Capital favors premier locations and amenities

Patrick Devereaux

Patrick Devereaux
Executive vice president, capital markets, JLL, Denver

Do you remember the Great Recession? At its peak in October 2009, the national unemployment was 9.9 percent and the national gross domestic product was 2.7 percent. Easy to forget those times today. The current national unemployment rate is 4.1 percent, and the 12-month U.S. gross domestic product growth rate is 4.4 percent. We are all very fortunate to be in Denver (and Colorado), as we have positively outperformed the nation during most of the Great Recession and the economic expansion. We have a current unemployment rate of 2.7 percent, and it’s been below 3.5 percent since July 2016.

Jason Schmidt

Jason Schmidt
Executive vice president, capital markets, JLL, Denver

The longest economic expansion on record per the Bureau of Labor Statistics was 120 months from March 1991 to March 2001, which is relatively recent. The current economic cycle began in June 2009 when the U.S. GDP started its first two quarters of positive growth; albeit slow at 1.3 percent. As of March, we are 104 months into this cycle, and if it continues into June 2019, we’ll break the record.

Many – OK, most – investors suffered significant financial loses during the Great Recession. I remember one of our clients stating that it was “almost fashionable” to give the keys back to a lender during these times. Capital is very focused on this not happening again. For the most part, investors and developers are being conservative and continue to be cautiously optimistic. The world economy is running on all cylinders, and it’s hard to not believe the next few years will have continued economic growth.

There is significant capital in the market, but it is selective. Going-in yields have a wide range due to the perceived risks of each opportunity. Many clients sat on the sidelines in 2017 due to the uncertainty of the economy and results of the presidential election. They are now believers in the future growth of the economy and ready to make acquisitions in 2018.

Core investors today are focused on buying assets that are well located and have desirable design (new construction, light-rail served, walkable amenities) that will outperform the market in case of an unexpected downturn; and they are willing to pay for it. Core-plus and value-add buyers want assets that have been mismanaged or undercapitalized, but the property must be in a location that is going to attract tenants for reasons other than low lease rates.

The most preferred locations continue to be the west end of the central business district (west of Champa Street, Lower Downtown, Platte Street), Boulder, Cherry Creek, Fiddler’s Green and Belleview Station. All of these locations attract millennial employee talent due to walkable access to numerous restaurants, light rail/transit and close proximity, in most cases, to the hottest new multifamily developments. Once the infrastructure development is completed, River North will rise to the top of desired locations as well.

Denver’s leasing community has coined the phrase “amenities arms race” to define what owners are doing to attract tenants. In the past, it was acceptable to upgrade your lobby and common areas to be competitive. If you had a common area conference room/training facility and could check the box for a fitness center; it was a bonus. This is not the case today.

Ownerships are going to extremes. Large collaborative lounges with couches and multiple televisions; on-site food kiosks or modern delis that encourage a social scene; and gaming areas with pool tables, foosball, pinball machines and cornhole are becoming the norm. The assets with these features (especially in the suburbs) are generating the most leasing activity. They also are attracting the most capital as they are anticipated to outperform the market going forward.

From an acquisition standpoint, newly constructed multitenant assets and long-term, credit-leased single-tenant buildings are highly sought after at record prices per square foot and very low yields. Office listings that are more commodity in nature (suburban, 1980s construction without on-site or walkable amenities) can trade at significant discounts to replacement cost, but cap rates are 50 basis points higher than 18 to 24 months ago.

The newly constructed 1401 Lawrence recently traded at a record price of $725 per sf and a 5 percent cap rate, demonstrating the strength of the buyer pool needing to acquire a top-tier asset in Denver’s CBD. The east end of downtown has less appeal. The most recent trade was over year ago. Dominion Towers transacted at just over $250 per sf and around a 6.75 percent cap. The east end of downtown is starting to incur more leasing activity and some contrarian value-added buyers are starting to pursue opportunities again at this end of the CBD.

Investor interest for newly constructed suburban assets continues to be strong. However, demand is not as deep in the suburbs, and yields are around 100 basis points higher than similar profile downtown properties. Several speculative office buildings have been built in the southeast suburban submarket, and most have been occupied by one to three large users with long-term leases. Granite Place at Village Center Place was designed to accommodate either a single-tenant or multitenant occupancy. This light-rail accessed and highly amenitized building was leased to two tenants with long-term leases. It recently sold for just under $425 per sf and around a 6 percent cap. Orchard Point was constructed in the mid-1980s and recently traded for just over $145 per sf and close to 7.5 percent cap. Although this asset has great highway visibility, it’s not deep in amenities and will require a capital investment by the new ownership. It’s a solid core-plus investment.

Denver continues to be regarded as a top-tier market for capital investment in office properties. Buyers are closely evaluating the risks associated with each opportunity and applying the appropriate risk-adjusted returns to determine their pricing. Investors are closely evaluating how well each asset will perform if there is a shift in the economy and pricing it as such. As a whole, it continues to be a great time be an investor in Denver office product.

Featured in CREJ’s March 2018 Office Properties Quarterly

Edited by the Colorado Real Estate Journal staff.