CREJ - Office Properties Quarterly - October 2015
Office assets continue to be popular among investors due to their historically higher returns compared with other asset classes. Colorado is a popular destination for investors to place their money, not only because they like to visit the state, but also because metrics for population growth, unemployment, job growth and the economy support the decision. As the buyer pool continues to grow in Colorado with out-of-state and international investors looking inside the coasts, we’re seeing cap rates compressing and a depleting inventory of high-quality and highreturn investments. The majority of the investors are looking in the Denver metropolitan area, but if investors are willing to look to the secondary and tertiary markets around the state, they’ll find similar opportunities often at higher returns with similar statistics. Denver is the first choice for investors looking to place money in Colorado. Denver is the largest city in the state and, as such, is the main source of Colorado’s commerce. Denver’s population ranks 23rd for all metropolitan statistical areas, according to the Census Bureau, and the population is anticipated to climb a few spots over the next decade. Denver has a low 3.8 percent unemployment rate as of September, a strong economy with gross domestic product growth hovering between 5 and 6 percent over the last several years, and consistent wage growth. The desirability of the city has attracted growth across all demographics and is seeing the largest increase in the millennial population. For these reasons, Denver is not only a desirable place to live, but also it’s a desirable place to invest. Cap rates are showing similar positive trends. We’ve seen cap rates compress 100 to 150 basis points over the last three years across all classes of office investments. Cap rates for Class A and B office assets are trending between 6 and 7.25 percent in Denver’s primary submarkets. Most of the investors we work with are looking for returns from 7.5 to 8.5 percent and, of course, they prefer Denver. But investors are willing to look at some of Colorado’s secondary and tertiary markets where they are more likely to (but not easily) meet their investment criteria. Sometimes we find ourselves educating more about the submarket than we are educating about the economics and tenant mix of the asset, especially when the asset is located in a lesserknown submarket. Colorado Springs is a great alternative. It is the second-largest city in the state, and the population has earned a spot in the top 100 MSAs in the county. Colorado Springs’ largest economic drivers are the military, high-tech/aerospace industries and tourism. The military is the top economic driver and has a large presence with the Air Force Academy, Fort Carson – which is also the state’s largest employer for civilian and military personnel – Peterson and Schriever Air Force bases, and the North American Air Defense Command. The aerospace industry is the second-largest driver of the economy with companies such as Boeing, Northrop Grumman, Lockheed Martin and General Dynamics having a presence in the city. Colorado Springs is probably most well known for its tourism, which is the third-largest economic driver. Popular destinations include Pikes Peak, Garden of the Gods and the Broadmoor. The office market in Colorado Springs consists of 190 million square feet and has a current vacancy rate of 8.4 percent. Class A and B office investment assets in Colorado Springs are trading between 6.75 and 8 percent for well-located and stabilized properties. Similar returns can be found in Castle Rock, where the community boasts excellent demographic and economic statistics. For example, Castle Rock has a lower unemployment rate than Denver at 3.7 percent, as of April; the average household income is over $100,000 per year; and Douglas County is ranked in the top 10 wealthiest counties in the United States. The Promenade at Castle Rock is one of the largest developments in the U.S. at $177 million with 1 million sf of retail and 320 residential units and an anticipated completion in 2016. The office market in Castle Rock is relatively small with about 950,000 sf, but Castle Rock has experienced strong rent growth and vacancies in the 6 to 7 percent range. Class A and B office investments in Castle Rock can be acquired at cap rates between 6.75 and 7.75 percent. We could continue with statistics from numerous other secondary and tertiary markets in Colorado like Grand Junction, Fort Collins and other Denver suburbs, but it’s sufficient to say that the spread between Colorado’s primary and secondary/tertiary markets is between 100 and 150 basis points for similar quality investments. As long as investors understand the submarket and are comfortable with all the important attributes in that submarket, many are willing to invest outside the popular Denver market.