CREJ - Office Properties Quarterly - September 2016
As the end of the summer is quickly approaching, we enter the fall with a real estate market that is in transition. But it is hard to pinpoint exactly why. As you look at metro Denver from a macro view, the fundamentals are very strong. We continue to outpace the nation in unemployment and job growth, and the city remains one of the best in the country for net migration. At the same time, there is a rise in vacancies and a slowdown in the investment market. Job growth in metro Denver continues to outpace national growth, making it the third-easiest city in which to find a job, according to Forbes Magazine in 2015. There have been 65,900 jobs introduced to the market between July 2015 and July 2016, creating a 4.53 percent rise in job growth for the trailing 12 months. The highest growth occurred among jobs that create office (5.8 percent) and flex (5.2 percent) space. The information, leisure and hospitality, and professional and business service industries appear to be experiencing the highest job growth rates, moving up 6.6 percent and 8.8 percent in the 12-month time period. Although job growth is increasing, unemployment rates also have increased from 3.1 percent in February to 3.8 percent now. However, unemployment rates still remain significantly lower than the national rate at 4.9 percent. Currently ranking third for net migration, Denver continues to add residents at an approximate rate of 80 per day. Unlike many other large cities, millennials have such confidence in the market that they are moving to Denver with the hopes of finding a job once they arrive, rather than necessarily planning ahead. To accommodate for this population growth and business expansion, developers are under construction on 16 office projects in metro Denver, totaling 3.6 million square feet. Of this space, 29 percent is preleased to companies like DaVita, Comcast, Prologis, Antero Resources and Polsinelli. As more space is supplied to the metro Denver market, average asking rates have slightly decreased along with a negative 106,982 sf of direct net absorption. Downtown Denver experienced negative 82,789 sf of net absorption. Vacancy rates in the market rose to 10.98 percent and 8.58 percent for Class A and B office properties, respectively, while asking rates have declined over the previous month. Asking rates for Class A and B office properties in the downtown Denver market are $35.45 full-service gross and $33.95 FSG, respectively. There currently is 1.2 million sf of sublease space available on the market, which is down slightly from the peak in second-quarter 2015. In the southeast Denver submarket, Class A office properties vacancy rates have dropped to 7.79 percent and average asking rates have increased over the previous month to $26.76 FSG. However, Class B properties have experienced an increase in vacancy rates to 14.43 percent with average asking rates decreasing to $21.90 FSG. The southeast Denver submarket also experienced negative net absorption of 486,717 sf through July year to date. There is 1.18 million sf of sublease space available, which appears to be trending upward. As the market fluctuates, investment sales have started to slow in comparison to 2015. In the trailing 12-month period from August, there were a total of 75 transactions for office properties 20,000 sf and above, totaling $1.8 billion ($178.34 per sf). The majority of these transactions took place in the southeast (28) and west (14) submarkets, while only 11 office properties transacted in downtown Denver. In comparison, transactions that took place throughout the previous 12-month period (August 2014 to August 2015), the number of transactions decreased by 38 percent and sales volume dropped by $565 million. The average cap rate among metro Denver transactions also ticked upward 44 basis points from the 6.28 percent to the current 6.72 percent. In addition to the change in transaction volume, the buyer pools have altered. Large institutional buyers and equity funds are choosing to invest money in other markets, while private capital has ticked up. In terms of who is investing, investor dollars from Texas have dropped 12 percent between August 2015 trailing 12 months and August 2016 trailing 12 months. In the same time period, international investment in metro Denver increased by 10 percent, mainly due to the CoBank building sale in Greenwood Village. While challenging to completely understand, the Denver metro market is ripe with opportunities for the savvy investor. The slowdown in both the investment and leasing market seems to be due to factors outside the typical fundamentals one would expect. Uncertainty in commercial mortgage-backed securities markets, a perception of the effect of the weakened energy industry and general sentiment due to an unprecedented presidential election seem to be the main drivers slowing the market. With job growth and other indices well above the national average, Denver is poised to see only a blip from the turmoil and will remain a solid market for investment for the foreseeable future.