Since the Great Recession, infill development has been hot in Phoenix. Real estate prices were low and developers and businesses were snatching up land and vacant properties left and right. Tenants were swarming to be a part of these resurgent trade areas. But Phoenix has seen a bit of a slowdown in infill commercial development recently, with four important factors causing the current trend.
Prices of land and potential redevelopment properties have seen significant increases in the last couple of years. Despite some demand from tenants, the property cost increases are not exactly sustainable for continued infill commercial development, at least at the pace we’ve previously seen. Much of this increase is due to seller expectations. The surge of activity post-Recession drove prices up, and now, even with activity cooling, sellers expectations for potential redevelopment properties are out of line with the current market conditions. In turn, many tenants are now being priced out of infill properties, and overall more reluctant to invest in infill real estate.
Tying into the fact that infill commercial real estate prices, as well as seller expectations have increased, tenants demand is beginning to level off. While at one point, particular infill properties were drawing attention from a handful of tenants, they are now seeing that drop to possibly one or two.
One contributing factor to the desire for less expensive real estate is the more expensive labor costs that many retailers are dealing with. The increase in minimum wage at the beginning of 2017 has forced some retailers to either pull back or reassess their expansion plans. Retailers who are in expansion mode, are often looking towards less expensive real estate, in attempts to offset the increased labor and operating costs.
While retail sales are up nearly 4% over the first five months of 2017 compared to the same period of 2016, overall sales have remained relatively weak to start the year. Sales dipped 0.3% in May, the largest decline since the beginning of 2016. That being said, many tenants are taking a more cautious approach to expansion.
While the economy and commercial real estate development have seen upticks in activity in recent years, the labor force has not followed suit, resulting in overall higher construction and development costs. Over the last year, material costs have somewhat leveled off, but the labor costs are expected to increase 4-5% year over year.
This is in large part to the labor shortage in the the construction industry. Between 2005-2015, 15.8% of U.S. construction workers left the industry. Many of these workers never returned, and labor costs have continued to rise because of it.
So, as we look at infill commercial real estate development, we’ve seen supply and demand somewhat mismatch itself. Demand has weakened due to the rising cost of commercial real estate, labor and development costs, and because of the state of retail. In the short term, we’re likely to see a continued pause in infill development.