CREJ - Office Properties Quarterly - April 2015
The Denver office market enjoyed a five-year run o r obust expansion from 2010 to 2014. Fourth-quarter 2014 vacancy fell to 14.4 percent, the lowest level since the boom year of 2000 and a 560-basis-point decrease from year-end 2009. Quarterly absorption stood at 208,682 square feet, bringing the year’s total to 1.5 million sf. From 2010 to 2014, a total of 6.7 million sf were absorbed. Submarket highlights. The central business district and Northwest submarkets posted the strongest performances for the year, with total absorption of 453,266 sf and 386,255 sf, respectively. Vacancy in the CBD is 12.6 percent, which is down from 13.3 percent in the previous quarter and down year over year from 13.6 percent. Lower Downtown has the lowest vacancy rate of the CBD’s three micromarkets, a drum-tight 7.3 percent. The NW submarket posted a strong performance in 2014, driven by vigorous corporate expansion, new business lines opened by existing tenants and tenants new to the market, culminating in the lowest vacancy since 2000. Vacancy plummeted 481 bps year over year to 14.3 percent. The southeast suburban submarket ended the year in the red, with full-year absorption of negative 218,819 sf. This loss, an anomaly, was due to significant downsizing by First Data, from 330,000 sf to 99,000 sf, and the first wave of migration of Charles Schwab’s 1,900 Denver-based employees to its new owned campus, which left two vacant buildings. Although the latter move was a driver of more than 250,000 sf of negative absorption, Schwab’s commitment to Denver promises substantial positive economic impact. The financial services firm plans to add up to 480 highpaying jobs over the next five years, and its 47-acre site has the space to accommodate 4,000 employees. Class A and B dynamics. The Denver office market’s Class A and B office sectors both continued to improve. As is typical in a recovery cycle, the Class A sector was the vanguard as tenants took advantage of relatively low Class A rates to upgrade space. After several years of flight to quality, recovery then trickled down to the Class B product due to the widening lease rate delta and lease up of the desirable Class A spaces. Class A vacancy plunged 610 bps from a cycle high of 19.1 percent at year-end 2009 to end 2014 at equilibrium (the point at which neither landlord nor tenant has a clear advantage) at 13 percent. Class B vacancy fell 490 bps during the same period to 16.5 percent. In 2014, Class A and Class B were neck and neck in terms of absorption with both sectors absorbing more than 600,000 sf. Rental rates. Upward pressure on asking rates continued in the CBD and NW submarkets. CBD Class A rates increased 7.9 percent year over year to $34 per sf, and NW Class A rates rose 7.5 percent to $25.54 per sf. These rates represent historical highs. Development. Denver’s strong economy and market fundamentals opened a development window: 11 office projects, totaling 2 million sf, are under construction or renovation. Development is concentrated in the LoDo micromarket of the CBD, and the SES and midtown submarkets. Investment. In 2013, Denver’s office investment market enjoyed its best year since 2007 with 11.8 million sf valued at $2.2 billion trading hands. In fourth-quarter 2014, sales totaled 5.7 million sf valued at $598.6 million, which pushed 2014’s totals past those of 2013, to 14.3 million sf valued at $2.3 billion. During 2014, Denver continued to be a hotbed for equity placement, with an influx of new institutional and international equity to the Denver metro area driving core pricing. Of particular note were the sales of the new Union Station “wing buildings,” which traded to GLL Properties, the U.S. subsidiary of GLL Real Estate Partners Gmbh, for a record-shattering $600-plus per sf. Suburban office sales led transaction velocity in the latter half of the year. Spreads between Class A and Class B rents have become significant and will affect investment patterns in 2015, prompting capital sources to move down to Class B product in order to chase yield.
Many CBD employees are petroleum engineers who are in short supply and would be retained except under the direst of conditions. Large oil companies, who are in turn the largest occupiers of office space, have the ability to hunker down and wait out the cycle, but some smaller firms, especially those burdened with debt, may fold or be ripe for acquisition. Finally, the CBD is not overbuilt and, reportedly, tenants committing to or looking hard at new and planned products are most exclusively technology, law and financial services firms – not oil and gas. Many experts project that oil prices will recover in the next 15 to 18 months and, if this is accurate, the effects on Denver’s CBD will be minimal. In any case, the CBD’s diverse tenant mix will prevent a reprise of the devastation wrought by the oil bust of the 1980s. “Denver has reinvented its economy since the dark days of the late 1980s and early 1990s when massive overbuilding, tax law changes and a plunge in oil prices conspired to send the local real estate market into the tank for the better part of a decade,” said Bob Bach, NGKF’s director of research, Americas. A recent study by the Brookings Institution ranks Denver in the top quartile of the nation’s largest 100 metropolitan areas for employment in advanced industries that depend on highly educated research and development, and scientists, technology professionals, engineers and mathematician workers, said Bach. The study notes that these industries will play an outsized role in powering regional and national economic success.