I’ve said it many times. My insight into the Greater Phoenix market comes from several sources. I read a few different publications; review several internet sites; analyze reports from prominent companies; devour government reports and fact sheets; pour over local data from The Cromford Report or InfoMarket; and I talk to a lot of you.
Data is interesting. Usually it confirms what my thinking is about the market and where it is going. I find that most of the time it is conversations with investors that prove to be the most valuable. While this information may be anecdotal, it is real people putting their money where their mouth is. It is also usually the most current information available.
I am writing this on a Tuesday and already this week I have heard from three AZREIA members on commercial property – not apartments. The calls have been on office and industrial, primarily office. So, the first thing I ask myself if this a reflection of a market change. Is the investor community – those that actually put money into an investment – sensing the bottom of the office market and thinking now is the time to get in? Do they see the unbelievably low prices and potentially high Cap Rates for office and think this is too good to be true? Are they nervous about missing the bottom? Employment is rising. Phoenix’s employment growth among cities with over two million people is at the top. Will businesses start to open and/or expand needing office space? Can I work a deal to acquire office space using seller financing? Based on occupancy, expense and debt service, what is my breakeven point? Investors ask these along with many other questions. For some, their answers are leading them to heavily consider the office market as an investment.
First some facts. Vacancy rates in office are very high which is bad for the sector, but good if you are looking to buy. So there is no question you can buy at unheard of low prices. While you buy based on an income analysis, many buildings are at less than $50 a foot, so they are price far below replacement cost. In a suppressed market like we’ve had for the last few years you have to be concerned with deferred maintenance. Office tenants are getting smarter. They know they can demand low lease rates and owner paid tenant improvement (TI). How long will it take you to lease it up and get to break even? Is all that risk still worth it if we truly are at the bottom?
To me it all gets down to staying power. Based on the debt service and expenses can you pick up a property now and if you can’t lease it up to breakeven in a short period of time, can you survive for a while? If you can, then the upside potential is very high. In some building classes rents may increase 50% as the market recovers. It certainly isn’t hard to believe rents increasing from $10 – $12 a foot to $15 to $18 a foot as demand increases and supply goes down. How long will that take? No one knows.
Commercial office bought at prices well below historical market will certainly entice some to participate. Future CAP rates as the property is lease are very high. The potential for low CAP rates (high building prices) when these same investor might sell in a few years are jus as enticing. There are reasons the prices are low. There are reasons early investors in this market cycle for office will position them to make a lot of money. The main reason is risk and staying power.