If investors thought industrial development in Phoenix was hot in the 1990s, then today's market must seem blistering. In 2007, 11.5 million sq. ft. of industrial space is projected to be delivered, eclipsing the record 10 million sq. ft. brought on line in 1998.

What's driving the latest industrial boom? The two largest contributors are Herculean job growth and the burgeoning population, which has swelled by 39% in the last decade. Phoenix now boasts a record 2.7 million jobs, with a midyear unemployment rate of just 2.7%, according to the Bureau of Labor Statistics.

“There are 4 million people that live in the greater Phoenix metro area now and that is what really drives our market,” says Jim Wilson, senior director for Cushman & Wakefield in Phoenix. “With over 252 million sq. ft. of industrial space, we are our own market.”

In the first half of 2007, developers completed 6.2 million sq. ft. of industrial space in Phoenix. Another 5.3 million sq. ft. is slated for delivery in the second half of the year, reports Grubb & Ellis/BRE Commercial LLC Research. Global companies demand bigger logistics centers to house sophisticated distribution systems. Those systems, in turn, will service larger geographical areas than earlier warehouses. And the buildings are vast. A1 million sq. ft. building is the size equivalent of a 20-plus acre farm.

Most of Phoenix's new construction will be warehouse/distribution, which makes up almost 60% of the city's industrial market. The remaining 40% of the market consists of manufacturing, service center and flex buildings, which can be finished out for either office or industrial use.

Much of that space will be used by retailers distributing to their own local stores. Ulta Salon, Cosmetics & Fragrance Inc. of Romeoville, Ill., for instance, will fill 323,000 sq. ft. in the Riverside Business Center with bath and body products sold through 17 of its metro area stores. The Home Depot, which was leasing 550,000 sq. ft. from Dallas-based Lincoln Property Co., this year signed up for another 380,000 sq. ft. in a second building.

“The company distributes to 31 Home Depot sites in metro Phoenix, nine in Tucson and a few others in New Mexico,” says David Krumwiede, executive vice president of Lincoln Property Co. in Phoenix. “So they service the region.”

Until recently, the region could satisfy users with requirements over 200,000 sq. ft. Tenant interest in the huge spaces remains competitive. But Phoenix didn't have enough industrial product, says Wilson.

Enter the mega warehouse

In the first half of 2007, the market absorbed 1.6 million sq. ft. of industrial space, much of that for the new Ulta lease, Atlanta-based Home Depot expansion, and two more big leases. Pilkington North America Inc. of Toledo, Ohio took 200,000 sq. ft., while Seattle-based Amazon.com Inc. signed on for 604,500 sq. ft., the largest deal of the year so far.

The size of those deals is significant, according to a Cushman & Wakefield mid-year report released in July. After years of limited options and high demand in both size and number of deals, developers responded with the area's first mega warehouses [over 250,000 sq. ft.], now available for lease, the report says.

Amazon.com's new space will serve as an online processing and distribution center hub. Built as a spec project by The Alter Group, it was the first foray into Phoenix for the Skokie, Ill.-based developer, but certainly not the last. The developer likes the bustling Arizona city.

“The Phoenix industrial market is quickly maturing and we're seeing demand for larger buildings. The population is growing, creating demand for product, and industrial tenants are taking space to service the demand,” says Patrick Gallagher, a partner with The Alter Group.

The new mega warehouses cater to the latest inventory management systems with high clear heights, oversized truck docks and plenty of parking. Bay sizes and spacing have changed to promote efficiency as well. New safety and fire components, which are costly to incorporate into smaller structures, are more cost effective in large buildings.

Finally, the modern buildings are more attractive than their lifeless, boxy predecessors because Corporate America wants these structures to represent the company. “Today's buildings have a cleaner look,” says Gallagher. “In the Amazon.com building, the architectural detail, especially in the corner elevations, and the amount of glass lines [meet] the highest standards. The amount of glass usage is probably the highest in the Phoenix industrial market to date.”

The big league

As an industrial market, Phoenix clearly outpaces other cities in the Rocky Mountain/Southwest region. Tyson Chave, a vice president for industrial developer ProLogis in Phoenix, says the city is growing more akin to Southern California, Dallas or Chicago in regard to larger industrial structures.

“We are seeing a trend here in delivering larger buildings. This is different from Denver where larger buildings were closer to 350,000 sq. ft. to 400,000 sq. ft. We've got some buildings under construction on the west side [of Phoenix] that are significantly larger, 600,000 sq. ft. to 1.2 million sq. ft,” says Chave, who recently transferred to Arizona from the ProLogis headquarters in Denver.

“The size differentiation is mostly driven by population. We are seeing all our global customers such as DHL Holdings (USA) Inc. and Anixter International Inc. having a presence here,” says Chave. DHL Holdings is the delivery arm of express delivery giant DHL, a subsidiary of Germany's Deutsche Post. Anixter is an international distributor of communication products, wire and cable.

Southwestern sizzle

ProLogis, the largest industrial owner in the world with 422 million sq. ft., owns 3.4 million sq. ft. of industrial space in Phoenix. Earlier this year the industrial giant acquired 78 acres in southwest Phoenix where it plans to invest $70 million in the creation of a 1.2 million sq. ft. industrial park, according to Chave.

Southwest Phoenix is one of the Valley of the Sun's hottest industrial markets, primarily because it offers plenty of land with easy access to freeways. The Alter Group was able to buy 160 acres in the southwest market to develop the $180 million Buckeye Logistics Center, slated for completion by 2011.

Not all new developments are 100-plus acres with mega-distribution capabilities. Niche developments of mid-size acreage are coming on line as well. In an in-fill project in Mesa, the second largest city in the metro area, Lincoln Property is building the 52-acre Broadway Commerce Park, which will total 800,000 sq. ft. The 400,000 sq. ft. first phase is leased mostly to locally operated service companies, such as NAPA Auto Parts.

Northwest of Phoenix, Sacramento-based Panattoni Development Co. in May 2006 acquired 35 acres in Deer Valley, where it broke ground this year on the 160,000 sq. ft. first phase of Alameda Business Park. The second phase will be 190,000 sq. ft., and will bring the total project cost to $45 million. “There is a need for people to be located in Deer Valley to service that part of the Phoenix metro,” says Jason Quintel, a partner with Panattoni. “It's a good place to access I-17 and Loop 101 to get around Phoenix.”

Critical growth phase

Most observers think Phoenix's robust industrial real estate market will get even stronger. “We are not at peak yet,” says Jonathan Keyser, a principal with CresaPartners in Phoenix. Demand is coming from users distributing within Arizona, and national users seeking a distribution and manufacturing site.

Deals in 2007 cover a spectrum of uses, including non-distribution purposes. Lockheed Martin Corp. of Bethesda, Md., for instance, added 50,000 sq. ft. north of Phoenix in Prescott Valley for a training facility while Air Products and Chemicals Inc. of Allentown, Pa., took 72,544 sq. ft. in suburban Chandler for infrastructure and back-up capabilities.

“We see everybody from small, locally owned companies to Fortune 500 firms coming here,” says Chave of ProLogis. They serve California, New Mexico, Utah or Nevada, among others.

In Phoenix, they don't fear earthquakes, hurricanes or blizzards. And the city's transportation infrastructure and proximity to the West Coast make it a natural distribution hub, says Mattox of Behringer Harvard, which recently acquired 65 acres for industrial development one mile south of the city's airport. “Phoenix is growing in population and has the right demographics,” Mattox says. “For logistics, Phoenix is a special spot.”

Steve Bergsman is a Phoenix-based writer.

PHOENIX - BY THE NUMBERS

METRO POPULATION:
4 million

Source: U.S. Census, 2006 estimates

UNEMPLOYMENT RATE: 2.7%

Source: Bureau of Labor Statistics, June 2007

LARGEST PRIVATE EMPLOYERS:

  1. Wal-Mart Stores Inc.
    25,969 employees

  2. Banner Health
    19,662 employees

  3. Intel Corp.
    10,900 employees

Source: Arizona Republic

METRO AREA VITAL SIGNS

Office:

14% vacancy, 2Q 2007

11.6% vacancy, 2Q 2006

$24.66 rent per sq. ft., 2Q 2007

$21.81 rent per sq. ft., 2Q 2006

Source: Cushman & Wakefield

Multifamily:

7.4% vacancy, 2Q 2007

5.9% vacancy, 2Q 2006

$706 effective rent, 2Q 2007

$672 effective rent, 2Q 2006

Source: Reis Inc.

Retail:

6.6% vacancy, 2Q 2007

6.1% vacancy, 2Q 2006

$6.43 rent per sq. ft., 2Q 2007

$6.20 rent per sq. ft., 2Q 2006

Source: Reis Inc.

Industrial:

91.1% vacancy, 2Q 2007

92% vacancy, 2Q 2006

$19.00 rent per sq. ft., 2Q 2007

$18.16 rent per sq. ft., 2Q 2006

Source: Marcus & Millichap

Hotel:

66.7% occupancy, 2Q 2007

67.8% occupancy, 2Q 2006

$114.93 average daily rate, 2Q 2007

$109.26 average daily rate, 2Q 2006

Source: Smith Travel Research

MAJOR PROJECTS:

Broadway Commerce Park is a major in-fill site in the suburban city of Mesa. Formerly a Motorola plant that was torn down, the 52-acre site will eventually boast 800,000 sq. ft. of manufacturing, warehouse/distribution, office and retail space.

Developer: Lincoln Property Co.

Completion: March 2008

Cost: $75 million

Buckeye Logistics Center is a 160-acre industrial park in northwest Phoenix with most of the development being large bulk distribution space of 300,000 sq. ft. and up. Duke Realty acquired the first finished structure, a 604,000 sq. ft. building that was leased by Amazon.com.

Developer: The Alter Group

Completion: 2011

Cost: $180 million

Is the industrial sector growing too fast?

Phoenix's thriving industrial sector is playing havoc with market fundamentals. Until this year, the metro area enjoyed six quarters of declining vacancy rates, from a high of 8.6% in the second quarter of 2005 to 6.5% at the end of 2006. With a flurry of new construction and 11.5 million sq. ft. of industrial space projected to be delivered in 2007, the vacancy rate climbed back to 7.6% this year, reports Grubb & Ellis.

David Krumwiede, executive vice president of Lincoln Property Co. in Phoenix, calls the vacancy rate “phenomenal” and predicts much of the new space will be absorbed.

“We have a high level of interest from potential tenants,” says Jason Mattox, executive vice president of Behringer Harvard, which plans to develop 900,000 sq. ft. of industrial space in Phoenix. The project will serve bulk distribution or Class-A industrial warehouse users in need of 60,000 to 130,000 sq. ft.

New construction dipped below 2 million sq. ft. in 2003 after the high-tech bubble burst and the 2001 terrorist attacks, according to Reis, a New York-based research company. However, rents remained constant for years.

“I've been in this market for 21 years and industrial rents have been in the range of 20 cents to 25 cents per sq. ft. per month for warehouse/distribution space since I started,” says Krumwiede.

Today, rents are climbing again, in some cases to as much as 40 cents per sq. ft. “In the last three years, rents have skyrocketed,” Krumwiede adds.

Most observers expect rental rates to ease as more product comes on line. Sales prices, however, are expected to remain strong.

In August, when The Alter Group began building its 604,500 sq. ft. warehouse building at the Buckeye Logistics Center, the company arranged a pre-sale to Duke Realty Corp. of Indianapolis for $30 million. It was an empty shell with no lease in place.

“That was sold at just below $50 a sq. ft.,” says Gallagher of The Alter Group. “Three years ago, it would have sold in the low $30s per sq. ft.”

Reis provides a snapshot of current real estate prices. In the first quarter of 2007, Phoenix buildings designated as manufacturing sold between $75 to $99 per sq. ft.; warehouse sold for $125 to $149 per sq. ft.; flex office/R&D $150 to $199 per sq. ft.; and general light industrial sold for $200 to $249 per sq. ft.

“Phoenix is hitting that critical growth phase, getting national recognition for office and industrial,” says Jonathan Keyser, a principal with CresaPartners in Phoenix. “Now we are recognized for all different types of facilities.”
Steve Bergsman