While Large Office Buildings Struggle, Occupancy Rises in Phoenix’s Smaller Properties

Article originally posted on CoStar on June 15, 2023

Occupancy in smaller office buildings in the Phoenix area is at its tightest level in more than two decades, continuing the rare trend of occupancy rates in smaller office buildings running counter to larger ones as corporate downsizing since the onset of the pandemic and demand from local companies with smaller footprints have affected the market.

Smaller office buildings typically perform better than larger properties in terms of occupancy, though the office market tends to move in sync. As the occupancy rate rises in smaller buildings, typically, the same occurs in larger buildings.

But since the onset of the coronavirus pandemic, the vacancy rate between smaller and larger office buildings has moved in opposite directions. Office buildings under 50,000 square feet have seen a clear compression in vacancy in the last three years, while larger properties have struggled in comparison.

These smaller office buildings have recorded a 180-basis-point decline in vacancy since the fourth quarter of 2019, despite a macro-level shrinking in tenant demand during that time. Meanwhile, office buildings over 50,000 square feet have notched a 710-basis-point increase in vacancy and are approaching the prior cycle’s peak in 2011.

The adoption of hybrid work has caused office users to reevaluate their footprints as space requirements per employee trend lower. As a result, a record amount of sublease space has hit the market, driven by large tech and insurance companies that have downsized or closed offices altogether. That includes Carvana, which in late May put 292,100 square feet on the market for sublease at the Marina Heights complex in Tempe.

Yelp announced plans on June 1 to close its 40,000-square-foot office at the Galleria Corporate Center, a roughly 450,000-square-foot, upscale office park in Old Town Scottsdale. In a public statement, the firm cited employee preferences for “the flexibility and other benefits that remote work offers” as a reason for closing the office. CoStar has not yet confirmed whether Yelp will put its space on the market for sublease. Other large tech tenants that have downsized in the area include PayPal, GoDaddy, DoorDash and Opendoor.

Large buildings often contain these national or international tenants with a broad portfolio of office space across multiple states. Decisions by major companies in recent years to cut footprints to reduce overhead and rightsize office space has caused vacancy in these larger buildings to climb.

Smaller office buildings on the other hand tend to be filled by local businesses with smaller footprints that aren’t as apt to remote work. New business applications have surged in Phoenix since 2019, according to the U.S. Census Bureau, driving additional underlying demand. As a result, tenant demand has been stickier in buildings under 50,000 square feet, keeping vacancy rates compressed.

Moving forward, aggregate demand for office space is expected to remain challenged and more space availabilities are anticipated as in-place leases roll. Smaller buildings, however, may be better positioned to weather these headwinds.