CREJ - Office Properties Quarterly - April 2015
Southeast suburban Denver is proving to be a dynamic and highly sustainable submarket for owners and tenants. Opportunities abound across more than 40 million rentable square feet of office space, with abundant options for tenants and significant movement among spaces. And it’s always easy to find a parking spot. Since recovery from the Great Recession began in June 2009, 17 of the 22 quarters have seen positive absorption. In a few cases, tenants have exited the Denver area or moved to a different submarket, but what is perceived as a setback for the landlord community only generates opportunity for tenants. Investment activity in SES is fascinating. Transwestern’s Investment Services Group tracks sales activity, and watched a compression of capitalization rates from 2012 to 2014 of more than 100 basis points for stabilized Class A product, and over 65 bps for stabilized Class B product. For this purpose, “stabilized” is defined as 85 percent occupied or greater. The practical application of this scenario for tenants is that the owners’ bases have risen dramatically, commanding higher rent for recently acquired product. Class A asking rates climbed an average of 4.78 percent year over year since 2010, while Class B asking rates followed with an average climb of 4.17 percent during the same time period. Given the customary 50-cents annual rental bumps, tenants that executed leases in 2010 will see a disparity of $2.32 per sf increase (in favor of the owner) in market asking rates compared with the ending contract rate for Class A space, and compared with $1.10 per sf disparity for Class B space. Another recent phenomenon is the rise in construction costs since 2012. Today, $45 per sf is the new $30, and $65 per sf is the new $40. In a buildout situation, it is becoming obligatory for owners to expend greater amounts of capital, which either will affect their margin or be amortized into the rental rate. This rise in construction cost contributed to increased rental rates, and made it more valuable to salvage existing infrastructure when planning new office space. With over 30 large-block tenants (30,000 rentable sf or greater) currently in the market, representing over 3.4 million rentable sf of space, turnover is unremitting. This statistic is intriguing because the large-block tenants in the market represent approximately 8.5 percent of the overall inventory. Typical users in the SES submarket include professional services firms, communications companies, financial services firms and engineering firms. Among the development community there is a clear direction for “urbanization” of the SES Denver market. For new developments to be successful, proximity to light rail and walkingdistance amenities are key. There are more than 30 proposed office projects in various development stages across the SES Denver. Here is a practical application to tenants confronting an office-leasing situation: Start early. Time is your friend. Forward-thinking companies that want to uncover all opportunities to drive value from real estate should approach the market well in advance of the renewal-option notice date. Trust your adviser. Interview multiple tenant representation specialists to ensure the right fit for your requirements and your business. Crossexamining multiple groups will give you access to several perspectives and ensure you are engaging the best team to handle your transaction. Don’t settle for the status quo. Many real estate professionals can point to comps and trends in the market, but few look for ways to deliver outlier results that disrupt the norm. Assembling a team of real estate professionals with diverse skill sets leads to the best solutions. Every lease is an opportunity to drive value, not only economically, but also emotionally by creating a physical space that will attract and retain employees. Understand why. Building ownership structures all have different goals and objectives. Negotiating with a real estate investment trust, private owner, institution or foreign entity presents different challenges that require insightful audience analysis. Cover the bases. Understanding the basis and financial structure of the asset in question can pay dividends in your negotiation strategy. Focusing on buildings with low amounts of debt and low bases can add substantial flexibility to the owner’s abilities. Recognize the details. Office leases are complicated financial instruments that require acute attention to every detail. Buildings will trade owners, but the lease documents will remain in place, commanding tenants’ outcome.