Phoenix Investment Volume Down 75% From 2021’s Peak

Article originally posted on CoStar on May 6, 2024

This year’s first quarter marked another slow period of sales activity for the Phoenix commercial real estate market as about $1.8 billion worth of multifamily, retail, office, and industrial properties traded hands, a 75% decrease from 2021’s average of about $7.1 billion per quarter.

The pullback in investment volume comes on the heels of higher interest rates and waning property performance. In 2021 and 2022, when borrowing costs were historically low and fundamentals were strong, transaction activity surged to unprecedented highs.

Since then, however, the steep rise in interest rates coupled with weakening net operating income growth has restrained sales for more than a year. Buyers have tightened underwriting standards to factor in lower revenue growth expectations and are demanding higher in-place yields when making acquisitions.

Potential sellers, meanwhile, have been slow to dispose of assets voluntarily, and many are opting to hold rather than sell at a discount to prior peak pricing. This disconnect between buyers’ and sellers’ pricing expectations is causing a stalemate in the investment market.

A retreat of multifamily sales has driven the slowdown. About $635 million worth of apartment assets were sold in the first quarter, an 84% decrease from the quarterly average in 2021. The substantial construction pipeline has plagued the Phoenix apartment market, keeping annual rent growth negative and vacancies elevated.

Newly built properties by merchant developers have remained a relatively steady source of transaction activity. About 50% of recent apartment sales volume came from complexes sold within two years of completion. In 2021 and 2022, new completions accounted for about 15% of sales.

The retail and industrial segments have been less affected because of sturdy property performance, though transaction volume has nevertheless slowed.

About $538 million of industrial properties were sold in the first three months, a 62% decline from 2021’s quarterly average. However, compared with the average from 2015 to 2019, sales volume was 20% higher in the first quarter, making industrial the only primary property type in positive territory, compared with pre-pandemic levels.

So, industrial properties have taken a growing share of investment activity, comprising about 31% of first-quarter sales volume. In 2019, industrial accounted for about 15% of total commercial real estate sales.

The surge in industrial development over the past few years has dramatically expanded the market’s offering of institutional-grade assets. REITs, private equity groups and other large investors regularly place capital here to acquire large, modern industrial properties.

Investors bought $338 million of retail properties in the first quarter, a 59% decline from 2021’s peak. Though larger deals that rely on financing have become less common, smaller deals to private buyers have maintained momentum. Investors in this space are often all-cash buyers with unique motivations such as wealth preservation, estate planning and tax optimization. Single-tenant net lease properties and small centers have taken a larger share of the investment pool.

In addition, retail property performance remains healthy, preserving NOIs and values. More than a decade of minimal construction activity has kept supply side pressure largely at bay, while steady consumption growth has fueled underlying retail demand. The availability of Phoenix retail space is near the lowest level on record and rent growth is strong.

The office sector trailed the pack, recording about $250 million in trades in the year’s first three months. That amount represents a 70% decline from 2021’s quarterly average and a 65% decrease from 2015 to 2019.

Challenges across multiple fronts, including structurally lower tenant demand and limited financing availability, have kept investment activity stagnant. Though some institutional-quality office properties traded over the past year, they often sell at a meaningful discount to prior peak pricing.

The medical office segment has emerged as a standout as the diverging demand outlook and property performance split the market. Vacancy for medical office buildings is down more than 200 basis points since 2019, while traditional offices have seen a nearly 700 basis point increase. As a result, the share of total office sales from medical properties has doubled from 17% in 2019 to 37% since 2023.