Western Real Estate Business

OCT 2018

Western Real Estate Business magazine covers the multifamily, retail, office, healthcare, industrial and hospitality sectors in the Western United States.

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M A R K E T H I G H L I G H T: C O L O R A D O 24 • October 2018 • Western Real Estate Business www.REBusinessOnline.com TECH COMPANIES, CO-WORKING SPACES ARE MAJOR CATALYSTS IN DOWNTOWN'S EXPANSION The model of growth in Down- town Denver has changed drasti- cally since 2013, when leasing ac- tivity in traditional core high-rise assets was dominated primarily by energy companies and finan- cial institutions. In the past 18 months, however, Downtown's expansion focused primarily on large corporate relocations and an explosion of co-working providers and technology companies that desire scalability options. This con- version represents a paradigm shift by owners and landlords of core Downtown assets, refocusing to appeal to "new tech" companies. NKF predicts that overall absorption in Denver's Downtown submar- ket will top 1 million square feet per year, through 2021, creating increas- ing competition for blocks of desirable space. Downtown Denver re- mains the preferred submarket for corporate expansions and relocations, colocation tenants and technology companies. This is due to its pool of young, educated and motivated workforce, nearby amenities and attrac- tions, numerous transportation options and housing explosion. NKF also notes that Downtown Class A office space has a median asking rate of $40.22 per square foot with new construction approach- ing $60 per square foot, a level Denver is seeing for the first time. Driving these rental rate increases is a flight to quality, buttressed by ongoing new construction. Attraction and retention of employees is the No. 1 priority in a tight labor market like Denver's, and this con- cern is propelling the current flight to quality. Compounding these forces is a desire for scalability, which costs a premium in today's market, especially as large block opportunities decrease. Available large blocks of space and the desire for scalability have changed the scene in second-generation Downtown core assets, which have struggled to achieve full occupancy, even during periods of in- creased leasing activity. Many larger and monied landlords and own- ers have invested significant cash in their properties to make 1980s-era buildings more tech friendly and desirable. The result is that almost any traditional Downtown high-rise is now signing (or experiencing leasing activity with) tech companies that have been forced to con- sider options they wouldn't have touched three years ago. They are motivated by a shortage of large blocks of space and increasing ask- ing rents, most notably in Lower Downtown (LoDo), Denver's newest tech hub. Co-working providers have especially noticed the switch and are snatching up space in core Downtown assets. Consider 1700 Lincoln Street, commonly known as Wells Fargo Center. This 1.2-million- square-foot, 1983-era office high-rise had significant large blocks of space remain vacant for more than 10 years. Beacon Capital Partners realized the untapped potential and invested in significant capital improvements at the property. The firm improved seating and gath- ering spaces with new conferencing facilities and soft seating op- tions. It also added a bike rack, which made the space substantially more attractive to tech users and co-working companies. Open Table and WeWork each leased more than 100,000 square feet at Wells Far- go Center this summer. Goldman Sachs had a similar experience at 1125 17th Street. The firm updated common areas and subsequently leased two full floors to Xactly. Tabor Center, owned by Callahan Capital Properties (re- cently acquired by Ivanhoé Cambridge), just completed a $15 million repositioning project that includes a new lobby, conferencing facili- ties and improved seating. WeWork took notice and leased up nine floors at the 1985-era landmark. Co-working facilities and technology companies are major catalysts in Downtown Denver's current leasing boom. Downtown remains the No. 1 market for corporate tenants due to scalability options, amenities, and access to public transportation, housing, and young, educated workers. Expect strong leasing activity to continue in this submarket, along with increased absorption and a corresponding growth in rental rates. NKF market data sourced from NKF Research, Denver Office Market Q2, 2018, published by NKF Director of Research, Lauren Douglas. Sam DePizzol Executive Managing Director, NKF ECOMMERCE ALLOWS DENVER TO EMBRACE SPEC DEVELOPMENT Growing demand from major distributors, manufacturing firms and ecommerce gi- ants has fueled the substantive expansion of Denver's industrial sector. Nearly 15 million square feet has been built since 2012, while the average rent neared the $8-per-square- foot threshold in the second quarter amid robust absorption. Developers remain com- mitted to Denver's industrial market with a population growth of roughly 37,000 people this year and a rise in ecommerce sales. As a result, the metro will record its strongest year of deliveries for the current cycle, reaching 6.5 million square feet in 2018. Amazon will occupy this year's largest project, a 2.4-mil- lion-square-foot distribution center rising in north Denver. A substantial portion of development remains speculative, which will likely con- tribute to another year of rising vacancy, pushing the rate up 90 basis points to 5.9 percent. Tepid rent growth should follow, moving the average asking rent to $7.77 per square foot with a 1.2 percent annual increase. Moving forward, rent growth should be supported by competition for new Class A space close to dense residential areas. These properties continue to attract investors as consumers' demand for quick delivery intensifies. This, in turn, is rapidly increasing asset value. Denver has recorded some of the best as- set appreciation in the nation, rising an av- erage of 8 percent annually over the past 10 years. On a per square foot basis, pric- ing passed $150 during the 12 months that ended at mid-year, soaring roughly 15 per- cent from the prior year-long period. The average cap rate compressed considerably over the past year, now resting in the low-6 percent territory. Out-of-state buyer activ- ity grew during the most recent trading pe- riod amid a 9 percent reduction in overall deal flow, emphasizing the attractiveness of industrial investment in Denver. Strong competition from institutional investors for well-located sites near residential areas will keep pricing elevated, which could moti- vate more private investors to list and cap- ture recent pricing growth. — Bob Kaplan, Vice President and Regional Manager, Marcus & Millichap What goes up must come down, as the saying goes, but laws of Newtonian physics don't appear to apply to multifamily real estate in Colorado. While some in- vestors have chosen to stick to the sidelines and wait out the end of this once-in-a-lifetime run of growth in the market, smart investors are continuing to find op- portunistic value along the Front Range. Those content to wait, however, may be missing out on appreciation to be found in pockets that have traditionally been overlooked in favor of tried-and-true neighborhoods like Capitol Hill, Congress Park, Wash Park and the Highlands. Investors have begun to feel that the Central Denver submarkets are topping out as rents have outpaced income growth and low cap rates are now butting up against rising interest rates. This has caused savvy buyers to look for the next beltways where money can still be made as the broader apartment market levels off. Jefferson County has traditionally been the "next" submarket that grabs buyers' attention after Central Denver as it's farther from the historically stigmatized Aurora market and closer to the mountains. However, we're seeing prices in Lakewood that rival those of Central Denver, leaving many to speculate on where the next opportunity lies. Colorado Springs has been on a tear, jumping from an average of a little more than $88,000 per door in the first quarter of 2017 to more than $130,000 per door in the current quarter. The average price per unit in Pueblo has grown from $35,000 per unit at the beginning of 2016 to more than $60,000 in the most recent quarter. Weld County is currently the fourth fastest-growing county in the U.S. and has shown average cap rates below 6 percent in the most recent two quarters. Closer to Denver, Aurora has begun to shake off that "no-go" reputation and has seen a pop in values in 2018. It wasn't long ago that you could pick up a Class C property along the Colfax corridor for 40-something thousand per door, but we are now seeing prices con- sistently north of $125,000 per unit. The three major growth catalysts in this market are Anschutz Medical Center to the east, the Park Hill neighborhood to the west and Stanley Marketplace in the middle. These assets have Aurora poised to follow a similar growth pat- tern to what we've seen in Jefferson County. Westwood is one of the last true Denver neighborhoods to "pop," but a drive down Mor- rison Road will provide ample evidence that investors are transforming that submarket. It will be interesting to watch how the neighborhoods close to the I-70 "Ditch" project and the $1 billion National Western redevelopment will be affected. Will they be too late in the cycle to take advantage of low interest rates and red-hot demand, or will those be the new pockets that heat up as the market falls back to Earth? MULTIFAMILY INVESTORS SHIFT THEIR FOCUS AS DENVER SUBMARKETS MAX OUT Thomas Graeve Senior Advisor, Pinnacle Real Estate Advisors

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