• Mon. Nov 28th, 2022

Denver-area commercial real estate defies pandemic expectations

ByWillie M. Evans

Sep 23, 2022

The pandemic has shaken commercial real estate markets to its core, creating more demand in some areas, like manufacturing, and destroying it in others, like offices. But 30 months after the first lockdown orders were issued, not all of the dire predictions have come to pass.

Take the rebound in demand for retail space, which is much shorter than expected after consumers shifted more of their purchases, even for groceries, online. Even as tenants fled densely populated areas during the outbreak, developers have continued to produce urban apartments at a brisk pace, raising fears of a glut.

Vacancy rates in Denver for commercial, multifamily and industrial real estate are in the 5% range, but for office space, they’re just under 20%, said Hessam Nadji, president and CEO of the management of Marcus & Millichap, at a gathering of the Denver Metro Commercial Association of Realtors earlier this month.

Demand for offices remains weak as employees fight for the right to continue working remotely and it could be a few more years before the fog lifts. And while companies have taken over the industrial space, the signs of retrenchment are mounting as online retailers pull back. But Denver doesn’t look as vulnerable as other markets.

Below is what regional brokers from a forecast panel compiled by DMCAR predict to be ahead in the areas they specialize in:

Office: an uncertain future

When employers closed their offices and sent workers home at the start of the pandemic, they probably did not anticipate that more than two and a half years later they would struggle to bring them back and face uncertainty. as to the space to be rented.

Office building tenants are accepting shorter leases for less space and trying to create the magic formula that will get their employees to give up commute-free shifts and self-prepared lunches to come back. Many still don’t know what their workforce will look like in the coming months, making it difficult to plan for their office needs, said Lee Diamond, senior vice president at CBRE.

A tight labor market played against a return to the demands of previous work in offices. With a shortage of workers and a high rate of quits, some employers were afraid to force the decision. A recession, however, could give management the upper hand by requiring workers to show up and sit down.

Another big problem for the office market is all the space that tenants sublet because they no longer need it. It was about 5 million square feet in metro Denver in the second quarter of 2021. It had fallen to 4.7 million more recently, but Diamond predicts it will soon climb back above 5 million square feet. The space glut is getting worse, not better.

Owners will need to be more creative in the concessions they offer and the amenities offered to attract workers to the office, including more on-site restaurants, fitness facilities and co-working spaces.

Office markets continue to see a flight to quality, Diamond said. This is a problem for older, less desirable class B or C spaces. They will need to renovate to stay in the game, but construction costs have skyrocketed from $100 to $120 per square foot before the pandemic to $280 per square foot now. This leads some building owners to hit the pause button until they know for sure that they can rent whatever they are upgrading.

Diamond said Cherry Creek is a hot office market and downtown Denver is bifurcated, with the new west side being much more popular than the east side.

Retail trade: stronger than expected

Retailers were hit with lockdown orders in the early weeks of the pandemic in 2020 and some forecasts predicted it would be years before brick and mortar recovered. They were wrong.

Metro Denver is seeing strong retail demand, especially from new grocery stores, said Courtney Key, partner at SullivanHayes Brokerage in Greenwood Village. Retailers actively seeking space include King Soopers, Whole Foods, Target and Costco. The problem is that there are not enough slots available to meet the high retail demand than expected.

“Construction costs are disrupting new transactions,” Key said. “There is incredible competition for pad space.”

Towels that might have cost $90,000 to $115,000 in 2019 now cost $120,000 to $150,000, she said.

National chains – think fast food, gas and banks – are overwhelming local competitors when it comes to winning bidding wars. And Denver is attracting “new-to-market” tenants from unexpected places, like the UK. They are targeting what they see as more vibrant neighborhoods such as Cherry Creek, River North and parts of downtown Denver.

Industrial: Denver could defy a slowdown

Online retailers have aggressively built fulfillment centers to store their products closer to consumers and shorten delivery times, and this trend has accelerated as more purchases moved online during the pandemic. Demand for warehouse space has also increased as supply chain disruptions caused by the pandemic have caused businesses to start stockpiling items so they don’t run out.

But as the recovery took hold, brick-and-mortar retailers clawed back their share of purchases and consumers shifted their spending to services rather than goods. Amazon, the market leader in adding new warehouse space, has gone from expanding to downsizing, subleasing space in some of its fulfillment centers and canceling plans for others.

Tyler Reed, general manager of Stream Realty in Denver, said the Front Range should fare better than other regions as Amazon pulls back. The online retailer remains committed to 4 million square foot facilities in Colorado Springs and Loveland.

“Amazon is healthy here, there is no sadness and unhappiness,” he said. And while the transition to online retail has slowed, it’s still in play, and that will require more warehouse space.

Industrial space along the U.S. 36 corridor between Boulder and Denver that cost $8 to $8.50 per square foot before the pandemic is now rented at $14 per square foot, Reed said. And rising industrial rents are happening across the metro area as demand continues to outstrip supply by millions of square feet.

“Rental rate growth is real and it’s happening,” he said. “It’s a pretty rosy picture.”

Multi-family: a glut in the making

Apartment rents typically go down a bit in the winter in the Denver metro area, but this year they went up, contributing to a 16% increase in average year-over-year rents, Josh said. Newell, director of Pinnacle Real Estate Advisors in Denver. .

Even with rising rents, apartment renters in the Denver metro area spend about 22% of their income on rent, below the 23% share of income on average nationally. A large influx of workers from more expensive markets, some of whom are working remotely and driving down wages, are better able to afford rising rents and luxury units being built.

“Flat fundamentals are still strong,” Newell said. “There is fear, but everything on the papers says it’s a good thing.”

Interest rates are rising sharply, forcing more buyers out of the market and keeping them rented. And unless there’s a big pullback in the tech sector, remote workers are expected to continue to play the spread, earning San Francisco-level wages and Denver-level rents.

So why the fear? Developers are expected to market about 15,000 apartments this year in the Denver metro area, but it appears only 12,500 of them will be “absorbed” or occupied by new tenants. Although the overall vacancy rate is reasonable at 4.75%, it should increase as these new units come on the market.

Here’s where the outlook gets risky. Metro Denver has 40,000 apartments under construction and another 72,000 in the planning stage, Newell said. Developers are looking to put 112,000 apartments on the market and there are questions about whether the market can absorb that, especially if people stop moving to Denver as they have for the past decade.

Much of this growth in new apartments is concentrated in the central business district, where vacancy rates already appear to be approaching 7.5%.

This new supply represents about a quarter of the existing apartment stock, Newell said. And while some projects may be cancelled, if developers’ projections don’t materialize, Metro Denver could see its apartment shortage quickly turn into an apartment glut.