Denver enjoys resiliency in changing marketplace

Steve Jellinek
Vice president, North American
CMBS Research, DBRS Morningstar

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Several factors suggest that the Denver retail industry is likely to see continued slow but steady growth even as some lenders and investors shy away from the sector amid bankruptcy filings, store closures and stiff rivalry from online competitors. DBRS Morningstar expects retail vacancies in Denver to remain near historic lows, buoyed by a lack of new construction, robust growth in population and employment, and bricks-and-mortar retailers’ abilities to innovate in response to increased competition.

With little new construction, the Denver retail sector has benefitted from improving rents and occupancies after a sharp downturn following the financial crisis. CoStar Group Inc. reports retail rents posted average annual gains of nearly 5% from 2013 to 2018, one of the best performances out of the 50 largest metros nationally. Because of this, quarterly availability has improved or held steady for the past eight years, and CoStar reported a healthy vacancy rate of 4.5% for the fourth quarter. Along with improving occupancy levels, the sector has experienced steady rent growth with fourth-quarter rents standing more than 25% above their prerecession peak.

Following the national trend, rent growth has noticeably cooled from growth rates observed earlier in the cycle. With retail inventory nearly at full capacity at the start of the year, the vacancy rate expanded slightly in 2019 following a string of store closures. These closings were largely a result of unprofitable national retailers that failed to evolve in the digital age rather than a perceived weakness in Denver’s retail market.

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Sears was behind most of 2019’s negative absorption. The 125-year-old retailer filed for bankruptcy at the end of 2018 and closed two Denver-area stores in early 2019: a 150,000-square-foot location in Lakewood and a 130,000-sf Sears at the Streets at SouthGlenn. Both spaces were still on the market at the start of the year.

Safeway continued to plague the market after years of store closures throughout the state of Colorado. The grocery chain shuttered another big-box location in 2019 – 54,000 sf at Westminster Plaza in Westminster. A Kmart and several Toys “R” Us locations also closed in recent years.

Even as consumers are opening their wallets – with Denver unemployment at 2.4% (well below the 3.7% national average) and consumer confidence high – consumers have shifted spending toward experiences, such as concerts and travel, and away from tangible goods. Digital threats remain at the heart of the retail industry’s crisis. E-commerce made up 11.2% of total retail in third-quarter 2019, up from 4.2% during the same period in 2010, according to financial data firm Refinitiv.

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As some traditional retailers are pulling back, other retailers that offer shoppers a more personal experience are expanding, as are discount retailers and experiential tenants. The top leases and move-ins of 2019 reflect the ongoing shift in consumer trends and where tenant demand is the strongest. Four of the top seven move-ins belonged to fitness centers: Vasa Fitness (56,000 sf), Chuze Fitness (50,000 sf and 40,000 sf) and Prestige Fitness (38,000 sf).

It’s not surprising that fitness centers fueled some of the biggest deals of 2019. In September, Minnesota-based Life Time Inc. acquired a 110,000-sf health club from Millice Group for $30 million ($273 per sf). One of the largest trades of 2019 was a California-based buyer’s acquisition of a 45,500-sf fitness center in Highlands Ranch for $22.8 million ($500 per sf). ACRE Corp., also based in California, sold the asset, which was fully leased by 24-Hour Fitness through 2035 with rent escalations every five years, beginning in 2025. The reported cap rate based on current income and expenses was around 7.4%.

As malls attempt to generate more foot traffic, they have focused on experiential retail to draw consumers in. For instance, Urban Air, a trampoline park for children, in early 2019 opened a 36,000-sf location at Towne Center at Brookhill in Westminster. By the summer of 2020, Urban Air will open a 50,000-sf location at the Cornerstar shopping center in Aurora.

The 330,000-sf Denver Premium Outlets in Thornton was completed at the end of 2018, and no further mall-style developments were being pursued entering 2020. Denver Premium Outlets hosts an array of high-profile tenants, including Kate Spade, Hugo Boss and a Nike factory store.

The Denver Premium Outlets competes with Colorado Mills in Lakewood. DBRS Morningstar’s commercial mortgage-backed securities surveillance group has been monitoring the $136 million CMBS loan on that property since a 2017 hailstorm demolished the roof, forcing a nearly year-long closure for repairs. Some shops never reopened and occupancy has yet to recover to prestorm levels of approximately 90%, hovering near 80% for much of 2019. The situation highlights the nuances of evaluating a single property’s prospects for backfilling tenant vacancies, even with quite healthy market dynamics buoying performance overall.

Developers are starting to blend in some significant retail components to downtown Denver mixed-use developments. Continuum Partners is building almost 90,000 sf of retail at its Market Station project, just a few blocks away from Union Station. Construction is expected to wrap up in early 2020. Market Station also will include 225 market-rate apartments and 95,000 sf of office space.

Vacancies are concentrated in bad retail centers and have not spread into the average retail center. Moreover, a concerted movement of households, wealth and employment to downtown submarkets has produced routinely above-average rent gains in the downtown and Cherry Creek submarkets, where vacancies have been razor thin for years. Centers and mixed-use developments with retail components in these rapidly growing neighborhoods are thriving.

In other cases, retail in bad trade areas often has been removed from inventory or is undergoing renovations and, in some cases, repurposing. With stronger demand drivers to weather the new age of retail, and supply that has only mirrored the national average despite superior demographic and economic trends, the Denver retail market has enjoyed an atypical amount of resilience to the effects of e-commerce.

Featured in CREJ’s February 2020 Retail Properties Quarterly

Edited by the Colorado Real Estate Journal staff.