CREJ - Office Properties Quarterly - March 2017
Over the last few years, Denver’s office property marketplace has been bolstered by strong hiring in the metro’s primary office-using sectors, which enabled vacancy to hover near a decade low by midyear 2016. By year’s end, local employers added 47,900 workers to payrolls, 10,000 of which were office-using positions. The office market will continue to improve in 2017 as firms expand into larger spaces and hiring in primary office-using sectors remains stable. This year, area employers will increase the Denver workforce by 2.8 percent, or 41,500 employees. This includes 10,000 office-using positions, which will help offset a robust development pipeline. In 2016, new supply encountered high demand throughout the Denver metropolis with companies including Comcast and Agrium signing leases at speculative office projects. Comcast announced that it would move 1,000 workers into a 212,000-square-foot building in Centennial this year, while Agrium moved forward with plans to consolidate its U.S. headquarters into a 120,000-sf space in Loveland. One of the largest projects completed in 2016 was the 127,000-sf FirstBank headquarters in Lakewood. Overall, by year’s end, builders had delivered 960,000 sf of office space to the Denver metro area. Developers, encouraged by several years of relatively stable vacancy levels and a healthy job market, will move forward with a number of speculative office projects this year to address persisting demand for new space. Construction will be largely focused in the downtown area and along Interstate 25 through the Denver Tech Center, Greenwood Village and Centennial. Denver’s commitment to providing an expansive network of commuter rail lines and alternative forms of transportation has attracted residents and companies to these areas. By the end of 2017, deliveries are projected to reach a cyclical high of 2.3 million sf of office space, a significant increase from the previous year. In 2016, vacancy remained at a historical low, ending the year at 14.6 percent. Heightened demand for Class B/C office space dropped the rate 40 basis points among this asset class, while an influx of Class A stock kept the overall vacancy flat. The vacancy rate was lowest in the midtown and northeast Denver submarkets and highest in the downtown submarket. This year, healthy net absorption will keep Denver’s office vacancy low as completions reach their cyclical peak; however, demand will not outweigh the new supply. For this reason, vacancy rates are anticipated to rise 20 basis points in 2017 to 14.8 percent, remaining well below the previous 10-year average. Low vacancy last year supported office property rent gains and boosted the average asking rent to $25.14 per sf, a 1.6 percent year-over-year increase. The average asking rent growth for Class A office space atrophied while average asking rents for Class B/C office space surged. In 2017, with vacancy hovering near historical lows, the average asking rent is forecast to rise 1.7 percent to $25.57 per sf. Denver’s strengthening market conditions in 2016 spurred buyer interest in office assets, although limited for-sale inventory hindered transaction velocity. That said, buyers targeted office properties in southeast and southwest Denver, along with assets in downtown and west Denver. This year, rising deliveries and strong space demand trends will lure a number of institutional-grade buyers and large funds into the office market. Newly stabilized properties and those priced above $20 million will pique investors’ attention. Additionally, as newly built properties are delivered, trades in this price tranche could potentially rise. These assets typically will sell at cap rates starting near 6 percent. Private local and regional buyers will remain the primary players this year, chasing higher yields in the western and southern submarkets, where first-year returns are 25 to 50 basis points above the metro average. Finally, given the diminishing number of value-add properties available for sale, investors in search of upside will seek opportunities in underutilized buildings near commuter rail lines.