MARKET HIGHLIGHT, NOVEMBER 2008

DENVER
Josh Gruhl, David Morrison, Greg Falcone and Larry Thiel

Stability and opportunity are words often heard to describe the Mile High City’s commercial real estate sectors. The Denver market still has its head held high.

Multifamily

The masses have departed following the Democratic National Convention, but real estate investors are keeping close tabs on the Mile High City. The phrase many astute investors are using when referring to the Denver market is “cautiously optimistic.” With its fundamentally strong rental market and its ability to attract high-quality employers, interest by investors and developers remains high. It is this proactive economic mindset towards renewable energy, together with a flurry of immigration into the state, that should prove to be the necessary fuel to drive the multifamily engine.

The Denver metro saw 61 apartment buildings exceeding 50 units trade in 2007, with 42 of those sales coming in the first 8 months of the year. In comparison, only 26 buildings have traded so far in 2008. A majority of these sales were buildings constructed in the 1960s, ‘70s and ‘80s, for which the owner has significant renovations slated; this continues the value-add trend so prevalent in 2007. Although sales volume is down significantly, local and national multifamily investors remain interested in bolstering their portfolios with Denver apartments.

Average vacancy for second quarter 2008 dropped to 5.97 percent, the lowest level since 2001. The lowest vacancies are in the Denver northwest submarket (3.7 percent), although 11 other submarkets also have sub-4 percent vacancies. The highest vacancy rates were in the outlying suburban areas of southwest Aurora (8.1 percent) and Castle Rock (7.88 percent). As vacancies declined, average rents rose by an average of $12 (1.4 percent), with the highest rents being in the central business district ($37 increase to $1,290), Highlands Ranch ($8 increase to $1,100) and Golden ($23 increase to $1,040). On a per-square-foot basis, rents currently average $1.02 market wide, with a high of $1.47 in the CBD and a low of $0.82 in northeast Aurora.

Apartment development has picked up within the past year. At the end of second quarter 2008, there were 34 communities underway comprising just shy of 7,700 units. Approximately 3,400 of the units are expected to be completed yet this year, double the volume of completed units in 2007. Developers have been encouraged by the strength of the rental market; however, the difficulty in obtaining financing and high construction materials costs have kept many developers from pursuing new projects. The result is that new construction deliveries will remain in line with absorption levels.

The trend of “greening” real estate development and operations has made its way into the Denver multifamily market. Red Peak Properties, a highly respected multifamily development firm based in downtown Denver, recently broke ground on the Seasons II development project in the Cherry Creek submarket. This 148-unit property will be the first for-rent multifamily property accepted into Built Green Colorado’s multifamily pilot program. Legacy Partners is also addressing this environmentally conscious market with its most recent project, Mayfair. Aside from being LEED-certified, Mayfair will include a wide range of green features, including a solar-power system in which residents can keep tabs on the effectiveness of roof-mounted solar panels through monitors displayed in the building lobby as well as individual unit monitors.

— Josh Gruhl is an associate broker at Grubb & Ellis Company in Denver.

Office

The Denver metro office market has had a good year, all things considered. The results are mixed, but the blessing for landlords is that rates and occupancy levels are solid and should remain so into 2009. Denver has not suffered many of the repercussions felt by office markets more heavily tenanted by financial companies, although retractions in these industries have impacted the southeast suburban submarket to some degree.

During first quarter 2008, the central business district experienced positive absorption as many 2007 leases resulted in early 2008 occupancies. However, second quarter brought slight negative absorption of 11,000 square feet, with a strong likelihood of subsequent negative third and fourth quarters as tenants begin relocating into new construction, including Newmont’s move to the southeast suburban submarket. Expansion was driven by energy companies, as Denver serves as a logical regional headquarters for companies developing natural gas fields in basins in northeast Utah, northwest Colorado and southern Wyoming. Class A space and high-rise view spaces are still in demand, with sub-5 percent vacancy for these office segments. New office building owners who bought into the market during the height of the investment boom have largely completed common-area improvements, boosting rental rates, and the overall vacancy rate has stabilized at around 13 percent.

The southeast suburban submarket, Denver’s other large office area which is slightly larger than the CBD at 28 million square feet, has fared slightly worse in recent quarters. The submarket experienced an up-tick in vacancy due to downsizing of mortgage and title companies as well as homebuilders. These pullbacks resulted in a 40 percent increase in sublease space for the first half of the year.

Tenants are still seeking quality, as evidenced by the 50 percent preleasing average for the five buildings currently under construction in lower downtown, as well as two new office towers in the southeast suburban submarket. Totaling 1.586 million square feet, lower downtown projects currently underway are Opus West’s 1401 Wynkoop/1400 Wewatta, Hines’ 1515 Wynkoop, 1755 Blake by First Century/Haselden, Westfield’s 1800 Larimer, Sugar Cubed by Urban Villages and Kennedy Associates’ 1900 16th.

In the southeast suburban area, Shea Properties is underway with the first phase of Village Center Station, and the Madden Companies is nearing completion of Palazzo Verdi. The combined effect of this new construction and its accompanying higher rates is helping the owners of second generation Class A buildings push rates that are nearing $35 full-service downtown and $25 in the southeast suburban area.

A possible ripple in the pond is the potential for further financial services industry struggles nationally, which would cause some downsizing in Denver. Some additional subleases and downsizing will undoubtedly arrive on the market in late 2008 and early 2009 as companies seek to maximize efficiencies, and it remains to be seen whether energy growth can partially or wholly offset this negative absorption.

With the Denver economy and job growth still outpacing the rest of the nation and a limited pipeline of new construction, the local economy may avoid a serious downturn.  This trend is very similar to the development that occurred in the late 1990s when a tight market led to only five new buildings in lower downtown, which were promptly absorbed.

— David Morrison is a senior vice president at Grubb & Ellis in Denver.

Industrial

Denver’s industrial market has been relatively insulated from the shocks felt by many national markets due to its regional focus and diversified tenant base. Following what was in many respects a record year, 2008 has experienced some decline in activity, but remains much more stable than other regional markets as well as other property sectors. The retail sector in particular has been hit by a slowdown in consumer spending, and recent boomtown markets such as Phoenix and Las Vegas were also particularly impacted by the housing meltdown.

Denver experienced increasing industrial lease rates and sales prices as well as high absorption and low vacancy throughout 2007, while 2008 has brought a modest slowdown to the market. Overall vacancy rates remain near the long-time average of 8 percent, and absorption continues to be positive, but deal activity has slowed dramatically. Average asking lease rates have decreased by $0.20 per square foot since the beginning of the year as landlords compete for diminished quantities of tenants. Other landlords have begun to increase incentives to attract deals, such as the $0.75 per square foot in moving allowances marketed by Airways Business Park in Aurora. Properties offered for sale have also reacted to a decrease in activity, with several owners reducing asking prices up to and exceeding $20 per square foot.

The presence of several large tenants in the market, as well as the relative health of the Denver market, has kept developers delivering new product to the market. New development has primarily taken place in Denver’s largest submarket, Airport/Montbello, with 1 million square feet already completed and 1.5 million square feet under construction. This new development could put downward pressure on industrial lease rates as it contributes to vacancy and as activity continues to decrease.

Denver area developers and owners remain hopeful about the future as Colorado is now an emerging leader in renewable energy fields. Ascent Solar recently purchased 120,000 square feet in Thornton, and PrimeStar Solar signed a lease for 43,000 square feet in Wheat Ridge. Most significantly, ConocoPhillips recently purchased the former StorageTek facility with the intent to build a renewable energy laboratory with construction beginning in 2009. The remainder of 2008 looks relatively stable for Denver, which could be beneficial to tenants and buyers as the combination of lower lease rates and decreased activity offer increased opportunities in the marketplace.

— Greg Falcone is an associate broker at Grubb & Ellis in Denver.

Retail

The consumer-spending slump has had many retailers scrambling to make ends meet. In response, landlords are becoming creative in restructuring lease terms and pricing in order to maintain occupancy and tenant mix. While the Denver-Boulder area still rates in the top 10 for retail potential in multiple trade lines, the area has been hurt by the multiple pullouts and bankruptcies at the national level. Especially the bankruptcy of Steve & Barry’s, which had just started to expand into the metro area, has opened up some large holes. In the short term, less discretionary income on the part of the consumer will continue to limit sales in the clothing, furniture and electronics categories.

Overall vacancy has not dropped significantly as of yet, with the majority of announcements related to new store openings as opposed to large-scale closures, although rates are slightly above 8 percent, higher than they have been in some time. Asking lease rates have also just begun to decline, although effective rates have been shifting for some time as landlords become more creative in structuring deals.

While the macro-market statistics might be in a slump, there are still niche markets catching investors’ eyes. The northwest Denver area has more than 500,000 square feet of commercial development underway, in addition to multiple hotel deals. The downtown and lower downtown submarkets also have more than 1.25 million square feet of office space in construction, all containing first-floor retail space. Other infill master plans such as Lowry and the new Federal Center development by Aardex are also moving forward. Alberta Development Partners is also incredibly active in the marketplace currently, with three diverse projects in various stages of development around the metro area — The Streets at Southglenn in Centennial, Cornerstar in Aurora and Northlands in Broomfield.

The financial markets continue to experience upheaval, dropping investment sales volume dramatically. The number of properties changing hands is down by 61 percent from last year, and the total deal consideration is down by nearly two-thirds. Non-recourse financing is hard to find, and developments that were all but underway are now without financing.

The events of 2008 will likely take some time to smooth over. Unemployment rates are still rising, and news from the investment and stock markets continue to backslide following each minor victory. The sky is not falling, although one can say with some certainty that we are in for a fairly stringent market correction for the next several months. Investors with the discipline to evaluate their portfolios in an unbiased fashion and target quality product can still make money in this market. Inflation is slowing, commercial mortgage delinquencies are at a paltry 0.28 percent and legitimate, well-financed buyers are still present in the marketplace.

— Larry Thiel is an associate broker at Grubb & Ellis in Denver.

©2008 France Publications, Inc. Duplication or reproduction of this article not permitted without authorization from France Publications, Inc. For information on reprints of this article contact Barbara Sherer at (630) 554-6054.