CREJ - Office Properties Quarterly - July 2015
The Colorado Springs office market was crawling slowly out of the recession for the past several years and finally is reaching a point of stabilization and growth. There are a couple of key components to the market that are critical to understanding future trends. First, in all three office submarkets – central business district, north Interstate 25 corridor and the airport area – a significant portion of the overall product type was constructed in the mid-1980s, and the general consensus of the marketplace is one of “tiredness” for these buildings. This perception has two distinct responses by the market; the first of which is downward pressure on lease rates as landlords must get aggressive economically to compete and buy tenancy. The second is an overall flight to quality whereby tenants are gravitating toward the newer, higher-quality assets. In some ways, we are in the middle to end of a marketwide shift wherein many of the historically competitive buildings in the office market have become functionally obsolete. These properties either will become owner-user buildings going forward or stagnate until they are repurposed. This movement toward new, higher-quality buildings that we have seen over the past five years has an adverse effect on the vacancy numbers, which averaged 20 percent vacancy between 2009 and 2014. In reality, when we break out the truly competitive subset of office buildings in each of the submarkets, the vacancy rate is in the 12 to 14 percent range and dropping (albeit at a modest pace). The other component affecting the market is the discrepancy between the lease rates that are acceptable to the landlord (market rates) and the cost of the tenant improvements, which seemingly have increased at a noteworthy pace. When looking at the total Class A and B office market, consisting of approximately 9 million square feet, the current average asking lease rate is $13.20 per sf triple net. Note that this rate is an average and does include a handful of buildings, about 15 percent of the total market, that are priced in the sub-$10 range in order to attract value users who are not as quality concerned. With tenant improvements in the $25 per sf range and in many cases (certainly for first-generation space) construction costs climbing well into the mid-$40s per sf, simple math dictates that these are transactions that any prudent landlord would not execute. While on the surface this seems like a problem easily solved by either the tenant coming out of pocket for TI, the lease rate increasing or an amortization into the lease rate, this stumbling block is causing disruption in the deal cycle. It may be several months before the market adjusts and accepts these costs versus rate discrepancies and the solutions become acceptable as “the new market.” As we look into the future of the office market for Colorado Springs with the affects of the two aforementioned trends, we predict a continued strengthening market for landlords and a tighter, more competitive and less tenant-favored environment for users. The vast majority of the tenant activity in the past several years was from companies with a local presence expanding and relocating within the marketplace. As we move through 2015 and beyond, we anticipate additional job growth from new companies relocating and expanding into Colorado Springs. Given the demand for the higher-quality product and the increase in TI costs, we anticipate continued rent increases and a growing gap between the higherand lower-quality buildings. While Colorado Springs never will reach the velocity of markets like Denver, the lease activity, absorption and overall market demand is steadily increasing and all indications are for that momentum to increase into the foreseeable future.