Office Market

The Denver office market is currently in expansion mode; with its 13th consecutive quarter of positive net absorption, there appear no signs of slowing down in the immediate future. The increased office absorption in Denver is largely due to existing companies expanding, however, it is also being driven by new companies relocating into the Denver metro area. To illustrate this growth over the last year, listed are some key facts pertaining to Denver’s office market:

• Lease rates are up 10% metro wide
• 20% in Denver’s CBD
• Vacancy rates are 13% in metro Denver
• Approximately, 1.9 million square feet of new construction

Lease rates continue to rise due to a shortage in supply and rising construction costs. It is predicted that by 2010, Denver Class A buildings may lease for up to $40.00/SF. The supply shortage is most evident in downtown Denver and southwest Denver, where vacancy rates hover below 10%. Current vacancy rates are the lowest since 2001, falling more than 90 basis points year to date. However, not all submarkets have enjoyed such success; Aurora and northeast Denver have vacancy rates of 19% and 22% respectively.

The majority of new construction is concentrated in downtown Denver comprising 1.2 of the 1.9 million square feet. Other active submarkets include Southeast Denver and a rising interest in Northwest Denver. Northwest Denver has seen a dramatic drop in vacancy rates, from over 30% to approximately 15% over the past six years, which is largely due to significant space absorption coupled with rising rental rates in both downtown Denver and Boulder.

Sizeable transactions that have been completed include: the IRS leasing 175,000 SF in downtown Denver, United Launch Alliance leasing 160,000 SF in southeast Denver, Callahan Capital Partners purchasing the Blackstone Portfolio for $770 million, and Denver Place Towers selling for $200 million.

Importantly, there is an interesting phenomenon occurring throughout the Denver metro area and the U.S.; private firms and other new players to the commercial office markets are doing business differently than the publicly traded real estate investment trusts (REITS) that have dominated the office markets. Whereas public REITs had to be mindful of managing their properties to achieve quarterly results, these landlords are not similarly constrained by public shareholders and are aggressively pushing rental rates, albeit, while risking higher vacancy rates. Their objective is clear: the goal is to realize much higher values in these assets by dictating the market rather than following the market. In short, these landlords are not interested in achieving “incremental” market rental rate increases but rather altering the tenant/landlord landscape by pushing rental rates to new highs in certain U.S. office markets.

Industrial Market

The Denver industrial market is the center of the Rocky Mountain Region and is the 18th largest industrial market in the country.

The 2007 annualized leasing activity is on pace to hit record levels with over 19 million SF of activity, a 76% increase since 2005. Vacancy rates have fallen to 6.18% in the 2nd quarter of 2007 due to a short industrial supply and affordable leasing rates.

The short supply has prompted many tenants to seek alternative submarkets as well as 2nd and 3rd generation spaces. The volume of 2nd and 3rd generation spaces being leased has also elevated the rental rates for this product. However, with more Class A buildings coming on the market, the rental rates should retreat to previous levels. In fact, new construction has increased by 88% since 2nd Quarter 2006 to meet the demand from tenants.

Industrial construction costs have risen 40% in the past year and are expected to continue to rise. Tenant improvement allowances and marketing costs have also risen, perhaps doubling in the past year.

Naturally, as result of increased demand and rising construction costs, rental rates have followed suit. Class C buildings have seen a 67% increase in rental rates in the past twelve months. Class B buildings have seen an 18% increase and are considered a value option for industrial tenants. Class A buildings, in addition to increased rents, have also been developed with increased efficiency. This efficiency has taken the form of higher clear heights, sprinkler systems, and more trailer parking.

In general, the highest industrial rental rates can be found in Boulder, while the lowest can be found by Denver International Airport.

Retail Market

The retail market has seen a contrasting year compared to the Denver office and industrial markets. After a record breaking year in 2006, vacancy rates have increased by 60 basis points and rental rates have decreased by 4%.

Boulder and southwest Denver have the highest rental rates while Aurora has the lowest. Lower rental rates can be partially attributed to more available space. There is currently 4.8 million SF of space under development in the Denver metro area. A large fraction of this space consists of big box stores that are under construction along the E-470 & I-25 north corridors.

In addition, there has been an overall slowdown in the Denver metropolitan retail sector, despite revenue increases for many retailers. Compared to 2nd quarter of 2006, Denver has seen 332,000 SF
of negative absorption.

Economic Forecast

In the near term, Denver should expect to see moderate job growth and low unemployment. Currently, Denver unemployment is 3.3%, or 120 basis points below the national average. Higher energy and construction costs, as well as rental rates, should continue to grow but may taper off from their current levels. The Denver Metro commercial leasing and investment activity should be strong throughout the balance of year. However, with a myriad of announced new developments throughout the metro area, it will be interesting to watch what projects are actually developed and succeed.