Colorado Real Estate Journal - July 6, 2016
Demand for income producing property comes from both population growth and employment growth; both have been very strong in Denver for the past six years. Occupancies and rents drive the earnings of properties and these follow the economic cycle with a lag. Economists are forecasting a continued economic expansion over the next four years and a continued slow pace similar to the last six years. Office occupancies hit a bottom in the fourth quarter of 2009 at 85 percent and we expect a cyclical peak of 90 percent in the fourth quarter of 2017, when the market moves into its hyper-supply phase, with occupancies declining to 87 percent by the fourth quarter of 2020. A number of smaller projects are creating the oversupply in the market, with the largest concentration being downtown, where most firms believe they can attract millennials to work. Industrial warehouse occupancies hit a peak of 96 percent in the fourth quarter of 2015 and look like they should settle back to a long-run equilibrium level of 93 percent over the next five years. Light-industrial property occupancies are not expected to peak until the third quarter of 2017 at 98 percent with a very mild hyper-supply phase through 2020, when occupancies decline a mere 1 percent. Demand from the marijuana industry has created a doubling of rents over the past five years and rental rates should continue to be strong. Retail occupancies hit a bottom in the fourth quarter of 2009 at 91 percent and are forecast to peak in the fourth quarter of 2017 at 95 percent. We again expect a mild hyper supply phase with occupancies declining to 94 percent by the fourth quarter of 2020. Apartment occupancies hit a peak of 95 percent in the second quarter of 2002, then again in the second quarter of 2008 at 94 percent and again in the second quarter of 2012 at 96.8 percent. Since that time they have bounced near the top of the cycle as 8,000-plus units have been demanded by millennials each year for the past four years. However, since the third quarter of 2014, the market has moved definitively into the hyper-supply phase of the cycle as supply has outstripped demand over the last three years. Our forecast shows this oversupply to continue until the second quarter of 2018, when occupancies may hit a low point of 93.5 percent. We hope that developers can control their production and allow the market to stabilize – as demand growth should continue for the next five years at least. While commercial real estate prices have recovered all their losses from the Great Depression and cap rates are at all-time historic lows, we do not expect this trend to reverse as interest rates continue to also be at historic lows and the 10-year Treasury bond (the benchmark for commercial mortgage rates and the best-followed “risk-free” rate) has now been 2 percent since the beginning of the year. Real estate cap rates are at large historic spreads of 3 percent to 5 percent over 10-year Treasuries – which attracts investors from around the globe. Prices have gotten so high in the major cites of the U.S. that even international investors are now coming to second-tier markets like Denver. Copies of Mueller’s Real Estate Market Cycle Monitor reports are available upon request.