After an extensive recessionary period when ‘uncertainty’ was the ruling word, Tucson’s commercial real estate sectors have settled into a sense of stability that signals firming fundamentals and a somewhat painfully slow return to market balance. Limited meaningful job creation remains the largest hurdle to overcome, with health care uncertainty and the impending presidential and congressional elections contributing to a cautious business climate. Some meaningful growth continues in Tucson’s medical sector, with economies of scale, more favorable locations, and proximity to health care centers fostering movement.
The residential market has been returning to health. A June report cites a 2.8 month supply of housing inventory with average closed prices increasing 11.6% from January to May 2012. While these statistics indicate a seller’s market, the significant lender-held inventory is a factor in overstating the perceived imbalance in the residential market. Further, high investor-owned housing stock could add to supply when significant price appreciation occurs.
Tucson’s commercial market dynamics closely follow those of Phoenix. With conditions improving in the sixth largest U.S. city and an uptick in the local housing market, signs point to positive change, albeit very gradual. Transportation and logistics in the region are drivers of construction activity, from the potential Picacho Peak rail switching yard to interstate widening in the northwest, downtown’s modern streetcar line, and expansion of the Port of Tucson enabling direct shipments to Asia.
Tucson Office Market
At the mid-year point, overall vacancy remained fairly stable, ending Q2 2012 at 12.2% with little variation in the last ten quarters (since early 2010). Year-to-date absorption is a somewhat anemic, yet positive, 69,493 square feet (sf) versus 252,653 sf of positive absorption for the full year 2011, which recovered from a negative 161,230 sf in 2010.
As a bellwether of a turning tide, asking rents ticked up across submarkets and class of space for the first time since early 2010. Further support for continued improvement in the market is demonstrated by a relatively strong pipeline for both new and renewal activity. Activity remains strongest in the medical sector.
Construction of Tucson Medical Center’s West Pavilion will open 77,000 sf of on-campus medical office building space to the Tucson market. The Tucson Orthopedic Institute relocation to the West Pavilion will create opportunities for health care groups to locate directly on this critical care campus.
On the sale side, Tucson office and medical office properties still do not sell under traditional investment criteria in this climate of gradual recovery. Most investor sales are driven by distress, namely short sales and auction activity.
Tucson Retail Market
Positive is positive, and the Tucson retail market did experience a slight decrease in vacancy from 8.6% in Q1 2012 to 8.5% in Q2 2012 with nearly 75,000 square feet (sf) of positive absorption. Looking back over the past two years, vacancy has been hovering in the mid eight-percent range with only minor fluctuation.
Strong activity and continued interest has remained in the Broadway Corridor, with the three largest leases of the quarter concentrated at Broadway and Craycroft, including Hobby Lobby’s entry into the Tucson market with a 50,000 sf store and Stein Mart’s second Tucson location.
Retailers continue to move up to higher quality locations, with tenants such as JoAnn’s, Stein Mart and Cost Plus taking advantage of higher traffic locations with visibility near Tucson’s major malls. Former Blockbuster locations continue to turn, with users such as urgent care centers, restaurants and mattress retailers benefiting from these corner sites. Medical clinic and urgent care uses are also striking deals at competitive lease rates in shopping centers as landlords continue to solve persistent vacancy issues.
Grocery activity remains stable, and with the Sprouts acquisition of Sunflower Markets, four Tucson stores will rebrand as Sprouts. Wal-Mart is moving forward with their embattled El Con location, after a July judicial ruling in their favor.
Tucson Industrial Market
The tenor of the market remains tentative, with fundamentals fairly flat. Year-to-date absorption at the midway point was a positive 54,632 sf, after a three-year combined period with negative absorption of 1,120,091 sf. Industries contributing to recent positive absorption include mining-related uses and telemarketing firms. Market-wide vacancy ticked down slightly to 11.6% but has remained in double digit territory since Q2 2009. Activity is fairly shallow, and velocity remains slow.
Despite relatively flat conditions, there were nine spaces leased of 10,000 sf or larger this quarter, the total number of this size leased over the previous four quarters combined. Activity in small tenant spaces is occurring, again without notable pace or volume.
Sales in the second quarter were larger and of a higher quality than in recent periods. Volume remains far from robust, with more user than investor purchases. Seven of the top ten sales were user buys with an average size of 28,000 sf and $46 per sf.
One sale of note is the Involta purchase of a 40,000-sf Tucson building being renovated for use as a Tier III data center. It will be the first co-location multi-tenant data facility in the region. Additionally, Zygo, an optical sciences firm, previously in 20,000 sf, purchased a 110,000-sf facility with plans to expand.Investor activity has been dominated by short sales and purchases directly from foreclosedlender inventory (REO). We do see some opportunistic activity as both businesses and investors pick up business from compressed competition. Trading of vacant commercial land remains virtually non-existent.
Fundamentals have ceased deteriorating and are showing very gradual improvement across the office, industrial and retail sectors. The pendulum still swings in favor of the tenant, with savvy landlords offering competitive packages to retain tenants and attract those few moving in the market. Moves continue to be dominated by ‘flight to quality’ relocations, where space quality or location is upgraded and consolidations are made for more efficient, cost effective space layout.
With elections only months away, little change is expected in market dynamics through year-end, with the potential for a slight uptick in the fourth quarter. Regardless of the presidential election’s outcome, the broader economy is likely to improve. Increased certainty should ease some of the remaining stagnation in business and investment spheres. Activity in the border region may improve as North American firms find value in re-shoring their operations to a more proximate, cost effective business environment.
Look for growing commerce, development and investment activity along the Tucson Modern Streetcar route following on the heels of significant student housing construction.
Despite low interest rates, the commercial investment market remains hampered by weak market fundamentals and tight underwriting and equity requirements. Expect a continued focus on properties sold to businesses who will occupy the real estate who can purchase well under costs to construct.
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Mike Hammond SIOR CRE is PICOR’s President, Founder and Managing Shareholder, and leads the firm’s activity in the border region, specifically, the state of Sonora, Mexico, where PICOR is incorporated and licensed. He has been a sales and marketing trainer for the national Society of Industrial and Office Realtors (SIOR) for 20 years, is a Counselor of Real Estate (CRE) and is active in regional leadership with the Urban Land Institute (ULI).