Phoenix area high-end office space renting for less

David Kadlubowski/The Arizona Republic The Camelback Corridor of Phoenix near 24th Street and Camelback Road features some of the most desirable office properties in the Valley. Office-rental prices at these and other properties have become competitive as the building owners seek tenants.


With more than one-quarter of the Phoenix area's office space sitting empty, owners of high-end office buildings have been beckoning to tenants inside less-desirable properties to "move on up" at little or no added cost.

As a result, the loss of existing tenants has been exacerbated at the bottom of the office-space food chain, among the so-called Class C properties, while Class A and Class B office properties have gained tenants overall.

What's driving that movement is intense competition among property owners to fill their available space at a time when few businesses are forming or expanding.

"It's sort of a musical-chairs phenomenon," said Blake Hastings, senior vice president with the Office Services Group at Cassidy Turley BRE Commercial in Phoenix.

Office-class climbing during a market downturn, which brokers generally refer to as "the flight to quality," has been around for as long as there have been recessions, said Pete Bolton, executive vice president and managing director of Grubb & Ellis Co. in Phoenix.

The shift reverses direction during periods of intense economic growth, Bolton added.

In the first nine months of this year, Phoenix-area office properties had a net absorption of about 150,000 square feet, according to CB Richard Ellis, a Phoenix real-estate services firm.

That means 150,000 feet of previously empty office space was leased to tenants, a positive change from the same period in 2009, during which almost 900,000 square feet of formerly occupied office space was vacated.

Meanwhile, office-rent prices have been dropping, according to CBRE.

In the past year, the average price per square foot per year (the standard measure for office properties) has fallen more than a dollar, from $23.44 in the third quarter of 2009 to $22.25 in the third quarter of this year.

The overall office-vacancy rate in the third quarter was 25.9 percent, up from 24.1 percent a year earlier, according to CBRE.

But the most striking statistic in recent quarters has been what real-estate brokers call "gross activity," the total movement of all Phoenix-area tenants from one space to another, also measured in square feet.

Gross activity in the first nine months of 2010 was 4.3 million square feet, CBRE reported, an astronomical figure compared with the relatively stagnant absorption.

Similarly, gross activity was high during the first nine months of last year, at 2.9 million square feet.

Bolton said two major factors determine which class an office property falls under: the quality of the building itself and the desirability of its location.

Class A is the swankiest and most-expensive class of office space. It encompasses the newest, highest-profile properties in the most popular commercial zones. Office-rent prices at Class A locations such as 24th Street and Camelback Road in Phoenix have come down as much as 50 percent since the real-estate market's peak.

Class B is the middle class. It includes quality suburban office and mixed-use properties and midrise office towers in popular commercial zones.

Class C is the least prestigious but also the cheapest. It generally includes older or smaller suburban properties, in addition to offices in industrial zones.

A breakdown of net-absorption data in the third quarter by building type reveals the general direction of tenants' movement.

According to CBRE, Class A office buildings picked up about 142,500 square feet of rented space; Class B added tenants in 73,800 square feet of space; while tenants vacated about 81,200 square feet of Class C space.

The reason, Hastings said, is that building owners in the higher classes can offer better accommodations for roughly the same cost as their lower-class competitors.

"Why wouldn't a Class B tenant move to a Class A property when it's only a few dollars more?" he said.

There are certain fixed costs associated with owning and operating an office building, Hastings said, and the cost per square foot doesn't vary much among Classes A, B and C.

What primarily dictates the lease rate a property owner can charge while staying in business is whether there is a mortgage on the office building.

By that token, a Class A landlord who owned the property outright could potentially charge less for rent than a Class C property owner with a mortgage.

In fact, that is what's happening in some cases, Hastings said.

He recalled a recent deal in which a Class A property owner offered his client 18 months free rent on a 10-year lease.

How was the building owner able to afford that? "They don't have any debt on the property," Hastings said.

by J. Craig Anderson The Arizona Republic Dec. 10, 2010 12:00 AM



Phoenix area high-end office space renting for less