Q2 2012 Denver, Colorado Office Market Trends

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Q2 2012 Denver, Colorado Office Market Trends

The market, tracking the local economy, maintains its positive trajectory, albeit not without some bumps along the way and some concern about the future of job growth. That said, demand has been strong since 2011, particularly in the LoDo (Lower Downtown) and CPV (Central Platte Valley) areas adjacent to downtown proper. While many tenant moves are lateral within the market, relocations to Denver from out-of-area locales are a helpful factor; a recent move from the Dallas area is a case in point (see Submarkets). Indeed, with a shrinking stock of large blocks of space, developers are reengaging. While still relatively high, the vacancy rate has been moving downward and positive growth has returned to average rents. Despite a slow second quarter, the market is well ahead of the pace of investment seen in 2011, when $1.2 billion were exchanged in 49 deals.

OCCUPANCY


Periodic high vacancy has been a way of life for the highly cyclical Denver area office market. Indeed, the 20.0%-plus vacancy rates ushered in by the latest recession amounted to the third such bout since the early 1990s (a 10-year bout that ended in 1992). Vacancy during the latest cycle peaked at 21.1% in the third quarter of 2010 as 18.6 million square feet stood vacant. The rate has been decreasing since. By the end of the second quarter of 2012 it had declined to 18.6%, down 50 basis points for the quarter alone and the lowest rate recorded by Reis for this market since early 2009. The volume of vacant stock as of mid-year was 16.5 million square feet, a decline of 2.1 million square feet from the 2010 high. While a 10-basis-point rise followed in July, the increase reflected a single large space evacuation in downtown Denver (see Submarkets) rather than a fundamental change in the dynamics of supply and demand; the downward trend in the vacancy rate should resume shortly.

As is typical for recovering markets with high vacancy levels, competition among landlords to retain existing tenants or secure new ones has resulted

in a “flight to quality” phenomenon as Class A rental concessions siphon off some number of lower-tier tenants to the higher quality spaces. Reis’ data speak strongly on behalf of the trend. Second quarter Class A vacancy was 15.3%, down 90 basis points for the quarter alone, down fully 200 year-over-year. At 21.8%, the second quarter Class B/C rate, for the sake of comparison, was unchanged and down 40 basis points since the second quarter of last year. In addition, Studley, Inc. tied recent improvements in occupancy to the “growing sense” among larger tenants “that the supply of bigger blocks of Class A was dwindling.”

SUPPLY AND DEMAND


“Although the official numbers suggest that hiring has lost a step,” notes Studley, Inc. “companies continue to relocate their operations to the Denver region.” Net absorption, accordingly, finds itself fortified by sources of demand unrelated to local factors. The 865,000-square-foot net absorption total counted by Reis for the first half of 2012, nearly equaling the total amassed through all of 2011, was accomplished in the presence of no new supply deliveries. The total for the second quarter alone was 403,000 square feet. While July followed with a negative total on the order of 117,000 square feet, the loss does not indicate a new worrisome trend. Rather, it reflects, for the most part, a large move-out downtown, which evacuation had been anticipated for some time (see Submarkets for details). While the volume of vacant supply remains high, Jones Lang LaSalle nonetheless reports a shortage of large blocks of available Class A space (see Special Real Estate Factors). In the words of local firm Newmark Knight Frank Frederick Ross (Ross), the availability of large blocks of space is “extremely limited.”

The lack of large blocks of Class A space, reported Jones Lang LaSalle, is pushing developers to “dust off” their plans. Significant recent and current development, meanwhile, has been led by single-tenant projects such as those for DaVita and IMA Financial Group in the greater

downtown market and TriZetto’s building in south suburban Douglas County. While spec development has remained sparse, however, it is beginning to return. The new 16M mixed-use project in LoDo is a case in point. And a spec project broke ground last September in northwest suburban Broomfield. A full-fledged return of speculative development, however, does not appear on the near-term horizon; build-to-suit remains the prevailing mode. Still, notes Ross, “developers are starting to plan projects in anticipation of the next development cycle. It is likely that one or more speculative projects will break ground this year in LoDo.” According to a second quarter report by Jones Lang LaSalle on high-technology industry, Google is looking for 160,000 square feet in the Denver area.

RENTS


Measured by the year, rent growth turned positive in 2011 following two years of loss. While last year’s gains were modest, the pace has accelerated. At $21.68 psf and $16.70 psf, asking and effective average rates for second quarter were up 1.0% and 1.2% since year-end, approximating the gains achieved all of last year. Each rate, meanwhile, saw a gain of a penny in July—on the way to respective increases of 1.7% and 2.3% for the year, according to the latest forecast. Respective second quarter Class A and B/C asking averages were $25.10 psf and $18.41 psf, up 0.7% and 1.4% year-to-date.

Following years in which leasing was dominated by short-term deals and lease extensions, “long-term leases have again become the norm,” explains Ross. “Business leaders have regained clarity and are making it a priority to secure office space ahead of rental rate increases.” Class A landlords have been able to raise rates and lower concessions, thus “resulting in higher net effective rates,” states Jones Lang LaSalle. With only one speculative multi-tenant project under construction per quarter-end (Eos in Broomfield), “landlords are gaining the leverage needed to raise rates across all submarkets and classes,” adds this source.