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Page 12 — Office Properties Quarterly — December 2016
At North Forest Office Space, we make leasing easy.
We offer affordable lease rates and guaranteed pricing with no hidden costs and upscale amenities.
Your clients can lease what they need today, and then add space as they grow.
Professional, medical and dental space in Brighton, Commerce City, Westminster, Firestone & Thornton • (303) 862-6367
DENVER • BUFFALO • ROCHESTER • AUSTIN
Offer your clients
office space
that grows
with them.
T he election of DonaldTrump
and signs that the country may
be heading toward an inflation-
ary environment have resulted
in a massive sell-off of govern-
ment bonds, creating a temporary
(hopefully) disruption in the capital
markets. As we’ve written in past
articles, the reactionary nature of the
capital markets to geopolitical events
has been exacerbated by the real-time
flow of information from all corners of
the globe.
The selloff has driven yields on the
10-year Treasury from 1.83 percent on
Nov. 7 to 2.39 percent on Dec. 5.The
50-plus basis point increase has sent
interest rate coupons on commercial
real estate loans skyrocketing with
lenders scrambling to understand what
will be the “new normal” for bond
prices in order to benchmark spreads
for the time being.
Denver’s office market has performed
well since 2011 with over 6.5 million
square feet in positive net absorption
and well over $10.5 billion in invest-
ment sales volume in the same time-
frame. Lenders and investors alike view
Denver as a solid office market due
to low unemployment rates and the
increasingly diverse tenant base.The
majority of investors acquiring office
buildings in Denver have utilized short-
term, floating-rate loans from banks
to execute their business plans, which
involve value creation by repositioning
and leasing up the asset.
Though lacking the interest rate
protection of a fixed-rate loan, 30-day
Libor – the most common index for
these loans – has moved only about
40 to 45 basis points from +/- 0.20 per-
cent to approximately 0.65 percent
over the last couple of years.The result
has been effective
interest rates in
the low 2 percent
to mid-3 percent
range, typically with
an interest-only
component, which
creates healthy cash-
on-cash returns and
helps to manage
coverage ratios dur-
ing transition.
Floating-rate loans
also offer the ability
to lend “good news”
capital toward ten-
ant improvements and leasing com-
missions that are accretive to the build-
ing’s value on a capitalized basis. Banks
have been the most abundant sources
of floating-rate capital, although there
has been a slight pullback due to
increasing regulations and exposure
issues as we move further into the cur-
rent cycle. Banking regulations have
introduced classifications such as high-
ly volatile commercial real estate that
aim to limit exposure to riskier projects.
At this stage in the cycle, ground-up
construction financing is as challenging
as it has ever been to obtain without
significant preleasing, lower loan-to-
cost requests or personal guarantees.
The benefactor of the recent hurdles
in the banking space has been the
independent bridge lender category
commonly known as debt funds. Simi-
lar to equity funds raised for the pur-
chase of real estate, these groups raise
capital from various sources to fund
loans for transitional properties.The
lack of regulations in this space allows
these lenders to offer high loan-to-cost
ratios (sometimes in excess of 80 per-
cent), generous interest-only periods
and the ability to
pursue nonstabilized
(sometimes vacant)
properties, all on a
nonrecourse basis.
The premium is
made up by charg-
ing spreads that typ-
ically are 100 to 175
basis points wide of
banks with effective
rates in the low 4
to 5 percent range.
The typical struc-
ture, similar to bank
loans, is a three-year
term followed by two one-year exten-
sions. Beyond the initial funding, debt
funds typically lend additional dollars,
covering up to 100 percent of the “good
news” capital for tenant improvements
and leasing commissions and, in some
cases, will contribute to a capital bud-
get.The sweet spot for these lenders
typically is above $20 million.
Long-term, fixed-rate debt is much
less common in the office space since
hold periods for office typically range
from three to seven years.The two
main lender categories in this space are
life insurance companies and commer-
cial mortgage-backed securities.
Life insurance lenders generally are
in high demand because of their favor-
able loan structures, low interest rates
and prepayment flexibility. Most of the
life companies have specific allocation
targets each year and can afford to be
picky, especially in recent years with
an abundance of activity in a strong
market.With more adversity to risk,
life companies typically shy away from
suburban office with the exception
being Class A assets with strong, stag-
gered rent rolls. Life companies favor
core assets in high-barrier-to-entry
markets like the central business dis-
trict, specifically Lower Downtown/
Union Station, Cherry Creek and Boul-
der.
CMBS lenders create opportunities
for more leverage-sensitive investors
and can offer lengthy interest-only
periods that help maximize cash-on-
cash returns.
The Denver office market has had
a strong run over the last five years
and is still a favored market for lend-
ers. Some of the perceived threats in
the market are easily overcome with
an appropriate amount of research,
especially when comparing present-
day Denver to its past. Once considered
heavily dependent on energy-related
jobs, Denver’s economy has diversi-
fied over the last 30 years to the point
that oil and gas related jobs only use
approximately 5 percent of metro Den-
ver’s office space.While a large concen-
tration of this space is downtown, the
recent turn in oil prices suggest that
the worst is behind us.
Colorado’s unemployment rate sits
at a healthy 3.5 percent with an addi-
tional 63,400 jobs expected to be added
in 2017, according to the Colorado
Business Economic Outlook from the
University of Colorado Boulder. In the
wake of the Great Recession, people
have focused less on following their
jobs and more on location based on
quality of life. Employers have followed
suit, relocating and expanding in the
Denver market to tap into an excep-
tional, highly educated and abundant
labor pool. Denver’s office market likely
will continue to performwell over the
next couple of years because of the
improved fundamentals.s
Jeff Halsey
Vice president,
capital markets,
CBRE, Denver
Brady O’Donnell
Executive vice
president, capital
markets, CBRE,
Denver
Financial Market