Vacancy Rate Across Phoenix Will Rise Amid Statewide Stay-At-Home Order

By Jessica Morin, Costar Director of Market Analytics, Phoenix
Market Analysts

Phoenix’s retail narrative has changed over the past several weeks, from concerning to damaging. Many retailers had temporarily closed stores before the March 31 statewide stay-at-home order. The call for the closure of non-essential businesses, social distancing and a curtail in consumer spending has come during what is typically a peak tourism season in Phoenix. The impact has been hardest on the hospitality, leisure and service industries, but office and industrial workers are also facing layoffs or furloughs.

In the week ending April 4, Arizonan’s filed more than 132,000 unemployment claims. Because of this, we can expect a much weaker jobs report and a drop in retail demand in coming months. Before the outbreak, Phoenix retail fundamentals were already disappointing. Widespread national store closures and previous years of overbuilding have weighed on the market’s fundamentals. While vacancies had improved significantly from the heights of the last recession, the Valley of the Sun carries the second-highest vacancy rate among all markets with more than 100 million square feet of inventory.

Internet resistant retailers, that were once driving demand and helping to offset the impact of widespread closures, are now the most vulnerable. Net absorption and leasing volume were healthy in the first quarter, but a pause in new leasing activity over the past few weeks will negatively impact future quarters of net absorption. The health of many retailers who signed leases earlier in the year, including restaurants, theaters, fitness and trampoline parks, is now questionable as social distancing cripples cash flows.

In CoStar’s severe downside scenario, the outlook is bleak. Net move-outs are expected to peak in the second quarter and continue through late next year. A moderation in the Valley’s supply pipeline, which is now mostly limited to build-to-suit projects, will help protect vacancies from climbing even further. Rising vacancies will impact rent growth. Many tenants whose businesses are being crushed are unable to meet rent obligations and are asking for some type of rent relief. On April 6, Arizona’s governor issued an executive order that blocks evictions for companies with fewer than 500 employees until the end of May. Though the order does not eliminate rent obligations, it encourages tenants to work with landlords and gives tenants a window of time to seek aid from federal and state resources.

Sales volume in the first quarter was similar to the amount recorded during the same period last year. It is still too early to see the full effects of coronavirus on the capital market’s scene, though we expect at least a temporary pause in new sales activity. Some deals that were well underway heading into the turmoil have closed in recent weeks, while others have fallen through. In CoStar’s severe downside scenario, pricing falls over the next eight quarters. The outlook is shaped by near-term rent reductions, longer-term rent stagnation, and a projected rise in capitalization rates.