Colorado Real Estate Journal - September 2, 2015
When the economy begins to spiral downward, you may hear reports in the news of falling housing starts, increased unemployment and a reduction in economic output. If this sounds all too familiar, you clearly remember the beginning of the Great Recession. How does the economic cycle affect land development and investors? The increase and decrease in land sales is an indicator of a greater picture, the strength of our economy and whether we are in a period of recession, expansion or somewhere in between. To determine the present state of the economy and its affect on land sales, first we must understand the business cycle as a whole. These periods can vary considerably in length, but are intertwined in the overall economy. Peak. The peak is when the economy is running at full steam. Employment is near or at its highest levels, gross domestic product output is at its upper limit and income levels are climbing. When the economy starts to overheat, inflation rears its ugly head. This translates to a surplus of land sale activity spurred on by investor confidence. Companies are thriving and expanding, and are at an economic strength that allows them to take higher risks. Employment rates are high as well, increasing the need for new housing, retail, industrial and office buildings. Recession. The saying “what goes up must come down” applies here. After experiencing a great deal of development, income and employment start to head south. As the prices of goods are slow to change, they most likely will remain near the same level as in the peak period unless it is a lengthy recession. Fewer cars, appliances, homes and other items are purchased during a recession, and the return to normal spending levels by consumers can take a while following the official end of a recession. The same occurs with businesses that make cuts on payroll, equipment and facilities. Retail businesses usually are among the first to delay opening new locations, while other types of commercial businesses quickly follow. Land sales for retail and all other types of commercial development came to a halt from 2009 to 2011. Trough. This period sometimes is referred to as a depression period. Depending upon the length of the trough, this is the time where output and employment are in an inadequate place and where businesses are looking eagerly for the next phase of the cycle to begin. Land sales generally cease to exist by the time the economy hits the bottom of the trough. Expansion and recovery. The economy grows once again and moves away from the all-time bottom experienced in the trough. Income, production and employment grow and the economic climate is good. The early stages of expansion and recovery allow businesses to acquire empty buildings as they expand. A healthy expansion will result in full absorption of available building supply resulting in land sales for new development to occur. So, where are we now, Colorado? The recession finally was put behind us starting in 2014 as we experienced major acceleration. Colorado officially entered the economic expansion and recovery period, which resulted in an increase in land sales and development. Among the numerous property types, multifamily typically requires the most initial new construction in order to satisfy new demand. Other businesses with larger building requirements including warehouse, distribution and manufacturing facilities, follow multifamily growth fairly quickly. Office buildings usually are the last type of commercial real estate to require new construction to satisfy new demand. The cherry on top for a complete recovery is a major rebound of land sales for industrial and office development, as this is an indication of a much improved and robust economy for Colorado. Following are second-quarter observations that indicate a strongly improved market. Statistics are courtesy of Xceligent. • The Denver industrial market experienced strong demand with 627,838 square feet of positive absorption. • The Denver office market experienced another quarter of positive absorption, with a net gain of 92,254 sf. • Land sales are up in the Denver metro area. Industrial users are building space because the available supply is lesser quality. • Speculative buildings are being fully leased prior to completion. The pent-up demand for space has users willing to pay more for new product. • An uptick in sublease space has driven the total vacancy rate up to 11.1 percent from 11.2 percent last quarter. • The southeast suburban market is experiencing a push in rental rates and activity, since the submarket is not “energy vulnerable.” Several completed or ongoing office developments include IMA Insurance at 1747 Wynkoop St., the Hines development located at 1401 Lawrence St. and 1900 16th St. Outside of downtown Denver, Arrow Electronics in Centennial is occupied; the Charles Schwab campus in Lone Tree has the initial building occupied; Mikron Corp. in Aurora has a target occupancy of September; and Mountain Man Nut & Fruit Co. is moving its headquarters to the Dove Valley Business Park with a target occupancy of next year. There are many variables that indicate the current economic health around the nation. But, for experienced commercial real estate professionals in Colorado, the strongest indicators of the market’s climate is the volume of land sales that occur, along with the volume of construction activity zoned for commercial buildings. Denver has made a strong recovery from the recession in comparison with other secondary and tertiary cities. Developers, enticed by revenue growth and attractive demands, are building and developing aggressively, which yields a rapidly growing volume of new construction in the Denver metro area. History indicates that a steep ramp up in construction typically weakens the market’s fundamentals. Despite this, Denver seems immune to the usual effects of new supply thus far, thanks to a strong local economy that is truly unique to the state.