CREJ - Office Properties Quarterly - March 2017
Last year concluded with positive absorption of 311,429 square feet to yield an overall vacancy rate of 17.8 percent in Colorado Springs for Class A and B office product. In comparison, 2015 year-end numbers reflected 245,365 sf of absorption and an overall vacancy rate of 19 percent. For the first time in four years, the market realized a healthy reduction in overall vacancy, which had hovered in the 19 to 20 percent range for the prior three years. The momentum carrying over into 2017 suggests we will see strong lease activity and positive absorption for at least the first half of the year, and lease rates are reflecting the demand. A missing component not accurately reflected in the absorption numbers is “lease activity.” For the first time in many years, 2016 experienced lease activity on space before it was vacated. A few noteworthy situations in which leases were consummated on space before the prior tenant’s leases were up included Booz Allen Hamilton’s lease at 565 Space Center Drive for 52,000 sf and Western Digital leasing 35,000 sf in Interquest. Total lease activity of new transactions, not renewals, exceeded absorption by approximately 135,000 sf. This is further evidence of the overall health of the market, as well as the diminishing supply of high quality available space. A great deal of the available or vacant space in today’s market is weighted toward older generation buildings and those properties with big blocks of vacant space, which means more limited quality options for tenant’s seeking space in the market. Lease rates continue to increase and at a more rapid pace, with a 2016 yearend average rate of $13.63 per sf per year (triple net) – up from $13.35 per sf in 2015. For tenants seeking space in traditional multistory Class A office buildings, they can expect rates to be much higher, with suburban product demanding as high as $17 per sf per year (triple net) and central business district product exceeding $20 per sf per year (triple net). Additionally and equally as important are the costs of constructing tenant improvements, which have escalated significantly. No longer can a tenant expect a landlord to “turnkey” work, and many tenants will need to subsidize the costs to improve their new space. One segment of the market that remains soft is buildings with large blocks, greater than 50,000 sf, of vacancy. These buildings skew the overall statistics, driving up overall vacancy rates and keeping average lease rates low. These campus settings do, however, appeal to high-count employers and are important in keeping Colorado Springs an attractive site for new employers. Overall, the city is in a positive place with existing hospital campuses expanding and new campuses being added – including the recently completed 86,000-sf Colorado General Hospital and Children’s Hospital 300,000-sf campus in Briargate. Land sales have been extremely strong, and multifamily housing developments are popping up throughout the city. Sales of single-family homes posted its best year ever in 2016, up over 16 percent from 2015, which was a record year. Downtown Colorado Springs is seeing significant activity with apartment development and is adding over 350 units that will be delivered later this year; this will fuel retail growth and bolster an already healthy office market, where vacancy rates are at 11.12 percent. The airport submarket, with its proximity to Peterson Air Force Base, traditionally has been a hub of Department of Defense users, and this market has seen a steady decline in vacancy to 23.28 percent after hovering in the low 30 percent range for many years. The new administration likely will have a positive impact in this area, and we expect lease activity to be strong in the second half of 2017. All indicators point to a steady improvement in the local market and this will fuel construction of new Class A office product, which we expect to see come on line in 2018, approximately 10 years from our last construction cycle. • Vacancy. Vacancy rates continued to decrease in the second half of the year. Given the market size, one or two 100,000-plus users entering the market, which is anticipated in the next 12 to 18 months, will drive vacancy to single-digit numbers. The majority of multitenant buildings have seen either no change or a reduced vacancy rate and current activity suggests the vacancy rate will drop in 2017. The market will continue to see decreasing vacancy, but until we have new companies relocating or starting up in Colorado Springs, our vacancy will continue to decrease at a more modest pace. • Lease rates. With the overall improving market, we have started to see most properties begin to push lease rates up and hold the line in negotiations. Older, mid-1980s generation buildings continue to pull the average down, but a number of them are starting to increase with the improving market. We anticipate the overall average to increase through 2017, and with the lack of newly constructed product on the market the ceiling for second-generation space is not yet set. • Absorption. Absorption has been positive year to date, and we ended 2016 with a strong fourth quarter. As was previously mentioned, the leasing activity (not reflected in absorption numbers) was very strong in the second half of the year and all indicators are toward increased absorption and leasing activity.