CREJ - Office Properties Quarterly - June 2016
Denver consistently is ranked as one of the best places to live and work. Our economy is growing and vibrant, population and employment rates are rising and the real estate market is booming. Our state attracts large employers due to the strength of its economy as well as a highly educated and growing workforce. Denver is a hub for innovation and entrepreneurship and has been named one of the best places for business and careers. The lifestyle and recreational opportunities offered in Colorado enable companies to retain top talent as they grow. While Denver is ideally positioned for continued office development, one of the byproducts of our strong economy and commercial real estate boom is a steady increase in office construction costs. Historical inflation of materials and building costs is estimated at about 2 to 2.5 percent annually. However, in the past six months, the cost of developing office space in the area has increased noticeably. What are some of the key factors driving this increase, and how can developers successfully deliver new office facilities in this increasingly competitive landscape? Contributing factors. When the real estate market suffered during the recession, many tradesmen left the construction and development industry, and the skilled labor workforce was significantly consolidated. As the economy became more robust and the commercial construction industry strengthened in Denver, subcontractors began experiencing an imbalance between the volume of work and the size of today’s qualified workforce, significantly driving up the cost of office development. This is compounded by the increased demand for residential development to accommodate the new jobs resulting from Denver’s growing economy, further adding to the need for subcontractors. The continued investment in major public improvements strengthens our economy, such as the expansion of Interstate 70 and the FasTracks transit program, including the opening of the commuter rail to the airport. While these public improvements are enormously beneficial for our community, they strain the capacity of the construction community to manage public- and private-sector work. There was a notion that labor costs would plateau or decrease due to returning labor from the oil and gas industry, but this has not widely occurred – in part because of the variance in wages for the oil and construction trades as well as differences in specialties and experience. The industry is not experiencing savings from the lower commodity costs of key construction materials. While the costs of steel and oil have decreased, we haven’t seen those savings translate into the stabilization of construction prices in the local market. In fact, research indicates that commodity prices actually increase when the real estate market is performing well. Additionally, land value plays a major factor in elevated office development costs. The cost per buildable square foot has increased from previous cycles by $10 to $30, depending on location. Land value in the Denver metro area has nearly doubled in some areas due to inflation, improvement of the local economy and, subsequently, the increased buying power of tenants to afford higher rent. Increased development in other sectors, like multifamily, also has influenced higher land prices, which in turn affects office development. Parking, which often is a major consideration for employers, is noticeably more expensive for both above-grade and subgrade options. When compared to costs from past cycles, above-grade parking in downtown Denver increased by approximately $4,000 to $9,000 per stall and subgrade parking increased by about $10,000 to $20,000 per stall. With the cost of parking being highly dependent upon the location of the project and the efficiency of each stall, strategic design is critical and can translate to huge economic differences for clients. Why Build? In this competitive landscape, clients may contemplate whether new construction makes sense. As development rapidly continues in Denver and the costs for new construction increase, the value of existing real estate is buoyed by the overall value of existing supply. While the cost per square foot may be higher for new space, today’s design, generally, is more efficient and tenants may require less sf for a more customized, modern product. With a 15 percent reduction in sf enabled by new construction, the economic gap can be bridged to receive a modern office space. Even in this window of higher costs to deliver new office space, clients find it strategically beneficial for their organizations. Tailored workspaces in a new building can enable corporate growth and benefit companies by increasing productivity, collaboration and retention of employees. Now, more than ever, it is important to proactively ensure that clients are aware of this environment and guide them to invest in the areas that maximize the most benefit and value for their companies. By thoroughly understanding clients’ needs, developers can prioritize spending to enable mindful growth and operational excellence for their clients.