The Defining Moments of 2007 in Denver Commercial Office Real Estate
By Ben Gilliam Frederick Ross Company
There were four defining moments in the Denver office market this year: rents, absorption, development, and the credit crunch.
In the first half of 2007, rents continued their escalating trend from the prior year. This resulted from the push/pull effect of buildings trading (with high cost bases) and tenant demand. In particular, the Callahan Partners acquisition of five CBD office towers, and the development rights for Tabor Center II, has had a market-making impact. The price point for those properties was very high, and asking rents in all of them are now moving higher to meet pro forma objectives. Overall, Class A and AA median rents downtown have moved from $24.00 per square foot at the end of 2006, to $28.50 at the end of the third quarter this year, a 19 percent increase. In addition, several leases were signed at the end of the summer that breached the $40 per square foot threshold, signaling willingness on the part of tenants to pay a premium for space in core properties. The currently unstable economy may result in somewhat slower rent growth in the coming months, however.
Absorption of office space has nearly tracked 2006’s torrid pace. Job growth in Denver is at 1.4 percent for the year, down from 2006’s 1.9 percent rate, but there has been enough demand to positively absorb over 2.2 million square feet through the third quarter. 2006’s 3.2 million total may be elusive this year, but only slightly. In particular, the CBD market has remained potent, with 626,000 square feet absorbed. While the residential markets have been suffering this year, the commercial office industry has seen continued growth, though that may slow as well.
All of this tenant demand continues to inspire developers to move earth and go vertical. Projects such as Westfield ’s 1800 Larimer, Hines’ 1515 Wynkoop, and Madden’s Palazzo Verdi all reflect bullishness of growth and investment potential in Denver . It is easy to sense optimism in this market when you see the dozens of tower cranes hovering over the metro area. Over 2 million square feet of office space is currently in the construction phase, with several million more in the pipeline awaiting preleasing commitments.
In spite of these positive elements, the dominant story in commercial office real estate this year has certainly been the credit crunch that began this summer, and its widespread impact on Denver commercial real estate. Prior to the subprime industry meltdown earlier this year, the office markets were humming right along, continuing the strong pace set in 2006. However, a ‘perfect storm’ hit hard this summer, with mortgage lenders shedding jobs in light of miserable earnings reports, in combination with homebuilders compressing due to the terrible housing industry here in Colorado. As a result, there has been over 600,000 square feet of vacant available space put on the sublease market this year. While this evokes the dark days of 2002 and 2003, we are not even close to that nadir, when over 5,000,000 square feet of sublease space was dropped on the market.
There are some other differences this time around, as there has not been a catastrophic event like 9/11 that further plummets sour economic conditions, like with the local telecom slump in 2002. Also, Denver ’s economy is more diversified than in previous economic downturns, such as the energy collapse of the late 1980s. There is no one industry type downtown or in the southeast suburbs that dominates office occupancy. Even the housing/mortgage slump, as significant a downturn as it is, is only having limited effects on Denver ’s vacancy levels.
Ross Research has seen less tenant activity over the past few months. Downtown office properties in particular have experienced a 50+ percent drop in showings to potential tenants. However, there are still some significant deals in the works, such as Xcel Energy seeking a new 350,000 square foot headquarters consolidation. The oil and gas industry is also on fire, with oil prices at all-time highs. Several known tenants are looking to expand in the CBD.
Moving forward, Ross Research forecasts moderate economic retreat in Denver over the next three quarters, with possible light at the end of that tunnel by 4Q08. While this will mean less new jobs over the short term, probably to the tune of 1.0 to 1.2 percent monthly job growth, and thus less absorption, the overall health of the corporate world in Denver is not seriously at risk.