Three years.
That is how long it has been since the onset of the COVID-19 pandemic and the seismic effect it had on all elements of life, including the commercial real estate market.
As the economy continues to rehabilitate, here is a look at today’s economy, the activity of each commercial real estate division, and where 2023 may be headed.
Economy
During the fourth quarter, employment in Tucson increased to 393,000 jobs, up 2.2% over the same time in 2021. At 3.8%, the local unemployment rate remained flat compared to one year ago and is forecasted to increase in the year ahead.
Household formation grew 1.9% year over year (YOY) with median household income increasing 5.8% YOY from $60,100 to $63,600.
Nationally, consumer spending grew at a healthy 8.5% rate and retail sales were similarly up 8.4% YOY.
Inflation persisted over 7%, high relative to recent years, while consumer and corporate balance sheets remain cash strong.
Office
Throughout 2022, the Tucson office market was challenged by post-pandemic disruption to work patterns and reconsideration of layout and use of space. The office vacancy rate rose slightly to 10.4% on the total available inventory of 28,887,249 square feet. (See related story.)
While the Refinery at the Tech Park was completed, adding 120,000 square feet to the market, health care and ancillary medical practices continue to be the largest driver of new activity. With employers working through hybrid models for their workforces, many businesses are considering smaller spaces upon lease renewal, a trend we expect to continue in 2023.
Work from home has also particularly challenged call center/telemarketing users and is only worsening as leases come up for renewal with a reduced in-person workforce.
Available large blocks of space suitable for office, back office and call center uses equal about 2 million square feet and will likely increase. Given the higher interest rate environment, seller financing is growing in popularity, and some owners are willing to carryback financing to get deals done.
Certainly, the busy Foothills submarket has been able to drive rates up, but otherwise rental prices in Tucson remained stable. Many owners have also been creative in utilizing incentives to move transactions forward, another trend that will continue and perhaps grow as well.
Rick Kleiner, principal, MBA, one of Cushman & Wakefield/PICOR’s office specialists, said, “COVID’s impact upon the professional office market was severe. Current data indicates that the typical office employee census is one-half to three-fourths of pre-COVID-19 numbers. Larger offices comprised of dense cubicle floor plans remain vacant. Over the near term a continuing return-to-office momentum will eventually bring about decreased office vacancies and increased rents.”
Industrial
The Tucson industrial market remained stable at year-end, with marketwide vacancy approaching a historic low of 2.5%. Net absorption in the fourth quarter was estimated at 590,980 square feet, about half in newly constructed projects.
Demand will continue to be driven primarily by logistics, distribution, manufacturing and the cannabis industry in 2023. Despite the low vacancy rate, only two new developments broke ground: Southern Arizona Logistics Center at Tangerine and I-10, with a proposed total of 1.7 million square feet, and Tucson Commerce Center at Valencia and Alvernon, with a proposed total of 780,000 square feet.
Land sales remained slow due to lack of inventory, rising construction and financing costs. Several notable investment sales transactions closed last quarter, and on deck for 2023, Sion Battery, TuSimple and American Battery Factory (ABF) have announced expansions and new projects in greater Tucson.
Sion will add 111,000 square feet to its existing plant, creating 150 new jobs by 2026. TuSimple is adding 35,000 square feet to its facility. ABF has selected Tucson as the site of its first giga factory in the United States with 2 million square feet under roof and an investment of $1.2 billion. Finally, Rainbird is also under construction with a 100,000-square-foot expansion to its Tucson facilities.
“The industrial market is experiencing historic high occupancies with a vacancy rate currently at 2.5%. New construction is scheduled to be delivered by the end of this year, but in the meantime, there is considerable pressure on increasing lease rates,” said Rob Glaser, CCIM, SIOR, office specialist at Cushman & Wakefield/PICOR.
Retail
Tucson retail vacancy rates held steady at 6.2% at year-end, while absorption rates are below normal. Most of the fourth quarter absorption resulted from properties built to suit.
One big beacon that will likely continue: Significant restaurant activity continued across the spectrum, including dessert concepts, health foods and other new entries to the Tucson food scene. “Med-tail” is also very actively going into spaces that were traditionally more retail oriented with concepts like injectables and medispas. Larger medtail companies like Action Behavioral, Archwell and Oak Street looked for spaces of 6,000 to 10,000 square feet. Quite a few new cannabis dispensary licenses have been issued in Tucson, and this may continue.
Other categories with activity of note that may continue include car wash, auto parts and grocery. Of note, Sprouts opened a new location in The Landing at Irvington and I-19. Fry’s Marketplace shopping center at Gladden Farms is moving forward after 15 years on pause.
Hot submarkets with strong activity include southeastern Tucson in the Houghton area, the I-19 corridor from the I-10 junction south to Sahuarita, The Bridges near I-10 in south central Tucson, and Oro Valley.
With build-to-suit activity dominating construction, investment speculators and cash buyers have been sidelined by the uncertain interest rate environment. While there is over 205,000 square feet under construction, 97% of it is pre-leased.
“Tucson’s leasing activity for restaurants remain active and strong. Valuation of retail properties for purchase are up modestly from last year,” said Andy Seleznov, CCIM, retail specialist with Cushman & Wakefield/PICOR.
Multi-family
The end of 2022 saw a decline and slowdown in the rental market. Units being marketed at pre-adjustment rental numbers are slow to lease. This softening in rents results from the market changes and renters exercising caution financially to not stretch outside of their means. In surveying local managers, many cite the fourth quarter as the slowest leasing quarter in Tucson since 2019.
Units that would previously have leased within days are now taking weeks or months to lease. The city of Tucson is still working to fill the need to place affordable housing tenants. Subsidized rents are only slightly below market rents with the goal of enticing owners and managers to fill vacancies with lower-income tenants. Going forward in 2023 and beyond, Tucson will likely experience softer YOY rent increases than in recent years.
Supply and demand in the Tucson MSA have completely flipped from the beginning of 2022. Owners who had pricing expectations based on property values in the first half of the year have had to adjust to the new reality if they wish to move their product in this market.
The softening in the rental market has caused more cautious underwriting and projections by buyers when evaluating deals. Finally, each year, regardless of the market’s strength, a seasonal slowdown is experienced during the holidays. In 2023, the market will likely cool and require closing the gap between seller’s expectations and purchasers’ willingness to pay.
“In 2023, we expect the apartment market to see a slight softening in pricing and rise in cap rates as interest rates remain unsteady. We are optimistic that investors still have demand for multi-family in Tucson, due to its relative affordability compared to the larger Southwest MSAs,” said Joey Martinez, principal, multi-family specialist at Cushman & Wakefield /PICOR.
Barbi Reuter is chief executive officer at Cushman & Wakefield/PICOR Commercial Real Estate Services, a Tucson-owned full-service commercial real estate company. Kate Zimmerman, social media and graphic designer coordinator at Cushman & Wakefield/PICOR, and Alison Bailin Batz, a local freelance writer, also contributed to this piece. Learn more at picor.com.