MARKET HIGHLIGHT, MARCH 2005

DENVER MARKET SEEKS HIGHER GROUND
Kristine Bain, Adam Christofferson and Marv Almond

Projected job growth of 2.5 percent in 2005 will help to further stabilize Denver’s commercial real estate market. The multifamily, office and industrial sectors are showing decreasing vacancies while retail, the Mile High City’s biggest performer, continues to lead the way with robust tenant demand driving new development.

Retail

Denver’s retail market remains the bright spot in the Mile High City’s commercial real estate sector, as this segment has maintained its strength throughout the recession. Denver’s overall retail vacancy rate is currently 6.9 percent and is holding steady.  New construction continues as approximately 2.7 million square feet were delivered during 2004. However, the majority of this new space is essentially leased when the projects are completed, so the vacancy rate is not adversely affected. Robust tenant demand continues to drive the market, particularly in new centers, and several new retailers are considering Denver in their expansion plans. Rental rates increased slightly during 2004, with the metro average at $14.45 per square foot NNN. Rates will remain strong and continue to rise during 2005.

The hottest submarkets for development and leasing continue to be the southeast corridor and northern Front Range cities. Both of these areas are continuing to see a substantial amount of new residential development, and retail follows suit. A few of the notable developments currently in the works include Alberta Development’s Southlands project in southeast Denver and Poag & McEwen Lifestyle Centers’ The Shops at Centerra in Loveland. Tenants committed to Southlands include Wal-Mart Supercenter, Sam’s Club, Barnes & Noble and Kohl’s. The Shops at Centerra will feature Foley’s, Barnes & Noble and Coldwater Creek.

Retail properties remain a great investment vehicle especially since the stock market has not improved dramatically. Retail investment activity in Denver during 2004 exceeded $677 million, nearly double the volume experienced in 2003 and well over 2002’s volume of $276 million. The average price per square foot is up nearly 10 percent and cap rates are down on average 100 basis points from a year ago, a testament to the strong investor demand for retail product.

Last year it appeared that the market was at its peak and would experience a modest decline. However, at the end of 2004 the market was still at the peak. It has not climbed higher, but neither has it descended by any discernible measure. Opportunities still exist for both buyers and sellers in Denver’s retail investment market. Even as interest rates rise, the market will remain strong for at least 6 to 12 months as the market’s momentum continues. Additionally, investors will remain cautious about returning to the stock market immediately and will still place a bulk of their funds in real estate.

During the last several years, all types of investors have turned to retail projects since retail has provided such stability. Many of these investors may not have as good an understanding of the retail market as true retail investors do and this could harm the market. Overbuilding within the retail sector could occur if non-retail developers move ahead with projects that are not thoroughly researched. Additionally, non-retail investors may not price their assets appropriately as the market shifts and may be frustrated with the slow sale process.

Retail remains an attractive investment because it is less management intensive than office or apartments and it is offering greater returns. The market will stay strong during 2005 even with the possibility of slightly declining values and rising cap rates.

— Kristine Bain is client services manager for Grubb & Ellis Company in Denver.

Multifamily

Investors have held the Denver apartment market in a positive light despite the economic challenges the area has faced in the past few years. The potential of a strong comeback lies in Denver’s large population of college-educated workers and significant base of national and regional headquarters. Now as Denver rebounds economically, the region’s urban core leads the way.

In 2005, Denver employers are expected to add more than 28,900 jobs, a 2.5 percent gain. A resurgence in venture capital will boost emerging tech industries, adding to the gains in transportation and hospitality that helped fuel job growth by 1.5 percent in 2004. From 2006 to 2008, the forecast is for 2 percent average annual job growth.

Multifamily transaction velocity for 2004 surpassed that of each of the previous 2 years, and per-unit prices set new records. With its long-term upside potential, Denver will continue to attract private multifamily investors and drive transaction volume in 2005. The prices for single-family homes continue to climb, thereby increasing the demand for condos. Investors might seek conversion opportunities in infill locations, where assets can then be repositioned with upgraded amenities and sold individually. Prices have been buoyed by institutional activity. Sellers in the Denver MSA included Fairfield Residential and Legacy Partners. Conversely, Equity Residential, AMLI and Forest City Enterprises acquired Denver assets in 2004.

The number of apartment completions in 2005 is expected to decrease. The forecast is for developers to deliver only 2,000 units, down from 3,000 units in 2004. As construction slows down, and net in-migration rises and mortgages rates inch upward, the vacancy rate should drop by 100 basis points this year, to 8.9 percent. The central business district will comprise 40 percent of new units coming online during the course of the year. Asking rents are expected to climb only 0.7 percent to $827 per month. In particular, apartments in the Boulder submarket near Colorado University, as well as properties in the more affluent outlying areas of the Denver community, post among the lowest vacancy rates in the MSA. The rents in these areas are the highest at $970 per month and are attractive to investors seeking stability over cash flow or upside.

For investors seeking upside opportunities in Denver, multifamily properties in the south and west central submarkets hold potential, as occupancies in these locations have yet to improve but are expected to once the economy is in full swing. While usually requiring a more hands-on approach in operations, these two areas typically afford investors higher returns. Investors might also want to seek properties in and around the suburb of Lakewood, as revitalization in the Belmar neighborhood has proven to be a great success.

Recent voter approval of the 12-year, $4.7 billion FasTracks transportation construction project will provide 119 miles of rail corridors throughout the Denver MSA. Speculative investors might seek out properties alongside or close to the proposed rail lines for redevelopment, repositioning or asset appreciation opportunities once the project is completed.

— Adam Christofferson is a vice president and serves as regional manager of Marcus & Millichap’s Denver office.

Office

For the second year in a row, Denver is reaping the economic benefits of job growth. The employment market is experiencing an increase of 2.5 percent, with the information sector leading the way and growing at a rate of 4.6 percent. Specifically, the Turnpike and Tech Center areas, which had undergone the adverse effects of high-tech and telecommunication bubbles, will show office growth in occupancy and rents. Close behind high-tech growth is office employment, rising at a rate of 3.9 percent and providing property owners with a more stable rent environment.

In fact, office vacancies in the Denver MSA will decline 100 basis points to 19.5 percent in 2005. Colorado Springs will be the best performer as government agencies such as the Department of Defense and Homeland Security plan to absorb additional space.

This year, Denver will experience rent growth of 0.5 percent, putting a stop to a 4-year period of declining rents. In particular, downtown Denver will experience rent increases — up to 1.1 percent — in seven out of eight submarkets. Asking rents will decline, in contrast, by 0.5 percent, whereas effective rents will trend upward at a modest pace.

Construction is expected to decrease in 2005 to 500,000 square feet, a 16.7 percent drop that comes on the heels of a 62 percent decrease in 2004. Most of the new construction will take place in Douglas County, where a 70,000-square foot Gates Customer Service Center is to be completed in Englewood.

Investors will be keeping an eye on the Centerra Development – a massive 1,200-acre project located between Denver and Fort Collins in Loveland. The project will include outlet malls, office space and home construction. American Realty Advisors has been one of the leading buyers in the Denver marketplace, with purchases including the Independent Tower for $104 million. For the most part, investors large and small are currently more concerned with price per square foot rather than cap rates. It is the belief that as local economic fundamentals improve, buyers will be able to fill space in their buildings at higher rental rates in the future.

Expect first-time buyers to seek properties in the Lakewood community, where Class B and high C assets have the highest occupancies and more stable cash flows. Additional new investors entering the Denver market will try to take advantage of the low prices and the favorable lending environment.

— Adam Christofferson is a vice president and serves as regional manager of Marcus & Millichap’s Denver office.

Industrial

The general downturn in the Denver economy in the last 3 to 4 years has definitively impacted the industrial market. A decline in manufacturing, the offshoring of production facilities and an overall decrease in the demand for consumer products have taken their toll. 

However, in 2005 the economy seems to be stabilizing, preventing any further declines in the Denver industrial market. New projects are on the horizon, and improved construction planning and a growing infrastructure are indicating a metro-region recovery.

With an annual net absorption of 2.8 million square feet in 2004, Denver moved back into positive numbers with expectations for more than 3 million square feet of total net absorption in 2005. These numbers will be aided by an improving economy and the resulting decision for companies to implement expansion and relocation plans. The market’s 9 percent vacancy at year-end 2004 reflects the first annual decrease in vacancy this millennium.

With increased absorption come stabilized leasing rates. The substantial decline we saw from 2001 to 2003 slowed over the past year and is expected to firm up in 2005. As of fourth quarter 2004, average asking rates were at $4.84 per square foot. The northeast submarket of Denver represents about 60 percent of the industrial supply and, therefore, has the lowest and most competitive rates, averaging about $3.50 to $4.50 per square foot. The higher-priced northwest submarket averaged a rate of $6.50 to $6.75 per square foot, with the southeast and southwest at about $5.00 and $6.25 per square foot, respectively.

The biggest growth in industrial leasable square feet is expected in the Denver International Airport/Montbello submarket. Currently the fastest growing airport region in the country, the area has grown consistently in all commercial markets. Toward the end of fourth quarter 2004, 291,100 square feet of warehouse and distribution facilities were under construction. Southwest and north central Denver also have significant potential for industrial growth.

Throughout the market, users are demanding properties with yard space. Rising in popularity are infill sites with easy access to transportation routes.

The greatest levels of activity will be seen from major developers including Catellus Development Corp., The Paul’s Corporation, Lauth Property Group, Majestic Realty and ProLogis. Approximately 2.2 million square feet of large speculative industrial parks are represented. Noteworthy projects planned for 2005 include the Eastgate and Centerpark Buildings C and D. The Opus Business Park and ProLogis Park 70 projects are already underway.

While most of these significant distribution projects planned for 2005 exceed 200,000 square feet, there are some new buildings being constructed at less than 20,000 square feet.

New industrial projects will continue to come on line, but almost 80 percent of available industrial space is in 5-year or older facilities. This may result in a wider gap in lease rates between new properties and second- or third-generation properties, but nothing worse than we have seen during the past 3 to 5 years.

Overall, as unemployment rates continue to decline, consumer confidence improves and manufacturing activity increases, the Denver industrial market will stabilize. While investors and developers remain cautious, there may be moderate increases as 2005 progresses.

— Marv Almond is an industrial broker for Dunton Commercial Real Estate in Denver.

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