Irrational exuberance may now be out of fashion in the residential and commercial real estate markets, but so far gloom hasn’t taken its place.

Instead, strength in the overall economy along with Tucson’s continuing advantages are keeping prices up and inventories low. That was the consensus of a panel of real estate experts who spoke last week at the mid-year real estate market overview presented by Tucson Realty & Trust. Interest rates and construction costs have risen, as have prices and the sale of vacant land has slowed dramatically.

However, tight supply and continued demand is keeping the local market up, even as some places, including Phoenix, are beginning to feel the pain.

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“We’re not going in the tank,” said George Amos, president of the Tucson-based commercial brokerage.

“This year is definitely not like last year,” he said, “but some buyers are going to continue to do well, and opportunities will continue to be there for them.”

Vacant land sales continue to be the most susceptible to changes in the residential real estate market. Associate Broker Richard Foerster said there’s now enough committed residential property to last the Tucson metropolitan area for the next two decades, but that doesn’t mean there’s too much inventory.

“Land prices, like the price of gasoline, are at an all-time high,” he said, “and should remain high.”

What’s keeping prices up in the Tucson area is the continuing arrival of between 18,000 and 25,000 new residents per year and growth of trade with Mexico. Plus, Foester said there’s a limited supply of available vacant land for residential development.

“Tucson should continue to grow and prosper,” he said, “and that means land prices will hold firm.”

Even as home builders step back, canceling escrows and selling off excess inventory, Foerster said investor money is likely to remain.

“What are the alternatives? If they paid cash for the property, they can continue to hold on,” he said, until demand catches up.

Industrial outlook

When it comes to industrial real estate, the issue is the continued decline in supply, especially for larger warehouse and manufacturing spaces. More than a million square feet of Tucson’s largest vacant industrial buildings have been acquired or leased over the last year, including La Costeña Foods’ acquisition of the 440,000-square-foot former Slim-Fast plant at 8755 S. Rita Road.

This has pushed the overall vacancy rate down to 14.5 percent, “the lowest it has been in 10 years,” said Tucson Realty’s industrial specialist, Patrick Welchert.

Although construction of 500,000 square-feet of additional industrial space is scheduled to be completed in the next year, all of it is for buildings of 15,000 square feet or less “and all new construction is coming out of the ground for $100 per square foot.”

This is pushing rental rates higher, Welchert said, “to about $7 to $8 per square foot on the Northwest side, with good freeway access, and about $4.50 per square foot on the south side, at the Butterfield Business Park.”

“For 15 years, Tucson’s industrial property market has been depressed. That’s changed and now we’re underserved,” he said.

Because of the perceived opportunities of the Tucson market, including mainline rail access to the Port of Los Angeles-Long Beach and the rest of the nation, he dismissed the risk that rapidly increasing industrial vacancy rates in the Phoenix area, especially for 100,000-square-foot or larger structures, could put the brakes on Tucson’s industrial growth.

“Even though our market has tightened up, the costs are still lower than other places,” Welchert said, “and reaching a million in population has taken us from being considered just a small college town and put us the radar screen for business expansion.”

Retail outlook

Because “retail follows rooftop,” Tucson Realty’s retail specialist, Tim Bentley, said demand for shopping and restaurant space will continue to be strong for several more months. But if the housing market continues to slow, so will retail construction, he said

Approaching the 1 million population benchmark is bringing a variety of national retailers to Tucson, building or leasing 20,000 to 90,000 square feet of space, each. While this has created a net absorption gain of 552,000 square feet, Welchert warned, “We’re not seeing a lot of activity in the smaller retail segment.”

High prices for land and rising construction costs are pushing up rental rates by as much as 15 percent, “up to $35 per square foot in desirable areas. This means smaller retailers are getting priced out of the market.”

Office space

Also facing resistance to higher costs is the office market, where finished space is now priced at up to $300 per square foot. In combination with higher interest rates, the rising expense is pushing owner-occupants and investors to the sidelines. This, in turn, may turn out to be a windfall for multiple-tenant buildings, office market specialist Michael Gross noted.

Even downtown Tucson is benefiting, he said. With the competitive office space market at a vacancy rate of 12 percent, likely to dip to 10 percent in the near future, “downtown has done relatively well.”

There will be some major new vacancies in the Tucson market in the next few months, especially as medical software firm Misys vacates 180,000 square feet, “but that will be on the east side,” Gross said.

“There hasn’t been a big office building constructed in Tucson in years,” he said.

As a result “owners of Class C buildings could do well. As office space gets harder to find, they’ll be able to hold out for a better price, and they’ll also have an incentive to improve the appearance of their buildings, which will mean they can charge more.”

In conclusion

While the investment market is in transition, with the future of up to 3,000 apartments scheduled for condominium conversion in doubt, Amos said the greatest threat isn’t from the market, it’s from the news media.

“There’s the threat of a self-fulfilling prophesy,” he said. “People hear or read the news that interest rates are up and the home market is slowing. They decide to wait, and that’s what causes the market to slow. When people start to believe something, it can come true. Perception can become reality.”

For Tucson, the danger is that negative perceptions may cause somebody in St. Louis, Milwaukee or elsewhere to hold on to their equity in the home they already own and not risk a move.

“This isn’t about interest rates because the change doesn’t affect payments that much. People will hold onto property or walk away from deposits because of what they hear,” he said.

Instead of gloom, Amos said people should look at the overall economy, “which remains pretty good.”

The end of the frenzy means less “irrational” buying, but that’s good news, he said. “We’ve left behind speculation and are back to the tried and true, buy low and sell high.”

E-mail comments for publication to editor@azbiz.com. Contact Philip S. Moore by e-mail at pmoore@azbiz.com or call (520) 295-4238.

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