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Denver CRE Performs Well in 2017 But Falls Short of Record Years

Industrial Continues Hot Streak Through 2017
February 8, 2018
The metro Denver commercial real estate market performed well in 2017, with rising prices and good absorption, but not outperforming most records set in 2015 and 2016.

Office and industrial led both leasing and new construction, while retail's continued recovery out of the recession has been stymied somewhat by struggles on the part of national big-box retailers.

Institutionally, multifamily was again responsible for the largest accumulation of sales volume, followed by the office asset class, in which a pricing record was broken twice over the year. New and existing investors still favor the Front Range as a place to put their money, and most think that the strength of the market here is enough to withstand uncertainties stemming from the troubled geopolitical environment both domestically and abroad.

Office market waffles

Following a tough leasing year because of decreases in oil and gas prices that put energy companies on their heels, the office market in metro Denver picked up in 2017, said Mandy Seyfried, senior research analyst at JLL Denver.

Net absorption in metro Denver in the past 12 months was 1.2 million square feet, according to CoStar data, compared with 1.1 million square feet in 2016, but the vacancy rate has ticked up to 11.2 percent from 10.3 percent a year ago because of the amount of new construction deliveries that occurred in 2017.

Nearly 2.5 million square feet of new office space were added to the market in 2017, eclipsing 2015, when just over 2 million square feet were delivered. Many of the properties completed were built speculatively, but are experiencing strong pre-leasing activity.

However, Seyfried expects that new construction will begin to wane in 2018 and 2019, as the development pipeline slows down later in the cycle.

Some proposed projects, such as Patrinely Group’s Block 162, a project that could bring as much as 600,000 square feet of speculative office space to 15th and California streets, could still get out of the ground before the end of the cycle, Seyfried said, but it’s increasingly risky to break ground on speculative projects.

Denver’s newest office tower, the 40-story, 670,000-square-foot 1144 15th St., will hold a grand opening in March following years of construction. The tower was built speculatively but leases have been announced for about 70 percent of the space, with others expected soon.

Average asking rents, which topped $25 per square foot, full-service gross, in 2017, are expected to stay mostly flat even as newer product with higher-end amenities leases up, Seyfried says, because of the amount of new construction available.

Between 2016 and 2017, average asking rates increased by 2.6 percent, and are expected to grow at a similar pace in 2018, according to CoStar projections.

Industrial juggernaut continues

Average asking rents for industrial space, on the other hand, are still in the middle of their ascension, growing 5.3 percent year-over-year to about $9.10 per square foot at the end of 2017, with the expectation that prices will continue to rise by approximately 4.7 percent to $9.50 by the end of the year.

Industrial space continues to make up the lion’s share of new construction underway in metro Denver, with nearly 5.5 million square feet of new inventory delivered in 2017, more than new office and retail construction combined.

Most of that space is either built-to-suit or is leased before construction is completed, indicating continued strong demand for industrial space as Denver’s profile as a distribution hub rises.

Nearly 4.4 million square feet of industrial space were absorbed in 2017, keeping the area’s vacancy rate at 4.7 percent, which is slightly higher than in recent years, but is still a signal of the strength of the market in light of new construction deliveries.

The expected completion of Amazon’s 2.4 million-square-foot building in Adams County alone places 2018 at almost 50 percent of 2017’s total industrial deliveries, and other new buildings anticipated in eastern Denver and Aurora near Denver International Airport, in the Colorado Technology Center in Louisville and in the southeastern metro bring the anticipated completions for the year to more than 10 million square feet, according to CoStar data.

Metro Denver’s industrial market is also experiencing a change in landscape as it grows. Historically, the eastern I-70 corridor has been the backbone of industrial development, but increasingly the stretch of I-25 between north Denver and roughly the Weld County line has become a hotbed for industrial development, industry sources say.

This shift was brought on by a number of factors, including the fact that most of the land along eastern I-70 is owned by a handful of large developers such as Prologis and Majestic Realty. Smaller firms that wanted to get in on the action had to look elsewhere for developable land.

Retail in flux

Amid a period of struggle for many large national retailers, retail development in metro Denver has hit a post-recession high point, with nearly 1.5 million square feet of new properties delivered in 2017.

"We’re still trending for 2017 at a low for vacancy rates, even in retail, which is a little contrary to the news about online retailing," said Jon Weisiger, senior vice president at CBRE Group Inc.

The retail vacancy rate in 2017 was 4.5 percent in 2017, its lowest since before the recession, and it is expected to hover in that range for the next few years.

Restaurants, fitness centers and entertainment concepts are filling in space that otherwise might be occupied my more traditional retail uses like purveyors of clothing or household goods. Grocery stores are also active in the market, with smaller local players like Marczyk’s Fine Foods and Lucky’s Market expanding with new stores. Big chains are building as well, Weisiger said. King Soopers, for example, is building a 123,000-square-foot store in Arvada that is set to open in 2019.

Average asking rents are also trending up, at about $21 per square foot, but pricing in retail is dependent on geography and surrounding demographics, Weisiger said.

In Cherry Creek, for example, rents can reach double and triple the average in other parts of the metro because of the concentration of high-end stores and nearby populations that can afford to shop there.

And while the onslaught of traditional retailers filing for bankruptcy continues, Weisiger remains optimistic about the future of retail real estate because of its adaptability.

"Retail is always in constant change," he said. "I don’t think I’ve ever been in a spot where there are concepts that are past their economic life. We’re seeing different cycles that continue to emerge. There are different categories that we all sort of watch, and yet there are always others that historically take their place."

Owners 'licking their chops'

Institutional investment in metro Denver is still concentrated in multifamily, with $5.7 billion of apartment complexes trading hands in 2017, according to CoStar data.

That number is staggering when compared to years like 2012 and 2013 before the apartment boom took off, but is still lower than 2016, when some $6.6 billion worth of apartments sold, led by the disposition of The Breakers, since renamed Tava Waters, in east Denver for $350 million.

Apartment sales are driven by consistently increasing rental rates in the metro area, plus an influx of younger inhabitants who may not be able to afford the area’s rapidly rising housing prices. Investors are paying a higher price per unit on average at $213,377, compared to $199,027 in 2016.

The second-largest asset class by dollar volume sold is office, which accounted for nearly $2.3 billion worth of investment in metro Denver real estate, a slight increase from 2016, but less than 2014 and 2015.

But, investors demonstrated in 2017 just how much they are willing to pay for high-quality office product in downtown Denver, breaking the per-square-foot price record twice, first with the acquisition of the Triangle building for $154 million, or $678 per square foot, in May, then with the purchase of 1401 Lawrence for $225 million, or $723 per square foot, in December.

But the jury is still out on whether 2018 will bring more record pricing. It all comes down to the product and whether or not an owner is willing to sell.

"A lot of owners are looking at 1401’s number and licking their chops," said TJ Jaroszewski, director of research at JLL. "It really comes back to the quality of the product and how risk-averse you are."

And while Denver is growing up as a city and has more properties that are capable of commanding record prices, it is still small relative to more mature coastal cities.

"In order to achieve record pricing, the product needs to be unique, and we’re not that big of a market," said Peter Merrion, director at HFF.

Still, Merrion sees another year of strong sales and good opportunities for metro Denver’s office institutional market. Capital continues to be plentiful, and existing players in the Denver market, as well as newcomers, find Denver an attractive place for that capital.

And although many of the city’s trophy properties have already traded in the cycle, there are still plenty of buildings to go around for those willing to look outside trendy areas like LoDo.

Value-add properties in uptown and midtown submarkets, as well as suburban assets located near transit, are still drawing interest and can create good returns for investors, Merrion said.

Molly Armbrister, Denver Market Reporter  CoStar Group   
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