CREJ - Office Properties Quarterly - April 2015
Denver’s office market and economy continues to thrive in 2015. Colorado’s 2014 year-end unemployment rate was 4 percent. Denver was the No. 1 city in the nation for millennial population growth in 2014, and it is estimated that 22 percent of Denver’s population is made up of millennials. Colorado had approximately 1.65 percent population growth in 2014 (fourth in the nation) and is now ranked the No. 2 city for number of bachelor degrees per capita. The 2014 year-end job growth was approximately 60,000 jobs. These dynamics resulted in Urban Land Institute ranking Denver the No. 4 market for commercial real estate investment in 2015, and Business Insider Magazine ranks Denver as the most comprehensive city for economic growth. Denver’s office investment market started rebounding in 2010. Some of the investors that were willing to make acquisitions early in the recovery are now harvesting profits. Two examples of this are The Triad at Orchard Station and Offices at The Promenade. M&J Wilkow purchased The Triad in 2012 for $63 per square foot at 72 percent occupancy. The asset was retrofitted and rebranded by the ownership over a two-year period. At the time of purchase, market rents were $16-$17 per sf; today they are $21-$22 per sf gross. The Triad is back on the market for sale and will prove to be a case study on market timing and value enhancement execution. There are currently several office listings that were purchased between 2006 and 2008, and the holding periods were extended due to the Great Recession. Denver weathered the downturn better than most markets. Numerous office owners were successful in holding through the recession, and they can now exit with upper-teen returns. Occupancies are nearing 90 percent, and rents are at levels exceeding past cycles. Upside potential today in Denver is rolling existing leases to market in an improving rental market. It’s typical today to see rents in place at $3-$5 per sf below current market rents in the primary suburban markets. Core-plus capital is aggressively pursuing assets in Denver, and they target 60 percent roll or more in the first three years of the holding period. Cap rates continue to compress as new capital pursues Denver office listings. There were 18 office trades above $15 million in fourth-quarter 2014; 11 of them sold to new investors to Denver. The capital pool spans from New York to California domestically, and Canadian capital is the most active foreign capital. Cap rates continue to compress as the depth of buyers increases. The 10-year bond has been below 2.25 percent since the end of November. At the time of this article, the 10-year is at 1.94 percent; it was as low as 1.67 percent on Feb. 2 (volatile). This has resulted in interest rates for long-term debt being plus or minus 4 percent. Most conduits and life companies are offering between two and 10 years of interest-only rates, depending on the loan to values and the creditworthiness of the borrower. Bank or fund bridge debt can be in the mid-3 percent. Hence, a 6 percent cap results in a positive leverage return of 10 percent during the interest-only period. Commercial real estate is the preferred investment vehicle as the risk and reward can provide higher returns than alternative investments. Denver’s most preferred core and core-plus markets are the infill locations of Lower Downtown, Cherry Creek and Boulder. There is about 1.25 million sf of new construction underway in LoDo and the west central business district. LoDo has a vacancy rate under 4 percent, and leases that were signed in 2008-2009 can be $7-$8 per sf below market today. Cap rates can be in the upper-4 percent for trophy assets constructed during the last cycle to mid-5 percent for redeveloped historic brick and timber properties. Prices per sf can range from $300 per sf for core-plus properties to mid- or upper-$500 per sf for trophy and core opportunities in LoDo. Cherry Creek is transforming from a dominant retail destination to a live, work, play environment. Cherry Creek is becoming a LoDo/millennial environment that caters to adults with some of the highest incomes in Denver. Due to the recent zoning change, there are two office assets, two multifamily properties and a hotel under construction. Leasing activity is strong and rents for new office product are in the mid-$30s per sf triple net. First Avenue Plaza (55 Madison and 44 Cook) recently traded for $285 per sf and under a 5 percent cap rate. Boulder is in the midst of a transformation due to a significant amount of value-add capital being infused into the market over the past three years. Unico and Goff Capital Partners both made significant investments into portfolios of older assets in Boulder’s core and eastern markets. With the repositioning of these properties, Boulder became even more attractive to technology and biotech companies. Office rents are increasing significantly, and the downtown core of Boulder can be in excess of $40 per sf triple net. Due to the lack of opportunities in Denver’s CBD and the low yields of assets in LoDo, investors are fully engaged in pursing core and core-plus listings in the southeast suburban market. Twelve office sales occurred in the fourth quarter above $15 million. Prices ranged from $66 per sf for a vacant call center facility to $210 per sf for a core-plus Class A multitenant building. Overall, Denver continues to be one of the most preferred locations in the nation for office investment capital. Transaction flow continues to increase as new domestic and foreign investors pursue upside in a rising rental rate environment. The Denver office market is experiencing benchmark prices per sf as lease rates exceed peak levels of previous cycles, and cap rates continue to be at historical lows.