Office Sector
At 17.1% as of 24Q3, 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.
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 second quarter averaged about 3,200 SF, representing a 42% 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 indicate a correction in values of at least 20%.
Construction
Construction activity has picked up to levels not seen since 2017 as developers hope to capitalize on tenant demand for new, high-quality space. Construction starts did slow over the past four quarters, but Denver still has one of the more active pipelines across the country. With 2.6 million SF under construction, the Denver market is on track to expand its inventory by 1.4%. Over the past decade Denver’s office inventory has grown by about 8.8%.
Only 40% of inventory under construction is preleased, and new construction will contribute to accelerating vacancy expansion in 2024. The bulk of recent construction starts has been built-to-suit towers for companies such as World Trade Center Denver, Anterro Resources, and SCL Health.
Recent large speculative developments were able to obtain financing before the rise in interest rates, and no unleased projects larger than 20,000 SF have broken ground since 23Q2. The largest speculative development to deliver, the 32-story 1900 Lawrence in Denver’s CBD, broke ground in 22Q2 after the developer, Riverside Investment & Development CO., received financing through partnerships with Convexity Partners and Canyon Partners Real Estate LLC in late 2021. The building is currently 6% preleased and delivered this spring.
The impact that new construction will have on fundamentals varies throughout the market. Roughly 760,000 SF is under construction in the RiNo neighborhood, located within the Platte River submarket. This younger, grittier section of Denver that has experienced explosive growth over the past decade typically attracts creatives and tech startups that are now reducing their footprints as they look for ways to cut costs. Vacancies are already trending above the metro average and are expected to move higher with 58% of the space under construction available for lease.
Conversely, Cherry Creek typically attracts more established banks, small energy companies, and law firms. These types of tenants are upgrading their office spaces to aid in recruitment and retention. Vacancy in the submarket diverged from the metro trend in 2021 and at 6.3%, is now 10 percentage points lower than the Denver office average. Of the 360,000 SF that is under construction, 98% is preleased. Even with elevated construction, market participants report that Cherry Creek remains landlord-favorable.
With nearly 2.1 million SF scheduled to deliver through the end of 2024, new construction will have a larger impact on vacancy expansion in the Denver market than in prior years when just 600,000 SF delivered in 2022 followed by 435,000 SF in 2023.
Industrial Sector
The construction boom that caused vacancies to spike over the past two years is fading, indicating that Denver’s industrial market may be in the beginning stages of a return to balanced fundamentals. Even so, 2024 could prove to be a challenging year. While the vacancy rate is not expected to rise much higher, at 8.4%, it is among the highest of any major U.S. market and will likely remain elevated through the end of the year as the final wave of projects from the building boom is scheduled to deliver.
Tenant demand accelerated in the final months of 2023 and into the first half of 2024, coinciding with key positive economic data, including an uptick in consumer confidence and wage growth rising above inflation. 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.
A large tally of projects, a total of 4.9 million SF, is still under construction. Most of this space is scheduled to complete construction this year, and new supply is projected to outpace demand through 24Q4. The big box segment will be most impacted by future deliveries, as roughly 85% of the current pipeline consists of properties 100,000 SF or larger.
However, most developments underway broke ground in late 2022 and early 2023 when interest rates were at all-time lows. Following national trends, developers have pulled back on construction starts amid higher rates and tighter lending requirements for construction loans. Over the past four quarters, local industrial construction starts have totaled only 2.8 million SF, down 76% from peak levels in 2022 and 47% below the pre-pandemic five-year average. This is setting the stage for fewer completions beginning in 2025, which should help Denver’s vacancy rate to stabilize.
Denver’s industrial market will need to contend with the remaining supply pipeline before rent growth can recover to pre-pandemic norms. With vacancies expected to remain elevated in the near-term, rent growth is projected to decelerate to 2.1% in 2024, marking the weakest recorded rent growth since 2011. However, the recent pullback in construction starts should limit additional supply pressure from hitting the market in 2025. With space availability likely to begin to tighten again next year, there’s potential for rent growth to accelerate during 2025-26.
Small bay properties are set to outperform, as the market remains dominated by small and midsize distribution tenants that serve the local population. With developers focused on bulk distribution centers in recent years, less new construction has been built to serve smaller tenants, and small bay properties remain in high demand with space listings that typically only last less than four months.
Retail Sector
As of 24Q3, Denver’s retail market continues to benefit from an exceptionally low availability rate, limited new construction, and a resilient consumer base. This comes despite longstanding concerns of a softening economy and Denver’s slower population growth.
Retail availability has hit a record low of 4.6%, coming in below the 10-year average of 5.5%. Low availability is beginning to impact leasing activity as tenants face challenges securing the right type of space. Leasing activity amounted to 550,000 SF in 24Q1, lagging the quarterly five-year average by about 25%. On the smaller end of the market, national chains, including quick-service restaurants, convenience stores, and banks, are driving leasing activity. In larger formats, experiential tenants were key drivers of demand, as reflected in the top leases signed in the first quarter.
Denver’s construction pipeline remains subdued, and the projects that move forward overwhelmingly consist of freestanding build-to-suits. Retail inventory has grown at the slowest pace of all major asset types in Denver, helping to restore balance in the market.
While availability and new construction remain minimal, retail rents have barely risen over the past year, up by just 2.6%, underperforming the national benchmark of 2.5%. When adjusting for inflation, rent growth in real terms is in negative territory. This trend contradicts the tight fundamentals that should support robust rent growth. Malls remain the main drag on overall rent growth, with annual rates up by just 2.3% in this segment. Conversely, Neighborhood Centers have outperformed in the past year, with rents increasing by 3.1%.
In line with national trends, transaction activity is down in the Denver market even as fundamentals remain strong. In the current high-interest rate environment, the buyer pool has shifted predominately to small private investors who target single-tenant net-leased deals valued under $5 million. Cap rates in this tier tend to be on the lower end of the spectrum but have generally moved upward since the beginning of 2022 by about half a percentage point and now average in the low-5% range. The number of deals closing above $5 million is limited, with the largest deals in the past year focused on value-added plays with higher cap rates owing to the heightened risk in this tier and the more management-intensive nature of these assets.
Denver’s retail market is projected to remain tight through 2024 due to limited new construction and positive demand. Retail sales growth has outperformed in recent years, indicating that retailers are doing more with less by focusing on efficiency in this continuously evolving sector.
Denver Economy
Denver, Colorado, has been experiencing robust economic growth, supported by a diverse range of industries including technology, aerospace, energy, and healthcare. The city’s population has been growing steadily, attracting young professionals drawn to its high quality of life and dynamic job market. This influx of talent has bolstered consumer spending and supported the expansion of local businesses. However, like many other cities, Denver faces challenges such as housing affordability and infrastructure demands that need to be addressed to sustain long-term growth.
As of mid-2024, the commercial real estate market in Denver has been performing well, with certain sectors showing stronger growth than others. The office space market, for example, has seen a gradual recovery as companies continue to navigate post-pandemic work arrangements. There is a noticeable trend towards flexible workspaces and co-working facilities, catering to businesses that prefer adaptive lease terms. While vacancy rates have improved, there remains a cautious approach to long-term leasing commitments, particularly for larger, traditional office spaces.
The retail sector in Denver has been undergoing a transformation, driven by changing consumer behaviors and the rise of e-commerce. Physical retail spaces are being reimagined, with a focus on experiential retail and mixed-use developments. Retailers that offer unique, in-person experiences have been more successful in attracting foot traffic. Additionally, neighborhoods with vibrant, community-oriented retail environments have shown resilience and are attracting new investments.
Denver’s industrial real estate market has been a standout performer, propelled by the growth of e-commerce and the city’s strategic location as a logistics hub. The demand for warehouse and distribution centers remains high, with companies seeking to optimize their supply chains. This sector is expected to continue its strong performance into the third quarter of 2024, supported by ongoing investments in logistics infrastructure and technological advancements that enhance operational efficiency.
Looking ahead to the third quarter of 2024, the commercial real estate outlook in Denver is cautiously optimistic. Economic indicators suggest continued growth, though at a potentially moderated pace compared to previous years. The office market is likely to see steady demand for flexible and hybrid workspaces, while the retail sector will continue to evolve towards more experiential and community-focused models. Industrial real estate will remain a key growth driver, supported by robust demand for logistics and distribution facilities. To maintain this positive trajectory, it will be essential for Denver to address challenges such as infrastructure capacity and housing affordability, ensuring a balanced and sustainable growth environment.