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Cooling Housing Market in Phoenix Doesn’t Damp Commercial Sector

By Maura Webber Sadovi
From The Wall Street Journal Online

Phoenix’s rapidly cooling housing market hasn’t damped the region’s commercial real-estate market. From a new football stadium for the Arizona Cardinals with a design inspired by a desert cactus to more than 16 million square feet of offices, warehouses and retail stores slated to be built in the region this year, the area’s commercial sectors are expanding at a brisk pace amid rising rents and falling vacancy rates.

Some 5.3 million square feet of office buildings are scheduled to be built in the region this year, about double the amount delivered in 2005, according to Property & Portfolio Research Inc., a Boston-based research firm. Meanwhile, some 7.4 million square feet of new retail space is to be delivered this year, up 26% from last year.

The commercial growth has been fueled by a continuing surge in population and employment, says Marshall J. Vest, an economist at the Eller College of Management at the University of Arizona. New arrivals first purchase homes, and now are helping to drive demand for places to shop and work, sending rents higher and triggering more commercial projects that previously didn’t make sense economically, Mr. Vest says. Over the next five years, office, retail, warehouse and apartment rents are all expected to grow at above-average rates, PPR says.

The good times for the commercial sector come as the party is quieting for the residential sector. Until recently, Phoenix has been one of the stars of the nation’s high-flying housing market. The area’s relative affordability, especially in comparison to the pricier California market, has attracted new residents and driven population at an annual rate of 3.3% in recent years — about threefold the national average — to nearly four million people, according to Moody’s, a unit of Moody’s Corp.

As interest rates have risen, homes are taking two months to sell, instead of days or weeks, says Mr. Vest. The seasonally adjusted median home price has slipped since the first quarter, and residential building permits fell about 35% on a seasonally adjusted annualized basis in June off the recent peak reached in January, he adds. The downshift comes after the area’s median home prices soared 78% to $272,200 from 2003 through the second quarter, outpacing the 26.2% rise nationally, according to the National Association of Realtors. “It really was a frenzy and that clearly started changing in mid-2005,” says Mr. Vest.

The disconnect between the commercial and residential real-estate cycles isn’t uncommon, in part because institutional investors that help to drive the commercial side are less immediately affected by interest rates. But the housing market and the related jobs in construction and mortgage financing that it generates are a key component of Phoenix’s economy, and some analysts say the economy — and ultimately the commercial market — won’t be able to sustain its current pace as housing decelerates. Already, job growth has slipped to a year-over-year pace of 5.1% in July from 6.5% in July of 2005, according to the Bureau of Labor Statistics. Still, that’s well above the 1.3% national growth rate in July.

“The commercial market is super strong but we do expect the Phoenix market is going to come off of the pure sizzle that it’s had,” says Hessam Nadji, managing director of research for Marcus & Millichap, a commercial investment brokerage firm based in Encino, Calif. One area that appears to be softening is investors’ appetite for apartments purchased for conversion to condos, he adds. Mr. Nadji expects the dollar volume of rental complexes purchased for conversions this year will be lower than the $1.8 billion in 2005.

Some investors remain confident that pure rental apartments stand to benefit from the current residential trends. Rising interest rates and the disparity between the price of for-sale homes and rental housing has increased demand for Phoenix-area apartments, while the strong population growth continues to bring new prospective tenants to the region, says Tom Garbutt, head of TIAA-CREF Global Real Estate, a unit of the New York-based financial services organization. “We’re seeing a lot of people coming back into the rental market,” says Mr. Garbutt. TIAA-CREF recently paid an average per-unit price of about $188,000 for nearly 2,200 Phoenix-area apartments that were part of a larger portfolio purchase.

Drew de la Houssaye is an associate with THE BROKERAGE Real Estate Group Beverly Hills. Drew specializes in westside luxury real estate, renovations and probate sales. He blogs on Westside real estate, entertainment and local events. If you would like to contact him, he can be reached via twitter, facebook, LinkedIn or email.

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