By Roland Murphy for Arizona Builder’s Exchange
Around 120 people packed a ballroom at the Phoenix Country Club this week to catch up on commercial real estate trends at the Arizona Association for Economic Development’s August luncheon.
Featured speaker Mark Singerman, VP and Regional Director for Rockefeller Group, took the lectern to share his insights on the area’s Office, Multifamily and Industrial CRE markets.
Construction Costs a Rising Burden
One factor that loomed over the various sectors – particularly multifamily – and served as Singerman’s greatest cautionary note was the extent to which construction costs have skyrocketed.
“Literally, for the last three years, multifamily-type construction (costs) have been going up at 1 percent a month.” He noted one 400+ unit project his company built in Gilbert in 2014 at a cost of $77 per foot. “That same project today is $120 a foot.”
The best, and perhaps only, answer to the problem is rigorous value engineering, he said. In Rockefeller’s case, the company has taken to slightly downsizing planned units. “You know what? People are okay with that. For a little less rent, they’re willing to take a little less square footage. We’re taking 50-75SF out of each unit, and it hasn’t affected our demand,” he said.
“That’s a good thing,” he continued, because the costs are brutal, and we haven’t seen a top.”
The biggest factor in those burgeoning costs is labor. “I’m sure you know; every contractor is struggling to get good labor. They’re having to continue to pay more to get the labor they have.” He blamed the aging of the construction workforce and the migration to oil industry jobs by many skilled workers during the last recession.
One factor I, personally, would have liked to hear Singerman address, but didn’t get a chance to ask the question during the brief Q&A period after his prepared remarks, was an observation made by Lee McPheters, Research Professor at ASU’s W.P. Carey School of Business, in an interview last month with KJZZ.
McPheters said, “When I look at Arizona, I just have to suggest this is one of those situations where, when we survey business owners, one of their top concerns is the difficulty of attracting qualified workers, but they really ought to finish that sentence, which is the difficulty of attracting qualified workers at the rate they want to pay.”
He continued, “The fact is that Arizona construction wages are still quite a bit behind some of our competitors, like Dallas and Denver, for example. Construction workers don’t put Arizona at the top of their list in terms of possible job opportunities when that market is so hot right now.”
Given that fact that, if all other trends remain consistent, it’s likely we can expect to see the labor shortage as both an ongoing burden and a continuing escalation driver in construction costs.
Singerman said one key issue in the Office sector is distortions in reported vacancy rates because a percentage of space in many submarkets is undesirable. “It’s sitting there vacant for a reason,” he said. “There’s always a certain number in the vacancy rate that’s functionally obsolete.”
He added in the region overall there is a dearth of large, contiguous office spaces, and that many markets have no large spaces left to lease.
A major problem, he said, is there is very little development in the pipeline, which makes attracting institutional lenders used to East Coast markets – where preleasing is the norm – wary.
“This is not a prelease market… Unless you build it, you’re not going to get the tenants.”
Despite the raging demand for multifamily developments in many parts of the Phoenix area, Singerman shocked some attendees when he pointed out that some submarkets have actually reached a point of equilibrium, where demand and supply are fairly evenly balanced.
Other submarkets, he noted, are significantly undersupplied, with family formations outpacing supply by up to 3,000-4,000 units.
As with Office, functional obsolescence is plaguing many industrial submarkets. Singerman chastised commercial brokers for inexactitude, because, although builders want to build when vacancy rates approach 10 percent, 3-4 percent of reported vacancies are in buildings that are either outdated or completely operationally useless.
Another concern is that institutional financiers want big box space to accommodate the needs of ecommerce distributors like Amazon. “The safety valve, with all that product out there, is the big box guys are happy to take it, even if it’s vacant. That has saved a lot of developers in given submarkets.”
One cautionary note for the development realm Singerman sounded is the unwillingness for institutional finance to consider multi-phase projects. “They want bite-sized. They want to get it built, lease it, sell it and walk away. If your site is too big for a single phase, you might have a problem attracting money. That’s just happened in the last three or four years,” he added, noting that land carry is just enough to make a deal unprofitable.
High Points and Cautions
Singerman noted the Valley has several trends and processes currently working strongly in its favor, the greatest of which is the South Mountain Freeway. “In my opinion, that’s going to be a game changer,” he said, praising the comprehensive construction approach ADOT and Connect 202 Partners have taken.
In his estimation, once completed, the freeway will functionally shrink the Valley and lead to a genuine blending of the east and west sides more than any other project ever has, to the point that warehouse industrial could become a factor in the East Valley for the first time.
Another positive for the state is the excellent reputation Arizona has earned around the country for its weather, affordability approach to development. He noted, however, “We do a terrible job promoting ourselves.” He advocated for a long-term vision for the entire state to act upon and actively promote.