MARKET HIGHLIGHT, MARCH 2006

MORE WANT TO BE DENIZENS OF DENVER
Ron Webert, Eric Shaw, Bobby Hutchinson and Larry Thiel

Things are looking up in the Mile High City, but, as the warm season approaches, which of Denver's commercial real estate sectors will be the hottest?

Industrial

The Denver industrial market has begun to show strong signs of life after nearly 5 years of lackluster leasing activity. However, year-end absorption for 2005 ended up at only 500,000 square feet, leaving plenty of room for improvement. This is good news for expanding tenants, who still have a variety of space options at competitive rates, especially at larger square-foot ranges. Currently, vacancy rates for warehouse and industrial product continue to hover around 8.3 percent, with rates for flex space slightly higher. Asking rates remain relatively steady at $4.07 per square foot for warehouse space and $5.24 for manufacturing leases. The majority of 2005's activity came during the second half of the year as both new and existing tenant activity increased substantially, leading toward increased absorption this year.

The Airport/Montbello, North Central and Southeast submarkets each welcomed more than 400,000 square feet of new tenants during 2005, with over 1 million square feet of additional prospects currently in the market. Flex space across the metro area is also beginning to enjoy the resurgence of both the biotech and bioscience industries as well as the return of venture capital funding, for which Denver ranks fifth in the nation. Reflective of the national trend, the largest percentage of vacant space remains concentrated in the largest buildings. For all major U.S. markets, vacancy for buildings less than 25,000 square feet is only 5.3 percent, and increases to a maximumwhile the vacancy rate for buildings exceeding 500,000 square feet stands at of 10.3 percent in buildings over 500,000 square feet. In Denver, the greatest vacancy lies in the 150,000- to 250,000-square-foot-range, where more than 15 percent of space is vacant, compared to 6 percent in buildings under 25,000 square feet.

Despite less than stellar leasing fundamentals, construction activity remains stable, with nearly every submarket awaiting the arrival of various build build-to to-suit, condominium and small-user spaces. Developments such as TransPort as well as smaller developments around cargo airports on the Front Range are also moving forward in an effort to capitalize on increased air freight to and from the growing metro Denver area. The industrial investment market also remains active, though somewhat constrained by limited product. Transaction volume reached a record level of nearly $5 billion in the past year. Significant transactions during 2005 included Invesco's $142 million purchase of the nearly 2 million-square-foot Pratt R&D park, located in Longmont, and the $36 million purchase of the Nome Business Center and Denver Business Center by Crow Holdings.

Denver's industrial market in 2006 will continue to witness decreased vacancy coupled with stable or slightly increased rental rates for multi-tenant and newer space. Value-priced spaces will also continue to see heightened tenant interest. With both national and Front Range purchasing manager's indices indicatings slight but steady growth in nearly every sector, properties of all types should benefit from continued employment and population growth pushing demand for product and distribution space. Value Large user space will be the last to recover because it is heavily reliant on significant expansion or new large corporations entering the market. Small tenant spaces and redevelopment of older buildings into multi-unit or condominium space, along with infill, will remain ongoing trends.

— Ron Webert is a senior associate for Grubb & Ellis in Denver.

Office

The Denver office market is seeing a swing toward a landlord's market in both lease rates and absorption after 5 years of tenant-favored conditions. The lack of new construction since 2001 along with positive economic indicators has allowed the office leasing market to catch up and begin to stabilize. Asking lease rates are increasing in virtually all markets, with a metro-wide increase of 50 cents to an average of $17.74 per square foot for all classes. Overall absorption for 2005 was nearly 3 million square feet, dropping vacancy to an average rate of 18.2 percent. Concessions are also beginning to dry up — especially in small and medium spaces — partially as a result of the 50 percent decrease in sublease space available in the past, creating downward pressure on rates.

Many submarkets have experienced a flight to quality by tenants, with many companies making a jump up in space during the past year, primarily from Class B to A, although more recent moves from Class C to B space or C to newer flex space are also common. Tenants also took advantage of improving economic conditions in 2005 by locking into long-term deals with favorable terms. Many tenants renewed early in order to take advantage of rapidly disappearing lower lease rates and higher tenant improvement dollars.

In 2006, the Denver market should see a shift towards landlords pushing rental rates and further cutbacks of incentives. Total investment in office properties in 2005 was double that of 2004, exceeding $2.5 billion in sales. The Denver market has attracted interest from national investors seeking landmark office properties, creating strong competition in that segment. This competition to place money in the market has forced investors to push pro formas aggressively, creating increases in both asking and effective rates.

Currently, there are slightly more than 1 million square feet of new construction online, predominantly in office condominium, small-user and mixed-use formats. The new construction trend involving mixed-use and transit-oriented developments, the first of which are just coming on line, is sure to continue this year and beyond. The Gates Company has already opened its first renovated buildings along the southeast rail line. One other transit-based project currently in the planning stages is Lincoln Station, which will deliver its first phase of office buildings by mid-2007. Further down the line, so to speak, are projects planned for other light-rail, FasTracks routes, with opening dates from 2012 to 2017.

— Eric Shaw is a broker associate for Grubb & Ellis in Denver.

Multifamily

The metro Denver multifamily market appears poised for another robust year. The primary factors that led to record-low capitalization rates of 5.6 percent in 2005 for 1960s and newer construction should remain in place, enabling apartment prices to remain strong. In addition to record low cap rates last year, the market experienced record-breaking sales volume. The total sales volume for 100+ unit properties reached $1.3 billion, versus $456 million in 2004.  

2005 brought 25,600 new jobs to Denver. Expect the same or better in 2006. A job growth that exceeds the national average, along with trends toward continued low interest rates, will continue to attract large numbers of out-of-state investors.

There are 1,800 multifamily units currently set for delivery this year, as opposed to the approximately 2,600 new apartment units added to the market in 2005. While this year's number may increase, it is expected to remain low by historic standards. In addition to relatively few units coming online, Denver continues to experience moderate average rental growth, currently at $843 per unit versus $825 a year ago. According to Apartment Appraisers & Consultants, the current vacancy rate has decreased to 8.39 percent from 8.55 percent in the previous quarter. As we move through the winter months, the primary concern amongst owners remains the volatility in utility prices. Owners of all product types have begun to brace themselves for record gas and heating fuel prices. While this uncertainty has been cause for concern, most investors feel that the negative impact this will have on their expense structure should be offset by an increase in gross revenue driven by the increase in rental rates due to a robust economy that will continue to add jobs.

There has been a noticeable increase in out-of-state investors eager to enter the Denver marketplace, combined with a general consensus amongst current apartment owners that conditions are improving. All things considered, 2006 should again eclipse $1 billion in sales as stabilization of rents and vacancy continues. Provided there's not a significant increase in the 10-year Treasury rate, as predicted, 2006 should prove to be another record-setting year for the Mile High City multifamily market.

— Bobby Hutchinson is a broker associate for Grubb & Ellis   in Denver.

Retail

In what may be the most dynamic investment market ever on the Front Range, retail remains a knockout contender, with $957.9 million in sales during 2005, nearly three times the volume in 2003. Significant Denver-area transactions included the purchase of the Applewood Shopping Center by Macquarie CountryWide Trust for $77.3 million and the sale of the Outlets at Castle Rock to Craig Realty Group for $64.1 million.

This retail investment activity is powered in part by a still-high level of tenant activity as seen by the successful pre-leasing of new properties, including several developments in the northern Denver metro area. Also boosting the momentum are the continued development along the Interstate 70 corridor, including the recent opening of the Bass Pro Shops and anticipated opening of Cabela's, and redevelopments such as 29th Street in Boulder and Belmar in Lakewood, Colorado.

Retailers have been capitalizing on Denver's job growth, which is expanding at a 2.1 percent clip, 30 basis points faster than the national average. In addition to growth by existing businesses, Denver is once again an attractive destination for national corporations. The decreased housing prices in comparison to other large cities have contributed to this increased national interest.

The first half of 2006 should see redevelopments and mixed-use projects continuing to dominate space additions with significant projects including Alberta Development Partners' redevelopment of Southglenn Mall into a mixed-use town center format and Forest City Enterprises' Northfield at Stapleton project, which is part of the larger redevelopment of the former Stapleton Airport.

Despite increased construction volume, retail rental and vacancy rates are anticipated to remain stable, providing steady returns for investors. Denver's retail vacancy has increased only slightly during the past year to 8.1 percent at year-end 2005. Asking rental rates continue to hover around $16 per square foot, with new construction commanding rents in the mid-$30 per square foot range. As some new product comes on line in various parts of the metro area there will be a flight to quality among higher-end retailers, creating excess space in aging assets. Fortunately, continued job growth and robust consumer spending will create opportunities for owners to re-lease the excess space to new retailers in the market at potentially higher lease rates.

From private equity to institutions, buyers and sellers will continue to trade retail assets at a feverish pace in Colorado. Opportunities still remain for savvy owners to capture the highest value for their properties.

— Larry Thiel is a broker associate for Grubb & Ellis in Denver.

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