Escalating costs impact Denver properties

Denver skyline

With property taxes steadily increasing, commercial real estate helping to fund large city initiatives and potentially mandated sustainability improvements, the cost of owning property in Denver is rising at a rapid pace.

“We are the caretakers for our owners in terms of their assets,” said Dan Simpson, who serves on the Denver Metro Building Owners and Managers Association board of directors. “We have a fiduciary responsibility to our owners. Keeping operating expenses down and focusing on the driving investment performance for our clients is key.”

While the major management associations recognize there are needs the city must address and recognize that increased property values can help building owners, there are calls that the city is unfairly relying on commercial real estate as a large funding source.

“I think what a lot people don’t understand is that those expenses eventually get passed back through to the end user,” said Tiffany Jackson, who serves as the chair of the legislative committee for the Institute of Real Estate Management Greater Denver Chapter 17. “Whether it’s in a commercial office building or in an apartment complex, it gets passed through in the form of rents.”

There is fear among some that all of these costs could combine to create a perfect storm in which tenants and owners must consider other options. “When you look at the spread between both rental rates and operating expenses in the central business district vis-à-vis the suburban office markets, if you’re a savvy business owner you certainly have to weigh those spreads,” said Simpson. “At some point, if it becomes too expensive, people will vote with their feet and go elsewhere.”

The best way for managers to help their clients as well as their tenants is to stay educated and get involved. Organizations like BOMA and IREM offer opportunities not just to stay informed but also to have a voice.

Following are overviews about three specific Denver challenges property managers should know about.

Property taxes. There are two components to commercial property taxes – the property’s assessed value and the mill levy. Every other year, the Denver County Assessor’s Office issues property values based on sales. In order to be in compliance, properties need to be within 5 percent of fair-market value. The purchase prices in 2015 included many record numbers, which ultimately impacted the magnitude of the 2015 assessments.

For some historical perspective, in 2005, the high-water mark was about $120 a square foot in value, said Matthew Poling, a commercial property tax principal with Ryan. Since then, we’ve seen some big increases in each reassessment year with the exception of 2011, when the value went down because we were at the trough in the market, he said. Additionally, in 2012, when Measure 2A passed and the city began to “deBruce,” taxes rose 18 percent.

However, even with this upward trend, the 2015 values shocked many. When Poling ran his numbers to examine the change in value for properties from 2014 to 2015 for a majority of the downtown Class A and B properties, there was roughly a 39 percent increase in value. When he eliminated buildings that were under construction in 2014 and finished in 2015, it dropped slightly to a 36 percent increase in property value.

“A 40 percent increase, on average, is high,” he said. “I think 2013 was probably closer to 20 percent. But when you combine those, that’s close to a 60 percent increase in value over a four-year window. It’s a big number.”

This year has not seen as many of the purchase-price records as the past assessment cycle did, so there’s an expectation that while property values will continue to increase, the 2017 assessments values will not increase as much, he said. These new values will impact the 2018 property taxes.

The second component is the mill levy, which is made up of all the taxing jurisdictions. In the city and county of Denver, these jurisdictions include the school general fund, school bond fund, capital maintenance, city bond fund, police, fire, urban drainage, developmentally disabled and the general fund. The current mill levy for the city and county is about 78.13 for all areas that don’t have additional special districts.

The mill rate went down just under 6 percent in 2015, so the average net increase in taxes was about 30 percent for 2015 – the 36 percent increase in property value minus the 6 percent decrease in the mill levy, said Poling.

On the ballot this November, Denver Public Schools is asking for additional revenue that equates to about 4 mills. If you look at 4 mills, divided by the current base rate, property owners will be looking at about a 5 percent increase in their rates in 2016, payable 2017.

However, Poling is predicting there will be a decrease in rates in 2017 because of all the value added to the area, he said. “So I’m estimating that the mill levy is going to go up 5 percent for 2016, payable 2017 (if the DPS initiative passes); and then I’m using a 2 percent decrease in 2017, payable in ’18, because of the value that is going to be added.”

Affordable housing. The affordable housing initiative, which passed City Council Sept. 19, adds a ½ mill levy and an impact development fee in order to raise revenue for the first permanent, dedicated fund for affordable housing. Mayor Michael Hancock’s plan calls for generating $150 million over the first 10 years to produce and preserve 6,000 affordable apartments, condos and homes.

The ½ mill increase on property taxes will start Jan. 1, as will the development fee. The mill increase for a typical homeowner will be about $1 a month and for commercial owners it will be about $145 for every $1 million worth of property value, according to the Denver Mayor’s Office.

“While the ½ mill levy doesn’t seem like that much, it’s just additive,” said Poling. “It’s not a huge dollar amount, in the grand scheme, although when you have a $300 million building, a ½ a mill can add up.”

Revenue from property taxes will be augmented by revenue from a new one-time development fee that will be imposed on new construction on a per sf basis. Fees will range from 40 cents to $1.70 per sf based on the type of development.

Energize Denver. In December 2015, Mayor Hancock convened a task force to examine and recommend ways for Denver to reduce energy consumption in large commercial and multifamily buildings by 10 percent in 2020 and then double it – to a 20 percent deduction – by 2030, said Elizabeth Babcock, air, water and climate manager with the city and county of Denver.

Over the course of the task force’s eight meetings from January to July, the team worked to come up with a set of recommendations. In the city and county of Denver, there are 3,091 commercial and multifamily buildings that are 25,000 sf or larger, which would be required to adhere to the program. Of the 3,000-plus buildings, only about 5 percent are located in the central business district, said Babcock.

The first part of the recommendation recognized that you can’t manage what you don’t measure, Babcock said. It was recommended that buildings over 25,000 sf within the city and county benchmark the energy used on an annual basis using the free Energy Star portfolio management tool. This task is predicted to takes a few hours of staff time annually and a little more time upfront to set up an account, she said.

Every building’s score would be shared with the city and made publically available. “The goal is for that information to be injected into the market, so there can be greater value or greater emphasis placed on energy efficiency,” she said.

If the building receives a score of 75 of higher, they’ve met the requirements – performing in the top quartile of buildings nationally – and are exempt from doing anything further. Of the commercial properties the program would impact, 81 were Energy Star certified (a score of 75 or higher) in 2015. There have been 148 buildings ever Energy Star certified in Denver, said Babcock.

If the property has not met the score requirement, it will be required to pursue one of three different pathways in order to improve the building. One pathway is the performance-based option, which requires improving the energy used per sf by 15 percent over a five-year period. The second pathway involves a retro-commissioning study. The building would be required to implement anything recommended in the study with a 2½-year payback or less. The third pathway is an audit, with the same mandate for any uncovered opportunities that offer a payback within the same 2½-year or less timeframe.

The projects focus on quick payback items that typically are lower in costs and offer a 40 percent return on investment, Babcock said. She calls these types of energy-efficiency projects “low-hanging fruit that grows back.” The larger capital investment projects and big-cost renovations are never necessarily going to be required through Energize Denver, she said.

The exact timeframe is still undetermined as the mayor’s office reviews the recommendations and determines priorities. But as it currently stands with the task force recommendations, single buildings over 50,000 sf would be required to begin reporting in 2017. Buildings 25,000 sf or larger would be required to start reporting in 2018, said Babcock.

The performer improvement deadlines will be randomly assigned to different compliant tiers, with the first group’s deadline in 2021.

Association Objections
“As we see values increase, taxes increase and bond initiatives pass, it continues to increase that burden on commercial property owners,” Simpson said.

“While we’re all in favor of funding schools and in favor of affordable housing, we have to be cognizant of the fact that our tenants are paying those tax bills and it has real impacts to their businesses and their bottom lines.” While all these examples relate to Denver properties, Jackson argues that rising costs impact managers outside of Denver as well. “The point is, whether or not someone manages in the city and county of Denver, he or she needs to be watching these things because they could happen in other cities,” she said.

If the city is interested in incentivizing owners to reduce energy consumption, there should be some incentive, in terms of a tax credit or something else, for owners who invest the necessary capital improvements to reduce energy consumption, Simpson said.

Both associations said they recognize the benefits of benchmarking properties and don’t object to that component. What upsets many are the required upgrades.

“We don’t like that it’s being mandated,” said Jackson. “Those of us in the real estate industry fully support energy-efficiency upgrades and we do what we can with our clients’ properties.”

CBRE wrote a letter of support of Energize Denver, which stated the property management firm already does all of the proposed requirements as standards across its buildings.

Featured in October 2016 issue of Property Management Quarterly.

Michelle Askeland is the quarterlies editor handling the Property Management Quarterly, Multifamily Properties Quarterly, Office Properties Quarterly and Retail Properties Quarterly publications for the Colorado Real Estate Journal. Prior to joining the CREJ, Michelle was the managing editor at RadioResource Media Group, where she helped publish a monthly domestic magazine and a quarterly international magazine…