We are 18 months into the post COVID pandemic commercial real estate market, and the good news is that office leasing activity is back to 70% of normal instead of the 50% it was 6 months ago. However, tenants are not making long-term decisions in our uncertain environment. Estimating future demand for office space is complicated, as we experience the largest global work-from-home effort in modern history. Its positives and negatives are still being assessed, but the consensus is the office will remain a critical part of a hybrid work model, as 59% of businesses expect to reduce their office space requirements, and 69% of companies say the typical 9-5 workday schedule is a thing of the past. The recovery of the office market is going to be a slow process, with some predicting the market will be unbalanced until 2025. As employees return to the office, companies will begin to embrace low-rise buildings, (recently coined as “groundscrapers”), with the ability to reach offices via stairs rather than elevators and a shift to multiple smaller suburban locations closer to where their employees live. It is highly possible that lower floors of office properties will become more valuable than the top floors with mountain views.
In the meantime, office vacancies continue to rise, and the quantity of office sublease space on the market has hit an all-time record high in Denver recorded history. Metro Denver ended second quarter 2021 with 4.7 million square feet of available office sublease space. Denver's overall office vacancy at the end of second quarter 2021 increased to 14.4%, up 3.7% from one year ago. Net absorption in the prior 12 months came in at a negative 4.8 million square feet, where the historical average is a positive 1.3 million square feet. The current availability rate of office space is 19.2%. The difference is the sublease space, which is currently not vacant but is available. Denver’s sublease space now represents 18% of all the office space currently offered on the market. With this quantity of sublease space on the market, most of it will not be absorbed before the term of the lease expires, at which time, the space will be returned to the property owner and then counted in the market as vacant. Office sublet space poses more of a competitive threat than initially thought and is expected to slow the office market recovery. The effects will largely be 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. If this were not enough, a wave of over 2.2 million square feet of speculative office space construction is expected to deliver in the next 12 months, further pushing office vacancies up. Some good news for tenants: average lease rates are now sitting at $28.67 per square foot on a full service lease, a 1.71% decrease from one year ago. As the market swings to the tenants favor, landlords are also boosting leasing concessions such as free rent, tenant improvements, and moving allowances.
Tenants of all sizes who desire to lease space should be able to command lower lease rates and significant incentives such that have not been seen since the 1980’s. Property owners will be looking closer at tenant credit and ability to withstand another round of stay at home orders. 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, all due to supply chain issues and construction labor shortages. 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”, accomplishing your goals, and keeping your companies occupancy costs as low as possible.