CREJ - Retail Properties Quarterly - September 2015
With 1.5 million square feet of absorption in the past three quarters, our retail market is at a highpoint midway through 2015. Marketwide vacancy, which has been declining consistently since 2012, is hovering around 5 percent and the average asking lease rate is at $15.48 per sf, a 2 percent increase from a year ago. Compared to most markets around the country, Denver fared well in the most recent downturn and has not looked back. Denver is experiencing positive employment and housing growth. Colorado had population growth of approximately 1.65 percent in 2014, ranking No. 4 in the nation. Our current unemployment rate is 4.2 percent, compared with 5.5 percent nationally. We have had steady job growth since the recession, ending 2014 with an increase of approximately 60,000 jobs. Our prosperity is a product of an elongated run of positive economic fundamentals accompanied by a historical imbalance in the retail space being delivered. Over the last 30 years, Denver delivered an average of over 3.5 million sf of retail space on an annual basis. Since 2010, this number has barely eclipsed 1 million sf per year, which is the case over the last 12 months as well. The current momentum undoubtedly will bring an increase in construction, yet it promises to stay controlled as stricter lending requirements, rising cost of construction and onerous entitlement policies will keep new inventory in check. Additionally, tenants are eager to find infill locations where new development is more complicated, costly and time-consuming. Housing starts are up 19 percent from this time last year and we are on track to exceed the 8,000 single-family starts from 2014. This is a figure that is unmatched since 2007. Additionally, there are 40,000 multifamily units under construction or planned in the metropolitan area. This construction is a direct impact of the millennial generation, which is widely seen by retailers as a lasting consumer base. Denver was the No. 2 city in the nation for millennial population growth in 2014, according to Slate.com, trailing only Austin, Texas. It is estimated that 22 percent of Denver’s population is millennials. Another main factor contributing to Denver’s success is the diversification in our economy. Prior to this cycle Denver was known for having an upand-down, boom-bust economy. The new economy boasts growth in key industries such as health care, financial services, technology, aerospace and energy, none of which has more than 18 percent of the economy, energy included. This diversification brings sustainability to our current market trends and creates a fundamental shift in Denver’s appeal to investors worldwide. This dynamic resulted in Urban Land Institute ranking Denver the No. 4 market for commercial real estate investment in 2015, and Business Insider Magazine ranking Denver as the most comprehensive city for economic growth. Recent sales in Denver show a steady line of new buyers to our market. Led by Canadian capital, these buyers consistently include institutional-grade international capital for the first time. For most capital, the main concern is not with wanting to be in Denver, but rather finding enough larger, quality assets to purchase. Denver earned a spot at the table when there is a record amount of capital available to invest in real estate (reported to be up 25 percent, to nearly $250 billion). The cards are stacked in our favor. Values for retail properties will continue to climb, as the lack of available space will drive lease rates higher. With quality (credit and lease term) as the main factor, cap rates will continue to compress, especially for the highly sought-after grocery-anchored and power centers. Single-tenant and small-format retail will experience the same success as anchored assets and remain the option of choice for private trade buyers. We will see increased construction at a controlled pace. Even with the recent closings of several Safeway stores, the grocery sector will continue to surge, evidenced by the recent opening of Evergreen’s King Sooper’s Marketplace at Serenity Ridge in Aurora. Others in the sector, such as Sprouts, Trader Joe's and Whole Foods, also will see new store openings. Fueled by unprecedented cap rates for large quality projects, we already are seeing development and there will be more to come including Promenade at Castle Rock, Glendale Riverwalk and University of Colorado's Ninth Avenue campus, as well as others. Although the number of transactions will increase, retail investment sales volumes may taper. Cap rates also may rise, based on the nature of the product offered to the market. Sales volume was down in 2014 as a number of high-profile power centers were sold in 2013, which was kicked off by the sub-6 cap rate sale for the south Denver marketplace. Although Denver has been a value-add trader's market, grocery-anchored shopping centers historically have traded to portfolio-minded ownership. This phenomenon, coupled with the number of power center and grocery-anchored sales in the last few years, has left few larger, quality assets for the investment marketplace. With new development lagging, the imbalance between supply and demand will widen and cap rates will continue to compress. The average annual cap rate for investment sales has bounced around over the past few years, but this is tied directly to certain types of assets rolling through the cycle at different times. The value trend on any given asset is up and this will continue unless we have a notable increase in interest rates. Available debt continues to create value in the marketplace as 10-year Treasury rates are close to all-time lows, near 2 percent. Interest rates are so low that the spread for lenders remains historically high. Unless there is an unexpected dramatic hike in interest rates, cap rates should not move in direct proportion to rises in interest rates, as lenders take up the cushion in current spreads. In Denver, the impacts of aggressive capital and increasing fundamentals will have a greater impact on value then any anticipated movement of interest rates.