Denver Market Overview

Return of Office Demand, Strongest since 2019, but it’s a Marathon, not a Sprint

Overview

The Denver office market is showing early signs of recovery, as leasing volume resembles 2019 levels. However, Denver is still a tenant’s office market.  Risks in the office market are clearly evident for both the short and long term, as many companies are settling on the type of work environment, in office, hybrid work model, or fully remote.  Office designs are changing rapidly to “we” spaces instead of “me” space, with heavy influence on multiple types of shared and hotel space options.  Tenants currently in the market for office space are reluctant to renew leases in older buildings, driving a flight to quality, with strong preference for newly delivered and under construction office buildings. These companies are able to afford the higher quality office properties by shrinking their leased footprint due to remote work environments.  Tenants with larger office space requirements are demanding their buildings be healthy environments, with building sustainability ratings and top-notch amenities, such as fitness centers, food service, outdoor spaces, meeting areas, rooftop terraces, bike storage, golf simulators, game rooms, mountain views, and access to transportation, which are now considered necessities instead of optional. 

Vacancy & Lease Rates

Leasing activity has rebounded to pre-pandemic levels, but there is an emphasis on migration out of the CBD. The rapid rise in vacancy that the market experienced in 2020 has subsided, but vacancies still continue to rise. For offices outside the CBD, vacancy rates have dropped considerably from pandemic level highs.  Denver's overall office vacancy at the end of 2nd quarter 2022 increased to 14.5%, up 1/10th of a percent from the end of 2020.  Net absorption in the prior 12 months came in at a positive 114,000 square feet, much better than the negative 1.8 million square feet in 2020.  Sublease space inventories have begun to rise once again.  Available office sublease space in Denver now totals 5.1 million square feet, breaking the highest record previously set in first quarter of 2021.  The current availability rate of office space in Denver is 18.8%, up from 18.1% at the end of 2020.  The difference between the vacancy rate and the availability rate is the sublease space, which is currently not vacant, but is being marketed as available.  The effects of the sublease space are largely felt in the Downtown Denver submarket, where the vast amount of sublease space is listed.  Sublease space puts downward pressure on overall lease rates, as these spaces are typically offered at a deep discount relative to direct lease space.  Average asking lease rates at the end of second quarter 2022 for office space increased to $29.12 per square foot from $28.60 per square foot at the end of 2020.  Year over year rent growth in Denver is now at 1.9%.  The DTC, Greenwood Village, and East Hampden submarkets have seen the highest annual rent growth.  Pricing still remains in the favor of tenants by commanding heavy concessions, such as generous tenant improvement allowances, moving and cabling allowances, free parking, and free rent.  However, the tenants have to know what to ask for!

New Construction, Tenant Finish & Outdated Buildings

Denver's office construction pipeline remains thin, with only 1.7 million square feet of new office buildings currently underway, a decrease of more than 50% from the previous year.  Tenants, working on leasing new office space, continue to see significant time delays in occupancy dates due to challenges with long construction permit times, rising tenant finish costs, supply chain issues, and labor shortages.  The pandemic has spelled the end for office properties that were already on their last legs.  Finding new uses for these structures will become the focus for obsolete older office buildings. Many cities and ownerships are looking at conversion of these properties, through adaptive reuse, into industrial, storage, or affordable housing. Denver is no different, with currently four applications into the city from property owners looking for permits to convert large CBD office buildings to residential use. The Platte River submarket has emerged as a highly desirable area for office tenants and new construction development has increased to staggering levels in this submarket in the last year.

Sales

Investors have returned to the Denver market after retreating in 2020, following the initial outbreak of the Coronavirus. $3.4 billion in office sale transactions closed since July 2021. However, quarter or quarter sales volume has been steadily declining since 3rd quarter 2021.  Over the past decade, Denver has become a destination for both corporate relocations and small startup expansions, due in part to the city's relatively lower prices, diversified economy, and educated workforce. While the long-term impact of the pandemic on Denver's office sector remains uncertain, the uptick in sales volume and investor interest signals that the office sector is starting to normalize from a capital markets perspective.  Investors also continue to target assets located in Denver's suburban submarkets as well.   The market CAP rate for leased office investments was averaging around 6.91% the first half of 2022, and the average sale price per square foot was around $253, up from $240 per square foot in the prior year.

Summary

Market trends we are watching:

· Space reallocation:  downsizing

· Location migration: to the suburbs

· Lease terms: short and flexible

· Work environment: flight to quality and amenities 

Tenants of all sizes who desire to lease space should be able to command significant incentives that have not been seen in decades.  Property owners will be looking closer at tenant credit and ability to withstand another round of a COVID variant.  Tenants with lease renewal options should make sure they have expert advice on market lease rates and not just accept a lease renewal rate proposed by their landlord.  With the office market in the tenants favor, don’t be fooled into thinking you can secure a lease space on short notice!  You will need significantly more time than in the past to accomplish space design, obtain construction permits and complete construction of new space.  For most tenants, starting the process 12 to 15 months in advance of your lease expiration is appropriate. For large tenants, starting 18 months to 2 years in advance is necessary.  Identifying upcoming space options and gaining market knowledge on other tenants negotiated lease rates and incentives is necessary to achieve the best economics on your lease decision. Retaining an experienced commercial real estate consultant to represent your company is imperative to navigating our “new normal” and accomplishing your goals.

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SHELDON-GOLD REALTY, INC.
Commercial Real Estate Services
9025 E. Kenyon Ave. Suite 100
Denver, CO 80237
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