But high vacancy in many areas continues to serve as a reminder of the magnitude of challenges ahead. Areas with high vacancy include those where the housing downturn was most severe. In Surprise and El Mirage, the vacancy rate in properties opened since 2007 exceeds 25%. Several spaces in these areas will remain dark this year and not become viable retail locations until the housing market strengthens. High vacancy and recent rent declines will sustain average cap rates of around 10% for multi-tenant assets. Intense interest in top-rated single-tenant properties, though, will keep cap rates for these properties near 7% in the months ahead.

At the end of 2010, nearly $1.5 billion of retail properties in the market were considered distressed, one of the largest amounts in the country. While distressed property listings will provide attractively priced opportunities for investors, they will continue to come to the market very slowly as lenders elect to stabilize or restore property performance before listing.

On a positive note, trophy retail asset sales will be primarily single-tenant net-leased sales in prime locations. There has been incredible demand among private and institutional investors for credit-quality, class A net leased assets. As more perceived risk enters the Phoenix retail sector, there will continue to be a flight to these properties in prime locations.

Office

The Phoenix office market has bottomed and will experience leasing and investment sales gains in 2011. As the pace of construction falls to the lowest level since the mid-1990s and job growth accelerates leasing activity, the vacancy rate will drop for the first time in five years. More than 800,000 square feet of office space will be absorbed during 2011, particularly in premier submarkets. Fortune 500 companies AECOM and Cole Capital recently inked deals totaling nearly 160,000 feet in the new 24th at Camelback II building, which will help push down vacancy in the area by 210 basis points. Outlying suburbs such as the West submarket, however, will continue to struggle. Vacancy peaked at over 40% in the area during the recession, and several more quarters of household growth and small-business formation are needed to return pricing power to owners.

Office transactions will accelerate this year as property fundamentals begin to move off the bottom and more troubled assets, particularly multi-tenanted properties in less-than-desirable locations, come to market. Private buyers are expected to purchase mid-tier properties in suburban areas for value-add opportunities and a wave of distressed assets and short sales hits the market. As banks unload nonperforming properties from their balance sheets, local and regional syndicates that have been waiting for indications of a turnaround will come off the sidelines to compete for discounted assets. Many of these listings will be vacant properties located in submarkets where construction was robust over the past several years, such as North Scottsdale. Owners unable to refinance loans will return properties to the bank or attempt a short sale, attracting cash-heavy buyers looking for per-square-foot pricing. Maturing debt poses a significant risk to the local office sector since high leverage loans originated at the market's peak will start to come due this year. Refinancing these loans will be nearly impossible for many owners without significant equity contributions, which could result in more REO activity and short sales. At the start of this year, the CMBS delinquency rate in the Phoenix office sector was already above 20%, and it stands to rise further as vacancy in the metro remains in excess of 25% over the next 12 months. Commercial real estate activity in Phoenix will occur on opposite ends of the investment spectrum this year. As a result, well-capitalized private investors, as well as institutional investors, will continue to compete for trophy product. The polarity of the market will attract some new investors as well. Over the past 18 months, there has been an influx of Canadian investors seeking single-family housing throughout Arizona, and those investors are now seeking to acquire assets at a discount. As the year progresses, expect Canadians and other foreign investors to target distressed multifamily and multi-tenanted retail properties.

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