MARKET HIGHLIGHT, MARCH 2008

DENVER
Ethan Reed 

A burgeoning multifamily market and a still-stout retail sector, as well as the strong fundamentals supporting Denver’s other property types, are keeping real estate players high on the Mile High City.

Multifamily

Denver is among the leading markets capturing the new demand growth trends — expansion in the numbers of prime (age 20 to 29), lifestyle and over-50 renters as well as the increasing diversity of the population. While some apartment markets require more caution than others, there are plenty of reasons to continue to invest in the Denver market. Although Denver led the nation in single-family foreclosures for 2 years, the worst appears to be over, and the result left thousands of former homeowners returning to the rental market.

In 2007, the Denver market absorbed 4,644 units, reducing the physical vacancy rate to 6.1 percent. Leasing activity is much stronger in the Class A properties, which now average 6.6 percent vacant, down from 10.5 percent at year-end 2006. However, there was year-end strengthening demand for all sectors and expect to continue doing so through 2008.

This strong demand, coupled with very low levels of new construction, has allowed Denver to emerge as one of the strongest apartment markets in the country. Few other markets are in a recovery cycle like Denver, posting low vacancy and sustained rental rate growth. The expectation for rental increases during the next 3 to 5 years is one of the highest in the nation.

In addition to the demand and rental-rate growth, there is little construction in the pipeline, giving investors hope that this expansion phase will continue well into the near future. Although rents are now beginning to reach levels that justify new construction, only 2,262 units delivered in 2007 and 2,500 units are expected to be delivered through this year. If absorption reaches 4,000 to 5,000 units, the physical vacancy rate at the end of 2008 could fall to below 5 percent.

In 2006, multifamily sales volume was $2.12 billion, the highest level ever recorded. In 2007, investor activity declined slightly to $1.69 billion — still a robust number. While apartments continue to gain favor with investors, the credit-crunch deterred some in fourth quarter 2007. Investor activity maintains pricing at record levels with an average price per unit of $95,974. Major transactions occurring throughout the Denver market in 2007 included the 710-unit Crestmoor Downs for $86 million, 567- unit Greenwood Park and Plaza for $82.5 million, and 337-unit Commons Park West for $75 million.           

Retail

The retail sector has been the shining star in the Denver economy and real estate market for years. While all other commercial real estate sectors suffered during the 2002 recession, the retail market continued to thrive. However, the housing downturn and sub-prime lending meltdown finally took its toll on the retail sector, resulting in negative annual absorption for the first time since 1998. Nevertheless, the Denver retail market remains near equilibrium with only a 6.4 percent vacancy. This rate is 40 basis points below the 10-year average of 6.8 percent and remains lower than that of the national average of 7.6 percent.

Denver’s retail market remains a low-cost alternative to many other markets with the average asking lease rate at $16.10 per square foot. One reason for this lower average lease rate is the greater availability in the Class C strip center product. Newer power centers are averaging $18.63 per square foot, but currently less than 5 percent are vacant.

Traditional grocers continue to succumb to pressure from Wal-Mart and Target. However, many retail analysts expect these specialty stores to continue to fill niches left by traditional stores that are unable to be filled by Wal-Mart Supercenters or SuperTargets.

Retail construction activity remained high although deliveries for many major projects were delayed. More than 4.8 million square feet of new retail space are currently under construction across the Denver market, down from 5.3 million square feet a year ago. 

This year, all eyes will be on new job creation, the housing market, interest rates and gas prices. Many economists do not expect retail sales to continue at the current strong growth rate. Although Colorado is no longer topping the foreclosure list, it still has a long way to go to absorb the excess inventory of housing units and return to strong growth and appreciation. The relationship between housing prices and retail sales is clearly evident. With the housing market expected to stabilize throughout the year and gas prices expected to continue trending upward, economists are hoping for more jobs and low interest rates to weather the storm.

Construction activity will also remain the focus of retail analysts as the pace of deliveries will have a strong influence on the degree that vacant space is able to be absorbed and landlords will be able to raise lease rates.

Office

While 2007 was a tumultuous time for the Mile High City as well as the rest of the country, strong fundamentals pushed the Denver office market to national prominence during the year. The Emerging Trends in Real Estate 2008 study by ULI and PricewaterhouseCooper ranked Denver as the Number 8 “commercial real estate market to watch” this year, and the Denver office market ranked Number 3 as a “top office property buy recommendation.”

In addition, Denver is listed in America’s Top-Rated Cities, 2007 edition, by Research and Markets, and ranked the fourth most walk-able city in the nation, according to the Brookings Institution report released December 2007.

Despite the housing downturn and credit crunch, 2007 was a very successful year for the Denver office market, including significant investment activity — most notably, the $770 million CBD office portfolio purchased by Callahan Capital Partners. The CB Richard Ellis-brokered sale was the largest real estate transaction in Denver’s history.

A strong, diverse economy contributed to an impressive 2.5 million square feet of net absorption during 2007. Direct vacancy is now approaching equilibrium in the downtown submarket and averages 12.6 percent across the market. This strong increased demand resulted in rapid lease rate growth of 10.3 percent market-wide, with downtown leading the charge at 18.4 percent annual lease rate growth. The Denver metro office average asking lease rate now stands at $20.08 per square foot, with Class A space averaging $23.58 per square foot. The downtown Denver average ticked up to $26.22 per square foot in fourth quarter 2007 while the southeast and northwest submarkets average $20.43 per square foot and $20 per square foot, respectively.

With the average vacancy rate at the lowest level since 2000 and lease rates approaching historic highs, developers have now responded with a flurry of construction activity. New projects currently under construction include 1900 16th Street, which consists of 550,000 square feet of Class A office space developed by Trammell Crow in Denver’s CBD. Other CBD projects currently underway include 1400 Wewatta, 1515 Wynkoop and 1755 Blake. In addition, Two Tabor Center is the most prominent downtown Class AA office project about to break ground, bringing 825,000 square feet of trophy Class AA space to downtown Denver.

In the southeast submarket, Palazzo Verdi is currently under construction, recently securing several pre-leasing commitments, and One Lincoln Station is underway. This year attention should shift to the northwest submarket as developers and investors are attracted to scarce large block availability, new retail and entertainment amenities, and increased demand generated by tenants fleeing higher prices and lack of availability in the downtown and Boulder.

Industrial

When looking forward to 2007, Denver industrial market specialists knew that it would be difficult to repeat the record-breaking performance of 2006, but they didn’t know that it’d come so close. After posting more than 5.4 million square feet of positive absorption in 2006 — the highest level recorded in more than 10 years — the Denver industrial market continued the trend of growing demand by absorbing another 4.2 million square feet.

One of the most encouraging signs of the strength of Denver’s industrial market is the diverse mix of users, property types and sizes that is making up its activity. All three major product types — warehouse/distribution, manufacturing and flex/R&D — performed well in 2007, posting positive absorption and rising lease rates. Major deals in 2007 included Echosphere renewing and expanding into a total of 307,000 square feet, Staples occupying 300,000 square feet and Nestle leasing 200,000 square feet.

Responding to the surge of demand in 2006, developers ramped up construction activity, delivering almost 3 million square feet in 2007. Major new projects delivered this year include Furniture Row’s build-to-suit at Prologis Park 70, Majestic Commerce Center Buildings 25 and 26, and Airways Business Center Building 2.

Lease rates increased by 10.8 percent through the year. While this made finding affordable space challenging for some users, the growth rate was much more moderate than that of 2006 when rates rose by 12.8 percent. As of fourth quarter 2007, warehouse/distribution space averages $5.97 per square foot while flex/R&D space averages $6.15 per square foot.

As demand continues to grow, developers should continue to respond by adding new product to the market. In some cases, developers willing to provide users with custom space tailored to their needs will result in older, functionally obsolete buildings unable to compete. However, higher construction costs may keep development levels moderate and result in increased renovation projects. In addition, the increased demand and higher lease rates should help to sustain investor interest through the national credit crunch.

Redevelopment of older, functionally obsolescent buildings will continue, especially within new transit-oriented developments generated by the FasTracks project. Users will continue migrating from dense urban areas to more affordable locations in proximity to better transportation access.

The coming year warrants much optimism. With measured new development, strong absorption should continue to reduce vacancy throughout the market. As the sector moves closer to equilibrium, landlords will be less inclined to make concessions, and rates should steadily increase. Nevertheless, with the proper guidance, tenants should be able to find attractive opportunities throughout the diverse Denver market.

Ethan Reed is marketing and research manager for CB Richard Ellis in Denver.

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