CREJ - Office Properties Quarterly - July 2015
About 97 percent of all Colorado oil and gas firms are located in downtown Denver, specifically Lower Downtown and the central business district, which makes it natural to wonder how the decline in crude oil prices is affecting the office market. The Denver office market is much stronger than it was during previous oil price drops, and the drop is not predicted to have much, if any, impact to the overall marketplace. So far, just under 600,000 square feet of space is available for sublease since the price decline, said Tim Harrington, executive managing director in the Denver Newmark Grubb Knight Frank office. The overall CBD market is comprised of about 25.8 million sf, so that space represents less than 2 percent. This dip has not affected rental rates. “I think that there’s a very good chance that it won’t affect rates,” he said. “I think that some of these sublease spaces will get backfilled, and it’s not going to be as negative an impact as it once was back in the 1980s.” The main reason for this outlook is the diversification of the market. Today, the oil and gas industry represents 10,446 jobs in downtown Denver, and 11 percent of all privatesector jobs, according the Downtown Denver Partnership’s Economic Impact of Downtown Denver Oil and Gas Industry study. Taking into account indirect industry firms, the sector takes up 5.1 million sf of office space or 22.6 percent of the total office space downtown. Back in 1985, when prices dropped and Denver office vacancy soared, the industry alone accounted for about 32 percent of the market, which made the city vulnerable, Harrington said. Denver experienced some of the highest vacancies in the world at that time, hovering between 30 and 32 percent. As the market struggled to recoup, full-service office space in brand new, Class A buildings ranged from $12 to $15 per sf. In the early 1980s, the same product would be in the $20 range, he said. Today, government, financial institutions, communications, engineering, legal and accounting sectors all account for at least 10 percent of the market makeup. “We’re so well diversified,” he said. “Denver is extremely healthy.” The current vacancy rates are headed toward 10 percent, said Bruce Johnson, Cresa managing principal. By Cresa’s definition, a healthy vacancy rate is between 10 and 15 percent, in which case the market is at equilibrium and it is neither a landlord nor tenant market. The oil and gas industry would need to give up an exorbitant amount of space to swing the vacancy rates past the 15 percent mark. This available oil and gas sublease space – which has been put up by four or five companies – presents opportunities for other sectors, said Harrington. An interesting comparison to the sublease space now available is the 850,000 sf of space that came on line at 1801 California St., when the Qwest and Century Link deal was finalized in late 2012 and early 2013. That much space was the equivalent to one or two new office buildings coming on line, but didn’t cause nearly as much conversation, said Johnson. And downtown Denver is leasing up that space right now. “I think this is a healthy enough downtown that we’re going to be able to absorb this excess space,” said Charlie Lutz, Cresa senior adviser. “There’s a lot of positive things trending in Denver right now.” With that in mind, don’t expect rental rates to change anytime soon. Compared with the 1980s, building owners have a different mentality, said Johnson. In the 1980s, 13.5 million sf of new product came to market, which contributed to the dramatic spike in vacancy. Presently, there is about 3 million sf under construction. These new buildings are under no pressure to reduce rents unless difficulties in lease-up are experienced after completion. Of all the current office product downtown, most of the buildings are 90 percent leased or better, with many of the leases extending seven or eight years out. These owners don’t need to panic, and they don’t need to respond in a rate-slashing way, Johnson said. A white paper published by Cresa examined the relationship between rental rates and oil prices. The results were inconclusive: • 1985-1986: Oil prices dropped 45 percent and rent rates dropped 15 percent • 1990-1993: Oil prices dropped 32 percent and rent rates increased 19 percent • 1996-1997: Oil prices dropped 42 percent and rent rates increased 6 percent • 2008: Oil prices dropped 42 percent and rent rates dropped 11 percent. However, the same study found a direct correlation between job growth and rent. The University of Colorado Leeds School of Business is predicting the state will add between 30,000 and 35,000 new jobs. (It originally predicted the state would add 45,000 jobs, but readjusted after oil prices dropped.) This correlation would predict Denver office rates will continue to increase. “It’s still positive job growth,” Johnson said. “More jobs means more companies need to lease more space.” In the 1980s, Denver saw 13.5 million sf of new supply delivered, which is almost half the office space in the CBD – the current total is 25.8 million sf, according to NGKF statistics. Up until 1985, demand outpaced supply; after 1985, the opposite was true. Following 1986, there was no new construction until 2000, and from 2000 to the present, a total of 4.1 million sf of new office product has been completed. Denver is witnessing a much healthier balance of supply and demand this time around.