MARKET HIGHLIGHT, MAY 2012

COLORADO
By Phillip A. Yeddis, Rich Hobbs, Mitch Zatz and Michael Hoffman

The state’s educated workforce and high quality of living have made Denver attractive to many investors and companies. While activity isn’t necessarily soaring, it is showing positive signs of growth and recovery in nearly all sectors and markets.

OFFICE

Yeddis

The Denver office market ended the first quarter of 2012 with an overall vacancy rate that fell to 13.1 percent. According to CoStar, the vacancy rate was down from the previous quarter of 13.2 percent. Net absorption was more than 1.6 million square feet, which included 900,000 square feet in the central business district (CBD), and 700,000 square feet in the suburban markets. Sublease vacancies also declined from 950,000 square feet to 900,000 square feet. Overall rental rates averaged $19.98 per square foot for full-service buildings. Class A properties averaged $23.81 per square foot for full service, while Class B averaged $17.73 per square foot. Both of these rental rates were up slightly, while Class C buildings remained flat at $13.50 per square foot.

Leasing activity will continue to improve in 2012, with net absorption remaining positive throughout the entire market. The majority of submarkets are slowly shifting from markets that favor tenants to neutral markets with rental rate stability and decreased tenant concessions, including less free rent.

As you can see, the outlook continues to be positive. There are several major indicators that market fundamentals are strengthening activity with limited new supply on the horizon. Additions/development projects that are planned for the Denver market include Arrow Electronics’ relocation from New York to Denver, which will bring more than 1,250 new jobs to the area; The Trizetto Group’s $110-million worldwide headquarters in the Meridian International Business Center in Douglas County; and Opus Development Corporation’s 165,000-square-foot project. The Trizetto Group alone anticipates that it will bring up to 750 new jobs to the area over the next five years.

The strongest demand for office space has been in the CBD. This has resulted in a lack of large blocks of space for tenants that want to expand or relocate in this region, as no new speculative construction has occurred.

On the investment front, institutional investors are leading the way with trophy property acquisitions. Based on a recent quarterly report published by Jones Lang LaSalle, these all-cash transactions are in the 5 percent to 6 percent capitalization rate range.

Numerous trends are helping to dictate the office market. Job growth is improving and stabilizing. As unemployment rates continue to decline, the demand for space will slowly increase, causing consumer confidence to increase as well. Denver’s diverse economy has helped aid this stabilization of the marketplace.

The service and energy sectors lead the Denver office expansion in the CBD and lower downtown (LoDo) markets. Both large and small companies alike are looking to expand and/or open new offices.

There is also a continued flight to quality, with tenant’s moving from Class B to Class A buildings. More build-to-suit opportunities are on the horizon. Transit-oriented development zones, along with Union Station and Central Platte Valley, are leading the way in leasing activity. Denver is predicted to be fully recovered by the end 2012.

A recent analysis by the Brookings Institution shows metro Denver was rated first among large U.S. cities when it came to population growth in the 25- to 34-year-old age range between 2008 and 2010. Denver also ranked seventh on Penske Truck Rental’s list of the 10 most popular moving destinations in 2011, proving that the area’s popularity shows no signs of slowing down.

— Phillip A. Yeddis, senior broker, Unique Properties, LLC/TCN Worldwide in the Greater Denver area

RETAIL

Hobbs

Over the past few years, the Denver retail real estate landscape has been as varied as the terrain in our state. Vacancy and foreclosure have taken us to the lows of the plains, while new retailers and developments have taken us to the highest peaks.

Denver made it through the worst of times with fewer battle wounds than many others in the Western United States. We owe this to several factors, including positive migration, high income and education levels and a lack of overbuilding. Ultimately, though, it’s the intangibles – like the climate, people and those spectacular views – that make Denver such a desirable place to do business.

Last year saw the continued activity from 2010, but with some more vigor and results. The results included investment and redevelopment deals to owner-user purchasers, along with pad sales and lease deals of all sizes, sorts and credit. The market was significantly better than 2010 and, for us, was one of our best years ever.

The activity, however, was all over the board without any clear direction. It seemed as if there was some pent-up demand needing a place to call home. Although there were deals, most were ugly, time-consuming and were often re-traded. However, the market was very strong for well-anchored retail developments, infill properties and well-located pad sites. Discounted rents didn’t seem to be as important either, as the focus shifted to the real estate. There were also many value buys for investors that should translate into 2012 activity. IKEA was a shot in the arm for the Denver metro area, as was a new King Soopers grocery store in the Cherry Creek trade area, a new Marketplace Store in Fort Collins, and a significant expansion and remodel in Westminster. BelMar, a mixed-use project by Continuum Partners, saw new development with Target, Best Buy and Nordstrom Rack opening.

Retailers of all shapes and sizes began touring markets again in 2011 to begin developing market plans and to build their pipelines. Lenders have begun to make money available for projects that are well backed, well located, well leased and have a story to tell.

This year will see activity in nearly all facets of the industry returning. Retailers are building their pipelines and will execute on plans developed in 2011. New retailers are looking to enter the market from quick-service restaurants – like Dunkin’ Donuts, Italio and Native Foods – to specialty grocers - Trader Joe’s announced its first Colorado location in Boulder – and pet supplies – like Pet Club, Kriser’s and Unleashed. With all this activity, we are beginning to see competition for space. King Soopers (Kroger) and Walmart are also expanding and planning upwards of 10 new stores. A few larger retail developments are now being planned, while some smaller developments are actually underway by groups like Regency Centers and Alberta Development. This year will once again show the nation why Denver is the best retail market in the country.

— Rich Hobbs, partner and broker, Crosbie Real Estate Group in Denver

INDUSTRIAL

Zatz

After emerging from the downturn, Denver’s industrial market is well and truly back on its feet. As options for large, Class A industrial users of more than 200,000 square feet dwindle, build-to-suit projects are popping up at levels last seen in 2006 and 2007. This is a great sign for the overall health and recovery of the state’s industrial real estate market.

Polystrand has almost completed a 120,000-square-foot manufacturing facility in southeast Denver; Interline Distribution is underway with a more than 200,000-square-foot warehouse project along the I-70 corridor scheduled for delivery in August 2012; and U.S. Foods recently purchased land in Eastgate Park where it plans to build a 400,000- to 500,000-square-foot building. There are several other users that have either made similar land purchases or are in the market for large portions of land. In fact, there is a healthy inventory of well-located development sites available, which can be purchased at prices that make sense for users choosing the build-to-suit route.

Although large blocks of quality Class A space are sparse in the Denver region, rental rates have not yet risen to a level that would compel developers to start speculative development. Also, there is little guarantee that their buildings will be fully or even partially leased. With rising construction costs, rental rates must increase by about 10 percent to 20 percent before developers dust off their speculative development plans.

On a positive note, rental rates are expected to rise in 2012. We therefore expect developers to start breaking ground in 2013. A trend that will support this activity is the growth of food and beverage companies like U.S. Foods. Other key industries to watch include oil and gas, as well as alternative energy, which shows notable growth and firmly impacts demand for both office and industrial real estate.

In Denver, we are still seeing a flight to quality, with tenants looking for Class A warehouse space, particularly functional buildings with yards for outside storage. The older, less functional warehouse space continues to struggle, however. The most common tenant request is currently in the 10,000- to 15,000-square-foot range. We are also seeing a noticeable shift as rising fuel costs are forcing some companies to re-evaluate their supply chain logistics and create more efficient uses of their real estate.

Out of the nine major Colorado submarkets in the first quarter, seven posted positive absorption for leasing in the warehouse/distribution sector. This comprised a total of 493,124 square feet. The majority, 328,974 square feet, came from the northeast and I-70/east submarkets. Activity in the leased manufacturing sector remained slow, posting negative net absorption of 228,330 square feet. Vacancy rates have also topped 12.4 percent so far this year, compared to 12 percent in 2011. Flex pricing remained flat over the past 23 months, but this is expected to rise by the end of 2012 and into 2013.

So far this year, investment sales have been slow. Only three sales of more than $5 million took place in the first quarter of 2012. While there are many qualified buyers waiting in the wings, there is very little product on the market. Average building sales are running at $55 per square foot to $60 per square foot, with a 7 percent cap rate for Class A assets. Fortunately, land sales are on the rise as build-to-suits gain momentum.

As the oil and gas industry accelerates in the Denver metro area, employment growth will gently push the local economy forward in 2012. Denver metro’s unemployment rate fell to 7.6 percent in January, down 1.5 percent from a year ago. With further job growth, albeit slow, consumer confidence will continue to rise. This trend should keep industrial demand healthy throughout the remainder of the year.

— Mitch Zatz, senior vice president and head of Jones Lang LaSalle’s industrial team in Denver

MULTIFAMILY

Hoffman

Accelerating job growth and in-migration will generate sufficient renter demand to push Denver vacancy to its lowest level in more than a decade, even as completions spike. Through 2012, many individuals relocating to the metro area for work will rent until they gain confidence in both their positions and the housing market, as distressed properties continue to account for a sizable share of home sales. While investors are targeting the for-sale housing market for rental properties, this poses minimal threat to apartments. This is because the single-family vacancy rate in the metro area hovers in the mid-2 percent range.

With the exception of Denver-North and parts of the Arvada/Broomfield submarkets, which account for a significant share of this year’s new apartment supply, apartment vacancy will continue to decline. Apartment construction remains limited to the west and southwest of Denver, while expansion at the St. Anthony Medical Campus should help bolster renter demand. Corporate relocations and expansions will drive stronger absorption in the Greenwood Village and Denver Tech Center areas, while the northern part of the metro will benefit from growth in the aerospace industry and the burgeoning biosciences sector.

Transaction velocity will accelerate as tight conditions attract out-of-state capital. At the same time, firming values and prospects for stronger returns in other metros will prompt more owners to sell. The bulk of sales will be concentrated at either end of the quality spectrum. Deals involving performing mid-size Class B and C+ properties will rise as renter demand elevates further amid job creation in lower-paying sectors. As a result, cap rates in this segment — which average in the high-6 percent to 8-percent range, depending on condition and location, could compress modestly.

Large Class A and B+ assets will remain the focus of major public and private investors seeking long-term opportunities. These deals will likely draw cap rates down to the 5- to mid-6-percent range. Similar to last year, local investors will dominate the market for small Class C deals, which range from an ever-decreasing number of distressed assets to well-located properties ripe for upgrades and rent growth.

Denver employment growth will reach 1.9 percent in 2012, up from 1.3 percent last year. Payrolls will rise by 23,000 jobs overall, led by gains in the professional and business services. This includes the education and healthcare services industries, as well as the trade, transportation and utilities sectors. Developers will also complete 3,300 units in 2012, nearly three times last year’s total. Deliveries will be greatest in the Denver-North and Arvada/Broomfield submarkets, which account for 65 percent of all units underway.

The combination of job creation, in-migration and housing market uncertainty will drive absorption to 3,500 units in 2012. Metro-wide, vacancy will decline 20 basis points, to 5.2 percent, as improvements in the first half more than offset supply induced upticks later in the year. Asking rents will rise 2.6 percent in 2012, to $921 per month, which is up from 2 percent last year. Effective rents will grow at a faster clip, with the average forecast to increase 3.3 percent, or $836 per month.

— Michael Hoffman, first vice president, regional manager, Marcus & Millichap’s Denver office

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