MARKET HIGHLIGHT, SEPTEMBER 2009

DENVER
Steve Poole, Jeff Hawks, Gannon Roth and J.R. Bitzer

While commercial real estate hopes may not be a mile high in Denver, there is certainly something to be said about steady and stable market descriptions.

Industrial

In recent years, the word “stable” was hardly an impressive description when it came to describing one’s local industrial market. However, considering the tumultuous condition of the current national commercial real estate industry, Denver’s reputation as a steady performer looks significantly more favorable.

With an overall vacancy of 9.1 percent, Denver has one of the lowest industrial vacancy rates in the nation for non-port cities. A major reason for this is due to Denver’s low construction volume during the past few years. The market has grown by just 3 percent in the past 2 years. An especially low volume of large speculative warehouse/distribution properties have been built during this period, with only five new buildings of greater than 200,000 square feet added to the market.

In Denver’s largest submarket (Airport/Montbello), which consists of more than 70 million square feet and houses the overwhelming majority of Denver’s warehouse/distribution product, the second quarter vacancy rate was just 10 percent. Some recent major transactions that have occurred within this submarket are a 400,000-square-foot build-to-suit project for Whirlpool and the leasing of more than 300,000 square feet by Subaru.

Per-square-foot asking rental rates for prime warehouse/distribution space in Denver have declined by approximately 3.2 percent from the peak to $4.21 NNN and 5.4 percent for manufacturing space to $6.19 NNN. Despite stiff competition from vacant office buildings, R&D/flex properties has not seen significant price reductions, largely due to newer construction for many of these vacancies.

Many tenants are enjoying additional concessions as they relocate to a new facility or renew their lease at their existing location. Landlords are now in retention mode in hopes of keeping their buildings as full as possible. Many owners are looking at their upcoming loan commitments with an eye to potential changes in loan structure by their lenders.

As with all markets, industrial investment sales have come to a screeching halt. Cap rates in the past 12 months for non-portfolio sales have exceeded 10 percent in some cases; however, Denver’s average cap rate is hovering in the 8 to 9 percent range. The most substantial investment deal to take place recently was the sale of the 174,000-square-foot Intertape Polymer facility in Brighton, which reportedly sold for $6.6 million at a cap rate of 9.02 percent.

The Denver industrial market is poised for a rapid return once the economy has stabilized. An annual absorption total of 2.5 million square feet or less than the 2008 total is all that would be required to restore the market to its 10-year equilibrium of 8 percent vacancy. While the slightly larger volume of unsold user properties would hold back recovery somewhat, a significant economic boost might entice many companies to withdraw these offerings as well.

— Steve Poole is a vice president in Grubb & Ellis Company’s Industrial Group in Denver.

Multifamily

Denver’s apartment market is one of the best apartment markets in the United States. Similar to Washington, D.C., metro Denver apartment owners have experienced a softening during the last 12 months but are still seeing effective rents at levels above 2007.

The current vacancy of 9 percent reflects 25,847 vacant units of the 287,194 total in the metro area. Concessions are showing an up-tick, especially in the older properties. During 2009, 4,450 new apartment units are being delivered, and the expected 1,750 units during 2010 will complete all properties currently under construction.

The lack of sales is a common theme across the country and Denver is no exception. There have been no apartment sales exceeding 200 units in metro Denver during the first 6 months of 2009. There has been exceptional demand though for properties offered for sale. Most properties marketed for sale see more than 10 offers and several institutional quality assets had more than 20 offers submitted. During the last 6 months, one local brokerage office received 119 offers from 72 different buyers on metro Denver apartment assets. None of those have sold as the spread between the sellers’ ask and the buyers’ bid price remains wide enough to prohibit any transactions.

— Jeff Hawks is a principal at Apartment Realty Advisors in Denver.

Retail

The recent shining star of commercial real estate with average annual returns in the high teens nationally, the retail sector is now the source of headaches for owners watching tenants close up shop more rapidly than new tenants are backfilling spaces. Vacancies are increasing, rental rates are going down and new developments are on the backburner, facing struggles just to break ground.

The Denver metro area posted an average retail vacancy rate of 9.3 percent, not surprisingly up from previous quarters and rising since early 2008. The Aurora submarket posted the highest vacancy rate of 12.6 percent, and Boulder posted the lowest vacancy rate of 7.3 percent. The rate in which these vacancies are increasing and tenants are going dark is slowing — a positive indication the bottom of the retail market may be near.

While vacancies are on the rise, there are still many local and regional tenants locking in lower rental rates in locations they would not have been able to afford during the retail heyday. Second quarter 2009 saw the first drop in 2 years for rental rates in the metro area, with an average of about $17 per square foot as of mid-August. While it is not unusual to see rental rates marketed in the mid-teens in centers that previously commanded high 20s, there still exists a few submarkets showing strength with rental rates. The Colorado Boulevard/Cherry Creek submarket showed average rents exceeding $28 per square foot, and the South submarket average remains slightly above $20 per square foot.

Gone is the “Field of Dreams” attitude of “if I build it, they will come” held by most retail developers prior to the recession. Very few new developments are breaking ground in the suburban submarkets that rapidly expanded 3 to 5 years ago, and the real opportunities are being seen in the infill, urban locations. For example, the city of Westminster put out an RFP to redevelop the 1.2 million-square-foot Westminster Mall, and small to large urban renewal projects remain active if well located.

Recent, notable deals include Chicago-based Klaff Realty LP selling its vacant Mervyn’s department store to Westminster Mall owner MD Management Inc. of Kansas City for $3.3 million in anticipation of the mall redevelopment; ACF Property Management purchasing the Broomfield Marketplace from BlackRock for $13.1 million; and KP Properties purchasing the former Circuit City on Colorado Boulevard from Health Facilities Credit Corp. for $7.5 million.

Most real estate professionals will agree the future for the once shining star is ambiguous and the headaches are not going away quickly, yet opportunities for brokers, developers and tenants are out there for the creative minded.

— Gannon Roth is a broker associate at Unique Properties/TCN Worldwide in Denver.

Office

As the housing market hits bottom and many claim Denver will lead the way to residential recovery, the same cannot be said for the commercial real estate market as the national spotlight shifts toward the commercial arena.

While the fundamentals of Denver’s office market are not great, they’re not bad either. Vacancies continue to rise, rental rates continue to drop, sublease space keeps increasing and there is the ever-present shadow space. The result from declining occupancy is significantly less transaction volume and a reduction in gross absorption.

What happens next is subject to Colorado’s employment picture. Generally, statewide unemployment has been prettier than the national picture: at the close of second quarter, the measure was seasonally adjusted to 7.6 percent versus 9.5 percent nationally.

Leases always expire, and landlords are doing their best to retain tenants at almost any cost. The result is declining property values for owners, who are faced with diminishing demand for their properties, looming loan maturities and a non-existent investment market as they come to the realization their properties are worth significantly less than 3 years ago and buyers lack the necessary capital to meet increasingly tighter underwriting standards.

By the numbers, the overall Denver office vacancy rose to 14.5 percent at the end of the second quarter, as compared to 13.6 percent at the close of fourth quarter 2008. Overall average asking rents in the Denver area registered $21.02 per square foot at mid-year, only a slight decrease from the $21.53 average at year-end 2008. Despite the decrease in leasing activity, net absorption remained positive in the second quarter at 204,822 square feet. There was a reported 1.73 million square feet of new construction underway in the market at the close of second quarter.

The Denver central business district fared better than the suburban office submarkets, with a second quarter vacancy rate of 15.3 percent and overall rents averaging $26.56 per square foot. Net absorption totaled 53,793 square feet in Denver’s downtown. At mid-year, there was 929,569 square feet of new construction activity in progress.

The numbers may paint a “doom-and-gloom” picture, but in reality it is an opportune time to take advantage of current market conditions. Companies with long-range plans can benefit from the tremendous values that can be found in the market, and those with more uncertain futures will profit from the ability to negotiate short-term leases for maximum flexibility. Either way, there are opportunities galore for all tenants of all sizes.

— J.R. Bitzer handles corporate services and tenant representation for Bitzer Real Estate Partners/CORFAC International in Denver.

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