Office Sector
At 16.7% as of 24Q1, Denver has one of the highest vacancy rates among major U.S. markets. Low office utilization has plagued nearly every market across the nation, but Denver is more susceptible than most due to the market’s high exposure to tech sector workers who have led the way in adopting flexible workplace arrangements. Denver’s occupancy has declined by 6% since 2019. Only San Francisco, at 14.3%, and California’s East Bay, at 7.2%, have experienced sharper drops during the same timeframe.
Office availability is likely to remain elevated in Denver for some time, as current leasing trends suggest that companies are adjusting their footprints to lower space-per-worker requirements when their leases expire. Leases signed in the fourth quarter averaged about 3,100 SF, representing a 45% decrease in average lease-size since its peak in 2015.
Even as demand has pulled back across the Denver office market, construction activity has picked up to levels not seen since 2017 as developers hope to capitalize on tenant demand for new, high-quality space. There are fewer tenants in the market relative to pre-pandemic averages, but those who are in the market are placing more scrutiny on the value that potential office space would bring to their businesses. As companies move away from older office buildings and into higher quality space, buildings constructed after 2020 are benefitting from leasing demand.
Comparatively, Denver has a high concentration of older buildings which have borne the brunt of softening demand. This subset includes some of Denver’s most iconic buildings in downtown that have struggled to maintain adequate cash flows as tenants vacate, leading to distressed or delinquent loans.
With the abundance of available space, the Denver office market remains tenant-favorable. While base asking rents have held relatively steady since the beginning of 2021, tenants have maintained leverage in lease negotiations by asking for steep concessions and higher tenant improvement allowances. Additionally, tenants can get a 30% discount on built-out sublease space relative to direct space.
Persistent weakness in the office market and an unclear outlook have suppressed investor demand. Investment volume in the past year was down by 60% from its five-year annual average, the most dramatic slowdown in sales among property asset classes. Price discovery is still underway, but a handful of recent repeat sales ranging from trophy assets to suburban mid-rises indicates a correction in values of at least 20%.
Sales
The Denver office market faces considerable challenges with one of the highest vacancy rates among major U.S. markets, and investor interest has waned in recent years. Trailing 12-month sales volume amounted to $837 million, which resembles 2010 levels when the market was climbing out of the Great Recession. Within the past five years, annual sales volume averaged $2.2 billion, and was as high as $3.5 billion over that stretch.
Recent large deals have been rare, which is reshaping Denver’s buyer pool. Traditionally, institutional and REIT investors have accounted for approximately 35% of annual acquisition activity but have pulled back and represented just 5% of sales activity in 2023. Private equity has taken on a larger share in the past year, accounting for nearly 40% of sales activity when historically this type of buyer has represented between 10-15% of annual sales. Private investors continue to account for about half of the buying pool, with most deals valued at less than $10 million.
Cap rates have risen across all property types as the cost of debt has increased. However, cap rates are rising fastest in the office sector. CoStar’s modeled cap rates, which include all office properties within the Denver market, have increased by about 130 basis points from its most recent low point in mid-2021 to about 8.7% in early 2024. However, transacted cap rates have varied widely in the past year, with medical office buildings fetching the lowest cap rates in the low-6% range, while older, high-vacancy properties have traded with cap rates approaching 9%.
Price discovery is still underway but a few deals that have closed recently in Denver’s suburbs have provided insight into valuation in Denver’s older inventory, which has borne the brunt of softening demand. Institutional investor Recentric Realty Capital purchased the 1982-built 3 Star Union Terrace Building in January for $8.68 million. That comes at a 23% discount from its last purchase price in 20Q1. Similarly, the 1981-built 3 Star 143 Union building in Lakewood sold in early 2023 for $24.9 million, a 20% discount from its last purchase price in 2015.
Even Denver’s well-leased newer office buildings in prime locations have seen values fall. Beacon Capital Partners purchased Union Tower West in February for $54 million. The 2015-built 4-Star office building is in the Platte River Submarket, one of the most attractive areas in Denver, and was 98% leased at the time of sale. Despite these positive attributes, the property sold at a 22% discount from its last purchase price in 18Q4.
Going forward, distressed or delinquent loans will be a central theme in Denver, particularly in the Downtown area. Several 1980s-built Downtown towers, including Wells Fargo Center, Columbine Place, and 1670 Broadway have defaulted on loans. In some cases building owners were unable to find a resolution, and The 410 and 1801 Broadway reached the foreclosure process. However, a few buildings including Republic Plaza and 1801 California were able to renegotiate loan terms due to new leases, therefore avoiding receivership. CoStar is tracking roughly $664 million in CMBS loans that will mature for office properties through 2026, and the delinquency rate rose above 10% in early 2024, up from 1.2% in 2019.
Industrial Sector
As of the second quarter of 2024, Denver’s industrial market demand continues to cool. Decelerating net absorption combined with a steady stream of industrial project completions have pushed Denver’s vacancy up by two full percentage points in the past year to 8.0%, one of the highest industrial vacancy rates among the 30 largest U.S. markets. Annual rent growth amounts to 3.7%, underperforming the national average.
Leasing activity swiftly downshifted in the second half of 2023 and is approaching its pre-pandemic average. Most recent leases are in the East I-70 corridor, an area of Denver that offers convenient access to major highways, rail, and Denver International Airport, as well as proximity to a skilled labor force. In an encouraging sign, larger space users were active in the market in the final months of 2023. Two of the largest deals of the year, each exceeding 300,000 SF, were signed in December.
Still, the big box segment has the highest vacancy rate, at over 15%. Developers had been undertaking increasingly larger speculative projects across Denver in recent years, and nearly 90% of the 5.9 million-SF under-construction pipeline consists of properties that are larger than 100,000 SF. Meanwhile, the market remains dominated by small and midsize distribution tenants that serve the local population. Small bay properties remain in high demand, with space listings that typically only last less than four months. Deliveries over the next 12 months will deepen the divide in fundamentals between the big box segment and smaller, infill properties.
While there is still a large tally of projects that are scheduled to complete construction in the next year, most new developments that will deliver in 2024 are those that broke ground in late 2022 and early 2023. Construction starts have fallen off dramatically since the spring of 2023, as developers find it increasingly difficult to obtain financing for new projects. Big box speculative developments have been most impacted by tightening lending standards due to this segment’s oversupply risks. The shift away from speculative development is boosting Denver’s preleasing rate, which registers 48% in 24Q1, up from 14% at the start of 2023.
Rent growth is decelerating in the Denver market, driven by an active construction pipeline and slower leasing activity. With the local vacancy rate expected to remain high this year, rent growth will likely slow further in 2024, to levels below the pre-pandemic five-year average of 6.8%. However, the recent pullback in construction starts should limit additional supply pressure from hitting the market by late 2024. Once space availability begins to tighten again, there’s potential for rent growth to accelerate during 2025-26.
Construction
Denver ranks among an extensive list of markets expected to face over supply issues in 2024. Over 6.7 million SF is scheduled to deliver over the next four quarters, exceeding the 10-year annual absorption average of 4.2 million SF. At 11.0%, Denver already has one of the highest availability rates in the country. Availabilities are projected to rise further in the near term as construction continues to outpace demand in the market.
However, construction starts have fallen off dramatically in recent months as developers find it increasingly difficult to obtain financing for new projects. Big box speculative developments have been most impacted by tightening lending standards due to this segment’s oversupply risks. According to market participants, the window to obtain a traditional construction loan for this type of project all but closed in late 2022.
Developers had been undertaking increasingly larger speculative projects across Denver in recent years, largely concentrating on the East I-70 corridor and the area surrounding Denver International Airport (DIA) where developable land is readily available. Hurdles including permitting delays and labor shortages impacted developments of all sizes, and building bigger became a more efficient use of time and capital. Properties 500,000 SF and larger now have one of the highest availability rates of 15.8%, up from just 1% in late 2017. This big box segment makes up roughly half of Denver’s pipeline and availabilities are projected to rise further as this space will take time to digest. But no speculative projects in this category have managed to get off the ground in the last 6 months, signaling that the big box segment should find relief from rising availabilities as soon as late 2024.
Meanwhile, new groundbreakings have largely shifted to build-to-suit developments. PepsiCo broke ground on its 1.2 million-SF manufacturing facility near DIA in the second quarter, which will be its largest plant in North America when it opens in 2024. Nearby, Whole Foods preleased 140,000 SF at the Highpoint Industrial Elevated Park. The shift away from speculative development is boosting Denver’s preleasing rate which registers 48% in 24Q1, up from 14% at the start of 2023.
Smaller projects are also getting off the ground because they don’t require the significant financing that larger projects do, and many are owner-financed. They’re also attractive from a leasing perspective because Denver’s industrial market remains dominated by small and midsized distribution tenants, and industrial spaces smaller than 50,000 SF tend to lease quickly. These small-bay properties made up 3% of the total construction pipeline at the beginning of 2023, but that figure jumped to 8% in 24Q1. While big box activity is largely concentrated near the airport, small-bay development is able to disperse
across the metro due to the smaller footprint required.
Denver Economy
The metro Denver region encompasses seven counties along the Front Range of Colorado and has a population nearing 3 million. The region’s population has grown by 10.9% over the past decade, compared to the national benchmark of 5.5%. The region is expected to grow at a slower but steady pace over the next 10 years.
Denver’s highly educated workforce, a globally connected airport, and low-tax environment have made the metro a hub for job creation. The region is home to 10 Fortune 500 Companies, including Arrow Electronics, DISH Network, and DaVita.
The Denver market recovered all jobs lost due to the pandemic by July 2021. The most recent data shows that 7,200 jobs were added in the past year, a 0.4% increase in employment. The unemployment rate of 3.4% continues to trend below the national average. The slowdown in job growth could be a symptom of worker shortage rather than softening demand for workers.
Denver has a high concentration of tech jobs, most of which are in the information sector which makes up 11% of Denver’s total employment. According to Metro Denver Economic Development Corporation, the region has the fifth-highest employment concentration in the nation and was the fastest growing cluster in the region between 2016 and 2021, rising 49.2%. This sector also saw the greatest job losses over the past year as tech companies scaled back operations in the current high interest rate environment. The high concentration of tech in Denver has made the city one of the more flexible-friendly economies, which is further complicating the office market outlook.