Will 2011 be better than 2010?

By Nathan Johnson & Tom Lee

Newmark Knight Frank Frederick Ross

The office market hit bottom in 2009, in terms of vacancy and rate erosion, and has shown slow, steady improvement in 2010. We have achieved three consecutive quarters of positive absorption in 2010 following six consecutive quarters of negative absorption from third quarter 2008 to year-end 2009. Year-to-date absorption stands at 892,367 square feet and overall vacancy is 19.8 percent, which is down from 20 percent at year-end 2009. So, 2010 was a year of stabilization, which will enable the market to move forward in 2011 and create opportunities for brokers, landlords and tenants. For most, 2011 will be better than 2010.

On the leasing side, well-capitalized tenants will have the opportunity to move into Class A buildings, signing deals at rates not much higher than Class B rates at the current cycle’s peak in 2008. This flight to quality will drive expansion in the Class A sector while recovery in Class B product will lag and functionally obsolete buildings will continue to languish. Rental rates have hit bottom and will recover moderately in select submarkets in 2011. However, the scarcity of large blocks of space in the central business district and southeast suburban submarkets will exert upward pressure on rental rates for the remaining large blocks and create a sense of urgency among large tenants in the market. In the recent watershed transaction with United Launch Alliance, the aerospace firm leased 466,000 sf in four adjacent buildings. This lease demonstrated some of the highest rates this year due to limited options.

Speculative development has been held in check by the tight credit market and the pipeline is empty. Though the market will likely not support speculative development for the next few years, developers have started acquiring land and planning projects, and will stand ready to pull the trigger as market conditions improve. Although 2011 will not be a banner year for development, several build-to-suit projects, including DaVita and IMA Financial, are scheduled to break ground.

Sales will increase in 2011 as further thawing of the debt market coupled with low prices entices buyers to come off the sidelines. Buyers of core assets will find lenders more willing and able to finance well-leased buildings with good cash flow. Cash buyers will have the opportunity to purchase commercial assets at low, or in many cases at below-replacement, cost and to reposition them to realize attractive returns on investment. However, overleveraged landlords burdened with high vacancies and declining rents still risk foreclosure as $300 billion in commercial loans roll over the next five years.

Job growth for the Denver metropolitan area is forecast to be slightly positive in the near term; however, several office-intensive industry sectors – including information technology, law, finance, oil and gas, finance and government – are expected to grow in 2011 and beyond. In terms of unemployment, Denver has outperformed the national average throughout this economic downturn. As of September, Denver’s unemployment rate was 8.1 percent, which is significantly lower that the U.S. rate of 9.6 percent.

In conclusion, 2011 will be better than 2010 and, more importantly, improving fundamentals will set the stage for the market’s next upturn.