CREJ - Office Properties Quarterly - March 2016
In 2015, the Denver office market continued a six-year trend of solid positive net absorption, the longest run since the 1990s. During this extended period of expansion, vacancy fell from 20 percent to stabilize at 14.2 percent, total net absorption topped 7.8 million square feet, and rental rates in core submarkets launched a trajectory that achieved historical highs. However, the market did come up against some headwinds during 2015. Closures and downsizing in the oil and gas sector accounted for more than 570,000 sf of negative absorption in the central business district submarket. Despite concerns, the CBD’s strength and diversity insulated it against catastrophic losses, and the submarket finished the year flat. The southeast suburban submarket was challenged by corporate downsizings but still ended the year in the black. All the other submarkets, except the southwest, logged solid positive absorption, led by the midtown and northwest submarkets, with respective full-year absorption of 279,567 sf and 272,712 sf. Growth in midtown was driven by the delivery of strongly preleased new projects in Cherry Creek, while organic growth, most notably by SCL Health, accounted for the northwest’s strong performance. Central Business District The CBD experienced expansion and contraction during 2015, posting fourth-quarter absorption of 153,857 sf, the highest of the entire Denver market, but relatively flat full-year absorption of negative 71,532 sf. Downsizing in the oil and gas sector occurred in each of the last three quarters. However, oil and gas losses this quarter were offset by several large move-ins. Vacancy decreased to 14.5 percent from 15 percent in the previous quarter but increased year-over-year from 12.5 percent due to net occupancy loss and the completion of 1601 Wewatta and the Triangle Building in the previous quarter. Both projects delivered empty but with strong preleasing by tenants scheduled to occupy throughout 2016. Asking rates continue on the upswing. Class A rates rose 26.8 percent from yearend 2009 to $36.15 per sf, and Class B rates increased 22.4 percent to $28 per sf. These rates continue to set records for all-time highs. Though the low price and oversupply of oil is impacting the nation’s energy sector, Denver has shown resilience due to its diverse tenant mix. “New construction, all in LoDo, is holding up well in the face of oil and gas headwinds, with strong preleasing,” said Jamie Gard, executive managing director. “Oil and gas vacancy is concentrated in the opposite end of the CBD’s new construction, in Skyline and Uptown. Though continued low oil prices will likely bring additional oil company move-outs, the CBD will return to positive absorption in 2016 and beyond with significant move-ins from Liberty Global, Prologis, WeWork, DaVita and Antero Resources totaling more than 500,000 square feet.” Southeast Suburban The SES ended 2014 in the red due to corporate downsizing and returned to expansion mode in early 2015, only to post negative absorption in the third and fourth quarters. Fourth-quarter absorption was negative 144,382 sf, but full-year absorption totaled 121,692 sf. The Class A and Class B sectors performed as mirror images. The Class A sector posted quarterly absorption of 175,801 sf and full-year absorption of 455,856 sf, while the Class B sector lost occupancy, with fourth-quarter absorption of negative 342,077 sf and full-year absorption of negative 360,369 sf. Occupancy loss in the Class B sector was driven by corporate downsizing and by migration from Class B to Class A assets by CoBank and tw telecom at year-end 2015. The Class C sector was flat. Vacancy increased to 14.8 percent from 13.4 percent in the previous quarter and year-over-year from 14.4 percent. Class A rates stand at $26.50 per sf and have eclipsed the previous cycle’s peak recorded at the fourth-quarter 2008. Class B rates are $22 per sf, which beats the previous high recorded in 2008 and represents a 33.3 percent increase from the cycle’s low of $16.50 per sf recorded in 2009-2010. “The SES is expected to be positive in 2016, with another year of moderate absorption buoyed by continued organic growth in financial services, professional and business services, cable, health care and home-building-related sectors,” said Gard. Supply Line and Sales Denver’s strong economy and market fundamentals have supported a development window for the past several years, and speculative development returned in 2015. As of year-end, 13 office projects, totaling 2.5 million sf, are under construction or renovation. This represents the largest development pipeline since 2006. Although the majority of projects in the construction pipeline are speculative, developers are still proceeding in a controlled and disciplined manner. New projects are either heavily preleased or, if speculative, confined to high-demand, niche markets and transit-oriented development locations. Ten buildings, including two owner-user headquarters, were delivered in 2015. In fourth-quarter 2015, sales totaled 3.7 million sf valued at $719.2 million, which propelled Denver’s annual total office sales to 14 million sf totaling $2.6 billion. This robust performance outpaced 2014’s total of 14.3 million sf valued at $2.3 billion. Denver is now a top-tier market, attracting national and international capital. The quarter’s top sale was the purchase of the new CoBank headquarters building by a South Korean investor for $113.5 million, or $413 per sf. “The office investment market in 2015 saw record transaction volume driven by liquidity, low interest rates and intense competition among a crowd of new investors vying for investment opportunities,” said Dave Tilton, executive managing director. “The CBD was the hot submarket with red hot neighborhoods like LoDo, the Central Platte Valley and RiNo seeing the most activity due to rapidly rising rental rates driven by new office, residential and retail construction. 2016 will see continued liquidity due to even lower interest rates and Denver’s popularity among commercial real estate investors, both institutional and private. However, the SES submarket will see more activity in 2016 with three new office buildings under construction and upward pressure on Class A rental rates with investors betting on Denver’s prospects for overall growth.” Outlook The future looks bright for Denver’s economy and office market. The University of Colorado’s Leeds School of Business forecasts that Colorado will gain 65,100 jobs and 95,000 residents in 2016. The professional and business services sector, one of the top office-occupying industry sectors, is projected to grow by a robust 4.3 percent in 2016, adding 15,000 jobs. Denver was ranked sixth among U.S. markets to watch in 2016 in the prestigious Emerging Trends in Real Estate report, which cited its quality of life, culture, growing concentration of technology firms, strong local economy, and investment in public and private infrastructure, all of which will foster sustainable growth. Newmark Grubb Knight Frank research forecasts Denver’s momentum will continue into 2016. Other predictions include: • Balanced market with strong absorption in secondary submarkets; • Rental rate increases; • TOD in high demand, by employers and employees, as additional FasTracks transit stations open; • Co-working/creative space in demand as millennials outnumber baby boomers in the workforce; • 2015 property tax assessments hitting in 2016 resulting in double-digit increases in tax expenses; • Additional company downsizing as oil prices remain low and hedges expire, but effect will be muted due to CBD’s diverse tenant mix; and • Population gains, continued job creation, albeit at slower rate than the previous three years, and falling unemployment driving continued expansion in 2016.