CREJ - Office Properties Quarterly - June 2016
Denver is experiencing extraordinary growth, which is drawing major companies to move headquarters to the city. International private equity giant Partners Group is relocating its North American headquarters to the Denver metro area, Uber opened a major office off of Brighton Boulevard and TIAA is going to substantially increase its presence in the city. Denver’s population and job growth continues to attract the interest of real estate investors. Colorado added nearly 102,000 people in 2015, representing a 1.9 percent growth rate. Denver disproportionately attracted 18,600 of those people, with a 2.7 percent growth rate. Those who are moving to metro Denver benefit from a 3.3 percent unadjusted jobless rate for the 10-county area, with Boulder County’s unemployment rate standing at 2.9 percent in April, which has remained relatively flat. For properties $10 million and greater, Denver’s year-to-date 2016 office sales volume decreased 35.4 percent to $582 million from $900 million against the same period in 2015. The suburban market only experienced a 22.3 percent decrease to $473 million from $608 million in 2015. The greatest contribution to lower transaction volumes came from the central business district office properties, which experienced a 62.5 percent decrease to $110 million from $293 million in 2015. Denver’s investment sales trends mirror what is occurring across the country. Nationally, suburban office sales showed a greater decrease of 20.6 percent in volume, but CBD sales only decreased by 12.8 percent. Given the relatively small size of Denver’s CBD, only one or two CBD office transactions would move Denver’s statistics substantially to the national averages. Denver’s emergence since the Great Recession has rewarded office investors who are experiencing strong rent growth driven by solid fundamentals. New construction combined with reinvestment in existing office buildings has resulted in a stronger asset base that is better equipped to meet the changing demands of today’s office users. Affordable office options remain available throughout the metro area while new construction and renovated assets are able to meet the standards of demanding tenants seeking cutting edge office space. Debt remains attractively priced and continues to be available – if used prudently – as most lenders are not willing to assume undue risk.
Across the entire metro area, vacant and available office space stood at a healthy 10.9 percent with an average rent of $22.01 per square foot. This represents a nearly 3 percent annual growth since bottoming in 2010. In the CBD and Lower Downtown, vacant and available office space stands at 11.4 percent with an average gross rent of $32.52 per sf, representing a 5.1 percent annual growth since the bottom. During this same period, metro Denver inflation averaged 2.5 percent. Given the fact that Denver is entering year six of its economic recovery, we have seen investors take a more cautious approach to underwriting in many instances. Scarcity value, as evidenced by newer assets or those with locational or other competitive advantages, continues to provide strong pricing with a look toward continued pro-forma growth. Other less differentiated assets are being priced on an “in-place” basis with existing returns expected to modestly grow over time. The transition between “proforma” and “in-place” underwriting styles can produce some disruption in transaction volumes, which has been evidenced in 2016 during periods of price discovery. Debt remains attractively priced and continues to be available – if used prudently – as most lenders are not willing to assume undue risk. The baseline returns that investors are demanding for their capital continue to produce strong pricing but with a greater reliance on inplace cash flows, which are known and measurable. Many investors who acquired earlier in this economic cycle made educated observations on future rent growth and absorption that were subsequently rewarded through market-based performance. When we look at 2016 vintage office underwriting, it is our strong opinion that office investors will find an attractive risk-reward profile, given that rent growth and exit cap rate assumptions have moderated. While we recognize that real estate always will be a cyclical business, those investors who seek to acquire quality assets often are proven right over time.