CREJ - Retail Properties Quarterly - August 2016
Led by stronger diversification in the economy and steady population growth, Denver has experienced a heightened interest from foreign, institutional and coastal capital in the last cycle. Coupled with segment-specific tenant interest, this lasting investment of new capital is pushing our investment environment to new heights and shifting our retail landscape through a newfound interest in construction. An elongated run of positive fundamentals accompanied by the historical imbalance of new construction has created pent-up demand in our retail market. Over the last 30 years, Denver has delivered an average of over 3.5 million square feet of retail space on an annual basis. Since 2010, this number has barely eclipsed 1 million sf. However, in the last four quarters combined, we have experienced 1.5 million sf of new construction. In first-quarter 2016 alone, there was nearly 400,000 sf of new retail construction completed with 1.35 million sf of building underway. Looking at the entire Front Range, the impact is even more dynamic. JLL is tracking over 20 million sf of new construction and redevelopments in the retail space. These projects will roll out in the next several years. The largest sector is power centers at over 10 million sf, which includes the redevelopment of the Foothills and Longmont malls in Northern Colorado and the Promenade at Castle Rock, where construction is underway on over 1 million sf. The grocery sector has been active with several newly opened or planned grocery centers. Sprouts, Trader Joe’s, Whole Foods and King Soopers all are pursuing deals in the market. King Soopers is looking to build up its market share, evidenced by its first downtown location and a number of 125,000-sf “marketplace” stores. Both Trader Joe’s and Sprouts have completed ground-up and leased locations throughout the metro area. The most recent was Trader Joe’s lease at West Bowles and South Wadsworth, making it the sixth location in Colorado. Retail is a crucial element in a number of mixed-use redevelopments happening in urban settings as well. Totaling nearly 2.5 million sf, these projects include 16 Market, Dairy Block, and 9th and Colorado. The redevelopment trend also is occurring in existing shopping centers, evidenced by the recent announcement of the transformation of Regatta Plaza, which includes 130,000 sf of retail space. This will be a prevailing trend as portfolio owners look to capitalize on the rising market. The current momentum undoubtedly will bring an increase in construction in the next several years. However, annual retail construction will stay below the historical average of 3.5 million sf. The largest inhibiting factor is the impact of e-commerce on brick-and-mortar retail. According to the U.S. Commerce Department, online sales accounted for more than a third of total retail sales growth in 2015, a number that is over 10 percent of all retail sales. Shown by the recent bankruptcies of Sports Authority and Hastings, as e-commerce evolves, we will see the real estate around us change and the magnitude of apparel, electronic and other dry goods retailers reduced. The active segment of the market will come from service concepts that don’t compete with e-commerce. Demand is high for grocers and restaurant tenants who are pressing to find quality locations in Denver. However, the demand is only one aspect for development. Stricter lending requirements, raising cost of construction and onerous entitlement policies will keep new inventory in check. Municipalities throughout the Denver metropolitan area are contemplating impact fees to help provide affordable housing as well as measures to eliminate urban renewal areas. Keeping entitlement costs under control and providing tools to enhance the public and private relationships for redevelopment is essential. This is true especially for infill locations, which are most desired by retailers, as they strive for access to main traffic corridors and densely populated areas. Denver retail will remain highly desirable for capital investment, and cap rates for quality assets will continue to compress. Paradoxically, we will see a tapering of retail investment sales for large core assets as much of the existing inventory is owned by portfolio-minded operators who typically do not sell. Furthermore, anchored tenants in new grocery developments often strive to own their stores. These shadow-anchored shopping centers are less desirable to the most-aggressive institutional buyer pool because these investments offer less control and a smaller transaction size. The lack of investment options accentuates the supply-demand imbalance, further enhancing value on the anchored core assets. A similar phenomenon exists for smaller private capital assets under $5 million. Due to a combination of real estate exchange capital and a lack of fruitful investment alternatives for private money, a war chest of capital is poised to react to Denver. Values will continue to rise for newly constructed or longer-leased assets with brand name tenancy. Although new retail construction in Denver will be less extensive than it has been in the past, it will render the highest values we have seen in our market. This cycle represents a first for Denver: a stable economy. Denver’s economy has never been as strong and its appeal to capital has never been as wide or deep.