CREJ - Office Properties Quarterly - January 2015
The outlook for long-term growth in Denver’s northwest submarket remains healthy. Overall economic improvements and stable demand from industries with strong employment growth are allowing landlords to maintain direct asking lease rates at higher levels compared to other metro suburban submarkets. Increased activity in the northwest market has exemplified owners’ abilities to maintain elevated rates during 2014. The northwest posted positive net absorption of 188,442 square feet in the third quarter of 2014, due to increased new tenant/expansion occupancy and approximately 154,309 sf of tenant occupancies in Class A product. This is driven by a balance between current tenant expansions and new tenants in the market. Paralleling strong third-quarter absorption figures, 2014’s positive net absorption figures reached 222,826 sf, the highest levels since year-end 2007. Future positive absorption in the market will be driven by Exempla, currently at lease to expand in Oracle’s campus by more than 100,000 sf and ICAT’s signing of a 37,067 sf deal at 385 Interlocken. These tenant transactions exemplify growth and recovery in the submarket. Increased current activity, year to date, is bolstered by organic growth from existing tenants in the U.S. 36 corridor, including the previously mentioned tenants as well as Reed Group, Ball Corp., Epsilon, Biomet and Datalogix. A strong labor pool, solid technology infrastructure, established amenity base and large office projects with ample parking continue to make the northwest submarket attractive to corporate users, particularly with technology-related businesses. The technology industry as a whole has displayed strong economic growth and employment has grown steadily in the sector, benefitting the office submarket. Although large corporate users remained cautious, the steady and continued improvement in corporate balance sheets, the strong performance of the tech industry and improving employment conditions are expected to drive improvements to office fundamentals in the northwest in 2015. As activity gains momentum, the average direct-asking lease rates are expected to maintain current levels. The northwest’s newer product and proximity to strong labor pools are the primary reasons its Class A product remained $2.90 per sf above Class A Southeast product, $7.49 per sf above Class A Colorado Blvd. Midtown product and $6.68 per sf above Class A West product. In contrast, cost-conscious tenants in the Boulder submarket are increasingly evaluating northwest options because Class A product in the northwest remains $7.88 per sf below Class A Boulder product. In the third quarter, the overall average direct-asking lease rate on a full-service gross basis decreased to $23.97 per sf, down 2.3 percent quarter over quarter. Overall, the submarket observed a year-over-year decrease in asking lease rates of 2.8 percent; diverging from overall Denver market increases, but remaining at levels above other suburban markets following significant increases that occurred in 2012. Class A direct-asking lease rates decreased to $29.20 per sf, marking a 2.5 percent decrease quarter over quarter, and a 3.5 percent decrease year over year due to Class A availability and competition. Specifically, the large amount of space leased at EOS caused Class A rates to decrease, because a significant amount of quality space is no longer available. Class B space observed an increase in lease rates to $23.16 per sf, marking a 1.5 percent increase year over year. Reflecting the strongest positive absorption of any Denver submarket in the quarter, direct vacancy decreased to 17.3 percent, a decrease of 246 basis points quarter over quarter and a decrease of 364 bps year over year. Momentum in direct vacancy decreases quarter over quarter and year over year is expected to continue in the final quarter of 2014 and into 2015 as multiple completed deals and active tenants execute deals and occupy space. While small users’ activity continues to be resurgent, larger user activity gained momentum, a sign that larger users are starting to gain confidence from steady economic growth and the prospect of future economic growth. At the end of 2013, strong investment office sales activity in the northwest was capped off with the owner-user purchase of 305 Interlocken (47,444 sf) by the U.S. Department of Agriculture. There were no investment sales in the northwest submarket in the first three quarters. Despite restrained activity in 2014, outside forces driving investment activity in the overall Denver office market (such as the low interest rate environment) and overall strong capital interest in the Denver market are expected to contribute to activity in the final quarter of 2014 and into 2015. Additionally, as prices continue to increase for core assets in Denver’s downtown submarket, investors are looking outside the central business district towards suburban submarkets in order to find lower-priced assets with competitive returns. This trend is exemplified by the two notable projects on the market in the northwest: 385 Interlocken and Superior Point. Strong leasing activity in 2014 allowed landlords to stabilize assets in preparation for future investment activity. As the only suburban submarket with speculative development in the last three years, the northwest saw demand outstripped by new supply, resulting in a challenging leasing environment for landlords. However, this new product provides large floor plates and the ability for new, efficient workspace planning, which is a requirement among many large corporate users. Further development will remain constrained until existing inventory in the market is absorbed. It is predicted that future development in the submarket will be driven by build-to-suit activity rather than speculative development. Long-term growth possibilities stem from improvements to U.S. 36 (providing the infrastructure needed for adequate transportation), a strong labor force, improving amenity bases and well-located retail and residential developments. Headwinds such as lackluster macro-economic growth, a supply and demand mismatch and a developing infrastructure are finally subsiding in the region and 2015 promises to be a positive year for northwest office market fundamentals.