CREJ - Office Properties Quarterly - January 2015
For the past 20 consecutive quarters, Denver has seen an unprecedented rise in rental rates in downtown and suburban office markets. Currently,- rents downtown are at record highs, with no clear relief in sight. For reference, the median asking rate for a central business district Class A space today is $33 per square foot, which represents an 18 percent increase from the previous cycle’s low in 2009, when CBD vacancy hit 19 percent. Since then the CBD submarket has absorbed 2 million sf. Hear me now, and believe me later: There is still value to be had in this historically hot office market. But first, some color. The market has seen major upticks in the past, specifically between 2003 and 2007, when investment sales activity was at a then all-time high. During this period, when compared with today’s landscape, we didn’t see the level of demand and absorption, the changing dynamic of tenants in the market or the overall popularity of downtown Denver as a new home for companies (e.g., Ardent Mills, DaVita, Transamerica, On Deck Capital). Furthermore, historically low interest rates have given investors the confidence to “stretch” to acquire assets, driving values higher. Since the previous cycle’s trough in 2009, many factors have led to Denver’s slow and steady climb to prominence. Activity in the energy sector improved with new oil and gas discoveries in the Bakken and Niobrara shale plays. Venture capital firms looked to place their money in startup companies, taking advantage of new developments in technology. Many of these employers who incubated in Boulder have moved to downtown Denver for a deeper talent pool (e.g., Send Grid, Rally Software). Amenities in the form of new restaurants, hotels and transportation gave businesses more to offer their employees. B-cycle and ride-sharing programs have made it easier to navigate the growing downtown area. And last, but certainly not least, the renovation of the historic Union Station put Denver on the global map as a major player in the competition for large corporate offices (e.g., IMA Financial, Antero Resources, First Western Trust, Hogan Lovells). Similar to previous growth cycles, investors are finding great opportunity in the form of rent growth, and have begun to pick off the low-hanging fruit, sometimes even reaching for the tops of the trees, as evidenced by the sales of the two Union Station wing buildings for $600 per sf. There is now more than 1.4 million sf of speculative office product under construction downtown or will be by the middle of 2015. All of these new projects are commanding lease rates in the $45 per sf full-service neighborhood, which allows the existing buildings to “draft” off these prices and raise their own rates. All of the above improvements spelled trouble for those tenants who basked in the glory of their relatively inexpensive overhead for the previous five years or so. In addition to the competitive hiring landscape facing most companies, they are now confronted with an even more daunting challenge: how to find a spot that won’t inflate the second-largest expense item in the budget. We suggest the following eight considerations: 1. Rethink the way you approached office space in the past. Traditional industries, such as legal, financial services, oil and gas and even…ahem… commercial real estate houses, are finding new and creative ways to maximize efficiency, while keeping employees happy and engaged. Consider the value of a more open layout with less enclosed offices, more open and collaborative workspaces, and even hoteling options for those who spend less than 50 percent of their time in the office. 2. Keep an eye out for landlords who bought low, thus giving them the opportunity to “reach” for tenants that are currently occupying space in buildings that have recently sold at those higher value numbers. 3. If you’re a technology firm or other Lower Downtown type, consider this – buildings in the central core and Uptown, which often are less expensive than LoDo, can create an environment that fosters creativity by tearing out ceiling grids and tiles, and installing new and clean spiral ductwork similarly found in the renovated warehouses. One traditional office building is taking a unique approach by adding a patio with pingpong tables and corn hole sets; another is adding a rooftop deck. 4. Believe it or not, the investment sales market could work in a tenant’s favor by finding landlords who need to lock down that one last tenant before they put the building up for sale. 5. On that note, seek out landlords who have significant tenant turnover on the horizon and could use more stability. 6. If you don’t absolutely need to be downtown, look to the periphery in areas such as the Golden Triangle, River North, Highlands, Santa Fe Arts District or other areas that offer more relief in the way of base rents, operating expenses and parking. 7. If you’re a startup, keep in mind that landlords aren’t thrilled about the prospect of dumping loads of money into building out space, so keep it simple, unless your investor is ready to come up with some form of a guarantee. Find space that can be re-used or re-purposed and still suit your needs. Get creative with flexible furniture that you can take with you along the way. 8. Most importantly, get into the market early and don’t get caught scrambling at the last minute. It’s a fast-moving environment with surprises around every corner. In short, there are still compelling reasons for landlords to compete for tenants. Open your mind, protect your bottom line and leverage the expertise of those who do this on a daily basis.