August 6, 2010—Tenants benefit from rent and tenant improvement concessions

By Richard Kleiner, Thomas Knox

INSIDE TUCSON BUSINESS

August 6, 2010

When considering the current status of Tucson’s commercial office market, the circumstances clearly are full of haze and uncertainty. That’s why we start by posing these questions:

Is the market static or gradually improving?

Tucson’s office market reflects this uncertainty. The lease market is by far the strongest in terms of activity. Tenants are reaping the harvest of a depressed market and gaining significant rent and tenant improvement concessions.

What is the demand for ownership?
The market for office investment properties has been very quiet through the first two quarters of 2010. Ownership of small, owner-user office buildings also is depressed and prices for shell buildings have dipped below $170 per square foot.

Are there bright spots in the office market?

Reflecting the expanding demand for health services, the medical office market is relatively robust. Practices are growing even in the face of healthcare reform and possible reductions in Medicare reimbursements.

In comparison to year-end 2009, Tucson’s current office vacancy rate remains stable at 12 percent. Net absorption has improved modestly and rental rates continue to soften, according to data from the CoStar group in its mid-year 2010 report.

Generally reflecting national economic conditions, Tucson’s commercial office market has been flat for eight quarters. New construction has been limited mostly to owner or built-to-suit activity.

The only multi-tenant office that was under construction was the 40,000 square-foot project at 3501 E. Speedway Blvd., a building that was 50 percent pre-leased. Sundt Corp. is completing its $8.6 million, 50,000 square-foot headquarters at 2015 W. River Road; and UniSource Energy Corporation has commenced work on its new $60 million, 170,000 square-foot headquarters building in the downtown central business district.

A new first-class research facility was completed for Sanofi-Aventis at 2090 E. Innovation Park Drive in Oro Valley. Sergeant Controls will build a 70,000 square-foot expansion project at Continental Ranch in Marana.

Tenant demand for space in all property types has been subdued and rents for office properties continue to decline.

Limited financing options that were available to small business created dramatic downward pressure on pricing of all property types, but perhaps most significantly in the category of condominium office space. Lower rents and generous landlord concessions have caused the “lease versus own” calculation to swing back in favor of tenancy.

Healthcare and education have been active market segments. Several significant leases have been completed for education facilities with expansions of Tucson College, Brown Mackie College, Embry-Riddle Aeronautical University, and the Academy of Tucson.

Tucson Medical Center has seen continued absorption of medical space in the Tucson Medical Park, a 37-acre parcel just south of the hospital on 5301 E. Grant Road. TMC intends to commence construction of a new 60,000 square-foot medical office building, at its campus north of Grant Road, by the first quarter 2011.

The 37,000 square-foot third floor of El Dorado Hospital, 1400 N. Wilmot Road, recently was leased to an operator of a pediatric, long-term health care hospital. The vacant second floor is also under negotiation with an operator of a skilled nursing facility.

Institutional owners are offering significant near-term rent reductions and improvement allowances. The central market is Tucson’s largest concentration of office space, identified as “the Broadway Corridor” from Country Club to Wilmot roads. This sub-market shows an 8.9 percent vacancy and average rents of $22.87 per square foot.

Typical of the competitive market in mid-town, lease renewals have fallen about $2 or more into the $17 gross per square foot range. Rent abatements and tenant improvement allowances also are common.

There are still many reasons in this market for participants to be nervous and cautious. However, we are seeing a bit more sales and leasing activity in the recent period. This is primarily due to the exceptional opportunities available to those buyers and tenants willing to take action.

We believe landlords must take the long view and adopt an aggressive pricing structure to attract or retain tenants and gain the attention of market participants. Economic conditions suggest it will be several years before we can expect a normally vibrant office marketplace to return.

Office/medical report by PICOR Commercial Real Estate Services from Richard Kleiner, Principal; and Thomas Knox, Associate Broker. Contact: (520) 546-2745 or [email protected]