I teamed up with Sam DePizzol, Newmark Knight Frank’s executive managing director, to discuss market insight and highlights of downtown Denver’s office market.
Douglas: What is your forecast for absorption in Denver’s downtown office submarket?
DePizzol: I predict that overall absorption in Denver’s downtown submarket will top 1 million square feet per year, through 2021. To put things in perspective, Denver’s downtown office inventory has increased by 13 percent in the last four years, all of which has been absorbed despite commanding record-high rental rates.
The last time downtown Denver saw a four-year run of robust absorption, totaling approximately 1 million sf per year, was in the early 1980s, when the Denver skyline essentially delivered. The average annual absorption in downtown Denver from 1980 to 2017 was 322,055 sf, according to NKF Research data, much less than the forecast annual totals for 2018 to 2021. In fact, the last time full-year absorption in downtown Denver totaled 1 million sf was 2006, a year of rapid expansion following recovery from the 2001 downturn in which absorption outpaced supply by a factor of 2:1. Given that the vast majority of new construction is Class A product and Class A buildings account for almost 70 percent of the downtown office inventory, the lion’s share of future absorption will be in the Class A sector.
DePizzol: This strong performance will lead inevitably to a shortage of large blocks of Class A space in Denver’s core downtown. We are tracking nine contiguous blocks of space 75,000 sf or larger available in downtown Denver as of November, and that number will soon be down to five, taking into consideration current deals in the works. Though the downtown office pipeline currently contains six projects, totaling 1.2 million sf under construction, we are not by any means “over our skis” on new product. New construction will slow in 2019 and 2020, with under 400,000 sf delivered each year, and will increase significantly in 2021, with an expected 1.2 million sf of new product. The relatively small deliveries in 2019 and 2020 will contribute further to Denver’s large block shortage overall.
Douglas: What are the implications for landlords?
DePizzol: Continued strong demand and the upcoming lull in the development pipeline will encourage overall downtown vacancy to plunge 450 basis points by 2020, a decidedly landlord market. This growth has pushed organic demand into mature Class A buildings located in the Skyline and Uptown micro markets, and this trend will continue. Just a few years ago, demand was concentrated in the Lower Downtown submarket, so this “rising tide” is beneficial to owners of diverse asset classes all over downtown. This continuing demand for new product will trickle down to older product, causing rental rates to appreciate 3 to 5 percent annually over the next few years.
Douglas: What are the implications for tenants?
DePizzol: The potential lack of large blocks of space and corresponding rental rate increases mean that companies looking at relocating to or expanding in Denver will have to act quickly and decisively to meet expansion needs or wait until relief comes with additional new construction. Overall rental rate increases driven by demand and escalating construction costs for new product mean that waiting could result in rental rate “sticker shock.”
Douglas: What trends do you predict for 2019-2021?
DePizzol: Desire for flexibility has driven explosive growth in coworking facilities in downtown Denver. Also, scalability has become a big issue for mature and maturing companies, and tenants are willing to pay a premium in today’s market for both flexibility and scalability. WeWork is seeking to capture full-floor tenants or tenants requiring future scalability in its facilities at Tabor Center and Wells Fargo Center, at above-market rates. Coworking providers and savvy landlords will continue to evolve their service models to provide both flexibility and scalability in order to attract and retain tenants in growth mode.
Douglas: What is Denver’s appeal to new and existing tenants?
DePizzol: Though cost of living, housing and office rental rates continue on upward trends, Denver remains a viable, affordable option for many corporations, especially coastal firms looking to relocate or establish satellite offices. Downtown Class A office space currently has an average leasing asking rate of $40.52 per sf with new construction approaching $60 per sf, a level never before seen in Denver. Even with expected appreciation, Denver rates are still half of Class A rates in downtown San Francisco, for example.
The current up-cycle has been long, second only to the cycle starting in 1990 after Denver recovered from the oil bust of the ’80s, positive fundamentals point to continued growth in 2019 and beyond. Denver’s economy continues to consistently outperform the nation in terms of job and population growth, home prices, state gross domestic product and personal income levels. The metro area entered its seventh year of strong job growth, averaging above 3 percent, and ranks in the top 10 for employment change from prerecession peak. Denver’s enviable economic fundamentals, quality of life and connectivity remain compelling draws for both employees and companies that seek to hire them. Much of Denver’s recent success centers on its appeal to corporate users, and absorption in downtown Denver has been driven by multiple new tenants in diverse industries, as well as organic expansion.