construction, the metropolitan Phoenix retail sector continues to see gradual recovery after several tough years following the economic recession.
“It’s a healthier improvement than we’ve seen in the past, which typically has been marked by sharp recoveries and steep falls,” says Ed Beeh, executive vice president and market leader in SRS Real Estate Partners’ Phoenix office. “We’ve been recovering nicely. This past year has been positive, and I expect 2016 to be the same.”
Bolstered by a growing job market and a low unemployment rate, the local economy underpins this positive retail trend. “More than anything else, there’s a general feeling of optimism in Phoenix right now,” says John Reva, senior associate with Jones Lang LaSalle’s local office.
Retail Follows Rooftops
The healthy Phoenix economy has triggered an uptick in housing development, with new multifamily projects going up not only in and around downtown Phoenix, but throughout the metro area. This visible residential growth and density, coupled with the modest amount of new retail construction, is causing existing retail properties to thrive, says Mike Ebert, managing partner with Phoenix-based RED Development.
“The entire Phoenix area is experiencing strong leasing demand,” says David Larcher, president of Phoenix based Vestar. “As housing continues to rebound, strong sales growth has come right along with it. With virtually no new construction taking place, retailers are having to scramble to find locations.”
This is evident in the latest leasing trends. Vacancy rates decreased steadily from 9.7 percent to 9.2 percent in 2015, according to Jason Price, director of marketing and research for Commercial Properties, Inc. (CPI). And, last year marked the frst time metro vacancy dipped below 10 percent since 2008, adds Terry Martin-Denning, CEO and designated broker at Phoenix-based NAI Horizon. “Many submarkets are even below nine percent,” she says.
As for rental rates, they are steadily increasing—and, like vacancy rates, they vary depending on the project’s class and location.
“Rental rates are all over the board,” says Brian Kocour, senior director, retail services, in Cushman & Wakefeld’s Phoenix ofce. “For C-class strip centers, you’re going to see anywhere from $12 to $15 per square foot. In downtown urban centers, you’re going to be in the $30s triple net, and, in some high-end projects, in the upper $40s and $50s triple net.”
Even with the variation, overall rates are rising, especially in areas where there is heavy growth and development fueling demand, according to Price. “Looking back, it’s encouraging to see that current rental rate averages are still up over the fve-year average for Phoenix,” he says.
Restaurants in Demand
Driving strong leasing activity for retail properties is the growing demand for restaurants—especially chef-driven restaurants with a farm-to-table menu. In fact, with an infux of Millennials living and working in the city, Phoenix is becoming an ofcial “foodie” destination.
“Residents are focking to restaurants headed by local chefs,” says Cindy Winters, principal with Eagle Commercial Realty Services in Phoenix. “Food is a huge driver, and a great way to get tenants in those infll spots.”
“Our restaurant industry is the most popular sector of growth,” agrees Kocour. “Within that sector, the local restauranteurs have been the biggest success of the last 12 to 18 months. Retailing is about the experience. To get people to come out and shop, the tenant needs to ofer something that’s a little diferent and unique.”
Ebert has seen the local restaurant trend in the properties RED Development manages, like its open-air shopping mall The Shops at Town & Country on the corner of North 20th Street and East Camelback Road. “New restaurants continue to add interest to the mix,” he says. “Grassroots Kitchen & Tap and Pizzeria Bianco are two local favorites that consistently drive traffic. It’s great to see the impact restaurants are having on retail.”
“In Phoenix, there is now a moreinformed consumer,” Reva adds. “This demand is completely marketdriven.”
In addition to restaurants, healthrelated tenants also are driving up occupancies throughout Phoenix. Health clubs like LA Fitness, which recently closed its acquisition of 24-Hour Fitness locations in the market, EOS Fitness and Orangetheory Fitness are taking space. And, some landlords are taking note of the health trend by grouping similar tenants together in the same center — ftness centers, spas, health food stores, medical ofce centers — to feed of one another’s traffic. LeDonna Spongberg, frst vice president with CB Richard Ellis (CBRE) in Phoenix, attributes this positive trend to the stabilized vacancy rates, which allows landlords to better focus on creating the right tenant mix versus just flling space.
Strong Investor Interest
With a steadied market and continued job growth, investors are becoming more and more attracted to Arizona, according to Spongberg.
“There has been a substantial amount of cap rate compression across market types, so there are some out-of-state and out-of-country money coming in and looking for deals,” Reva says.
“There’s quite a bit of liquidity out there,” Beeh adds. “Cap rates are very low and owners are trying to capitalize on that rate.”
Current cap rates for retail properties in Phoenix depend on the quality of the asset. According to Michael Pollack, president and founder of local firm Michael A. Pollack Real Estate Investments, true, A-quality centers are delivering cap rates around 6 percent, while B- and C-class centers are between 7 and 8.
Even with the low cap rates, Eric Kenas, director of research and marketing for Newmark Grubb Knight Frank’s southwest region, notes the overall improvement in ofer activity in the metro area. “In general, investors are willing to take on more risk for higher-yielding cap rates,” he says.
“Investor demand has been strong,” Larcher agrees. “This is evidenced by our recapitalization of Tempe Marketplace, an open-air shopping center located along the Salt River near the interchange of the Loop 101 Pima/Price Freeway and Loop 202 Red Mountain Freeway. The $367 million investment confrms that Phoenix is back in the spotlight for capital sources.”
David Guido, managing director of Newmark Grubb Knight Frank, also sees the return of exchange investors, which he believes is a good indicator of the market returning to stabilization. California investors, in particular, are showing their interest in Phoenix. For example, ORION Investment Real Estate recently closed the sale of Greenway Promenade in Glendale to buyers out of Monterey, California.
“The buyers were drawn to the center because of the 7+ percent in-place return and the ability to capture additional upside through lease-up of the vacant space,” says Jared Williams, an associate with ORION. “This type of return plus upside is nearly impossible to fnd in the California market.”
The same set of California buyers also recently acquired Shea 70 Plaza, a 33,615-square-foot retail center located near the intersection of Scottsdale Road and Shea Boulevard in Scottsdale for $8.5 million, or $253 per square foot.
Out-of-state interest is coming from the East Coast, too. In early December, New York-based Kimco Realty Corp. completed a signifcant transaction with its purchase of Arizona’s oldest operating mall Christown Spectrum, which is anchored by Wal-Mart Super-center, Costco and SuperTarget and offers redevelopment and value-add opportunities. The 850,000-squarefoot power center sold for $115.3 million, or $135 per square foot.
“Price per square foot is a direct reflection of the quality of tenants and the location,” Pollack says. “I’ve seen deals for sale in this market for $70 per square foot for multi-tenant, Class C commercial buildings with vacancy issues, and I’ve seen deals for smaller, single-tenant Class A assets in excess of $1,000 per square foot. I’ve even seen a few ground-lease deals trade below 4 on a cap rate. That’s pretty incredible for our market.”
“It’s the market we saw back in 2003 and 2004 before the great run-up,” Guido adds. “We’re more normalized.”
Smart Development
Though there are many parallels in the current market to the pre-crash market of the mid-2000s, one thing that’s very diferent today is the lack of speculative development. But that doesn’t mean no construction is happening. In fact, the market is seeing retail developments break ground in a meaningful way for the frst time in more than five years, says Joe Doucett, senior managing director with Newmark Grubb Knight Frank.
“There are a handful of neighborhood centers under construction, a couple of planned power centers and a number of redevelopments happening all over town,” Doucett says. “Our team is working on a new lifestyle center in Downtown Chandler, The Row, which is a great example of a small specialty site that will bring exciting new restaurant oferings to the city of Chandler.”
Infill and adaptive reuse projects are taking place in high-density urban areas, with developers creating critical mass of retail and restaurant projects not dissimilar from organic urban streetscapes, says Traci Russell, vice president with CBRE.
“We’re seeing a lot of smaller single-tenant buildings get repurposed for tenants, most often quick-serve restaurants who can pay high rents to justify the expense of a signifcant renovation of the building,” Martin- Denning says. “Downtown Phoenix, Arcadia, Downtown Scottsdale, Arrowhead, and North Scottsdale are primarily the areas where this is happening.”
In the Grand Avenue corridor in Downtown Phoenix, Developer SimonCRE recently purchased a remodeled and refurbished 36,000-squarefoot historic property for $3.16 million. The two-story property will be 100 percent occupied by local mattress company start-up Tuft & Needle, which will house its headquarters in the office space upstairs and its showroom in the retail storefront.
“The city of Phoenix has invested a lot of money retroftting the Grand Avenue corridor into a thriving creative community,” says Joshua Simon, president of SimonCRE. “So many of the old historic buildings in and around downtown Phoenix have been demolished over the years, but the ones that remain are pretty desirable for redevelopment.”
Redevelopment opportunities aren’t limited to downtown markets, though, as New York-based Carlyle Development Group discovered when it purchased the failing, 40-year-old Metrocenter Mall of of Interstate 17 a few miles north of Christown Spectrum.
“When we looked at the mall, we looked the opportunity this site can convey in a changing environment,” says Warren Fink, Carlyle Development Group’s chief operating officer.
“And, the more we investigated the area, we came to the conclusion that this was a fabulous urban infll site that needs to be so much more than the 1.3 million square feet of retail that it currently is.”
The company recently secured Wal-Mart as an anchor tenant, who will begin construction on its space this year. And, once city council approves its rezoning proposal, Carlyle Development Group will move forward with its full masterplan that will include discount-focused retail, multifamily, office, healthcare and senior housing, in addition to a new transit hub planned for Phoenix Metro Light Rail. “It’s an undertaking that’s going to take time,” Fink says. “But, with immediate access to the highways and light-rail transit, people are going to want to be here.”
Also making headlines in the market is a unique entertainment-themed project transforming the Salt River Pima-Maricopa Indian Community along the 101 Freeway in Scottsdale. OdySea in the Desert is a 35-acre, multi-level, $250 million mixed-use retail and entertainment complex that will feature a 200,000-squarefoot, state-of-the-art aquarium and 77,000 square feet of retail shops and restaurants, among other attractions. ORION worked with the developer to find the right mix of retailers and restaurants for the project, and some of the signed tenants include restaurant concepts Johnny Rockets and Humble Pie and interactive retailer Arizona General Store and Trading Post.
As we enter 2016, experts expect to see more of the same leasing, investment and development trends— which is a great sign for the Phoenix retail real estate market.
“I expect to continue to see our market thriving because we have the infrastructure in place,” Kocour says.
“I see more companies looking at our market due to this and the low cost of living. We have a lot of real estate offerings, a lot of absorption, and we are able to deliver. We can still convince landlords to do aggressive, creative deals. I think, with all the good things that are happening, it’s going to be a really good year.”