CREJ - Retail Properties Quarterly - May 2015
As we near the halfway point of 2015, the Denver metro area continues to be one of the top markets in the country to invest in retail properties. Overall vacancy rates are approximately 5.8 to 6 percent, and are anticipated to decrease slowly over the year as tenant demand will outpace supply. By year-end we expect vacancy rates in the Denver metro area to be in the 5- to 5.3-percent range. The lack of supply also is going to result in continued upward pressure on rental rates, with rents rising 3 to 3.2 percent over the course of 2015 (after increasing approximately 2.5 percent in 2014). Strong fundamentals and historically low interest rates, coupled with a lack of quality investment properties currently on the market, result in a strong environment for sellers of retail investment properties. Strong job growth in the metro area is one of the biggest drivers behind the declining retail vacancy rates. Employment grew by 3.2 percent in 2014, which is more than 50 percent higher than the national average. It is anticipated that employment will grow by about 3 percent, or 45,000 jobs, in 2015. The continued strong job growth environment, coupled with oil prices remaining low ($56 per barrel at the time this article was written), should lead to strong consumer and tenant demand. While there may be some reduction in employment in communities that have been heavily reliant on the shale-oil boom, as low oil prices lead to layoffs and reduced hiring, the overall impact on the purchasing power of consumers in the Denver metro area will be a net positive. While strong job growth and low oil prices have resulted in increased tenant demand for retail space, the supply side of the equation has remained muted. There are a number of reasons for the lack of new development, including stricter lending requirements, the high cost of construction and a focus by many developers on redeveloping or rehabilitating older infill assets. Even though new developments are limited, there are some notable projects in the works. The largest retail development under construction in the Front Range is Alberta Development’s Promenade at Castle Rock, which will include over 1 million square feet of retail and 320 apartment units. Demolition work recently began on one of the largest infill redevelopments currently in the pipeline, Continuum’s mixed-use redevelopment of the former University of Colorado hospital campus at Ninth Avenue and Colorado Boulevard. The mixed-use development will include 250,000 sf of retail, 125,000 sf of office and approximately 1,000 apartment units located on 26 acres. The total cost of the project is estimated to be more than $400 million, with the first stages coming on line in 2017. Another large development along the Colorado Boulevard corridor recently was announced by the city of Glendale. Glendale 180, a 300,000-sf entertainment center located off Colorado Boulevard at Virginia Avenue, is projected to break ground in the fall. One of the largest rehabilitation projects in the works is General Growth Properties’ $75 million to $80 million renovation of the Southwest Plaza Mall, with the intent of bringing the mall back to its once region-dominating form. For a point of reference of the scope of this rehabilitation, GGP paid $113 million for the mall when Matlock Group exclusively listed and sold the property to GGP in 1998. In addition to these larger projects, developers are targeting trendy and up-and-coming neighborhoods like the Highlands along the 38th Street corridor west of Interstate 25, River North Art District and Sloan’s Lake Park, where they are building smaller retail and mixed-use developments. A few of the developments and redevelopments include the redevelopment of Elitch Lanes into a Natural Grocers at West 38th Avenue and Tennyson Street; the redevelopment of the H.H. Trammen Building in RiNo at 27th and Larimer streets into The Market, which will offer fresh produce, meats, cheeses and baked goods; and the Sloan’s Lake Park mixed-use development that will include an Alamo Draft House movie theater and 14,000 sf of retail. Another mixed-use development recently began demolition at 35th and Larimer streets in RiNo, and is scheduled for completion in early 2016. The development will include 10,000 sf of retail and 62 apartments. The development by Littleton Capital Partners is being funded in part by Fundrise, a leader in real estate crowdfunding, which recently expanded into the Denver market. One thing we continually hear from investors is that there is a lack of investment opportunities in the Denver metro area. Strong fundamentals and a seemingly neverending string of good press, including landing at No. 4 on Urban Land Institute’s 2015 Markets to Watch report, has Denver near the top of buyers’ investment lists across the country. Additionally, recently we have seen an increase in interest from international investors, although they tend to target only larger, cream-of-the-crop Class A properties. According to CoStar, there were 29 retail investment sales of over $2.5 million during first-quarter 2015 totaling almost $233 million in value. The largest of these transactions was Quebec Square at Stapleton, which was purchased for $52.25 million at a 7.1 percent capitalization rate. The 269,580-sf power center includes the following tenants: Ross, PetSmart, Party City and Office Depot. The property is shadow anchored by Walmart, Sam’s Club and Home Depot, which were not included in the sale. Moving forward, we expect it to remain a seller’s market unless and until there is a sizeable jump in interest rates in a short period of time. At the moment, interest rates remain near all-time lows, with the 10-year Treasury rate near 2 percent. However, as interest rates rise, capitalization rates will rise with them. Cap rates will not necessarily increase in lock-step with interest rates, as current spreads being charged by lenders are significantly greater than they were before the economic downturn, so there appears to be room for spreads to compress if competition heats up among lenders in a further improving economy. The biggest threat to the seller’s market is a sudden spike in interest rates, which will inject a layer of uncertainty into the market, put upward pressure on cap rates and make buyers more cautious. Higher interest rates also will make other investment vehicles more viable for investors chasing yield. If the Federal Reserve is able to thread the needle and slowly increase interest rates over time, coinciding with an improving economy, the impact on investment properties will not be as great as decreasing vacancy rates and increasing rents should offset some of the value lost due to an increase in cap rates.