Rising lease rates: How are office tenants reacting?

Andy Cullen

Andy Cullen
Partner and managing broker, Tributary Real Estate, Denver

The Mile High City’s growth undoubtedly is something to be celebrated. Once viewed as a second-tier city, Denver has become a recognized and respected competitor for business and leisure among major cities in the U.S., including both coasts.

As more companies look to expand and move here, demand for office space has led to one of the biggest development booms in decades. While this new era offers many opportunities for companies to engage with the community and strengthen the local economy, it also comes with some drawbacks that aren’t lost on tenants.

Notoriously high construction costs and rising annual property tax valuations (with some assessed values increasing by as much as 40 percent) have led to increased lease rates. While owners might not be feeling the pinch yet, rising lease rates are affecting how tenants assess their real estate needs.

The River North and South Broadway districts often offer lower triple-net expenses, are providing some relief compared to the central business district and Lower Downtown.
Courtesy Tributary Real Estate

Real estate is one of the top three expenses for a company, and many executives are starting to feel the pressure between being in an ideal location and office space while also wanting to grow operations and develop talent. The simple truth is that some tenants will not be able to accommodate these rising lease rates, especially in and around downtown Denver.

Take Denver’s Lower Downtown neighborhood, for example. Five years ago, gross lease rates in LoDo were hovering around $25 per square foot. Due to multiple factors, including market demand, new tax valuations and the area’s mill levy, today’s base rates are averaging between $30 and $35 per sf. On top of that, triple-net expenses have been quoted by some owners upward of $20 per sf for 2018.

Downtown Denver as a whole has a similar story. Two years ago, even before the new tax valuations, Big Brothers and Big Sisters of Colorado made the decision to relocate outside of the central business district with a need to remain accessible to their stakeholders and the communities they serve.

“As any nonprofit knows, it’s always a challenge to balance the desire to be as close as possible to the audiences you serve and the need to tightly manage overhead costs, such as rent, in order to have the resources to serve the greatest number of people,” said Dave Ryan, CEO of Big Brothers and Big Sisters of Colorado.

The move ultimately gave them the operational flexibility needed to continue attracting and retaining top talent, but it’s not just nonprofit organizations feeling the pressure.

For-profit companies also are looking at alternative locations outside the CBD because of rising rent costs. In 2011, one of our clients moved into prime office space in downtown Denver with a gross lease rate of $24 per sf. Today, that same space has a base rate of $30 per sf with triple-net expenses around $17 per sf. Many companies coming out of five- to seven-year leases are going to face similar hikes and, for some, there comes a point when it no longer makes operational or financial sense to pay higher rents.

While the CBD and LoDo remain major business hubs, they’re not the only areas in Denver where companies want to be. Two particularly sought-after neighborhoods include the River North and South Broadway districts.

While office buildings in RiNo are facing climbing base rates similar to LoDo ($30 to $35 per sf), the triple-net expenses aren’t nearly as high right now, gaining the attention of companies looking for access to desirable neighborhood amenities at a lower cost.

South Broadway, which has flown relatively under the radar over the past few years, is seeing a resurgence of activity. Base lease rates in this area are averaging between $16 and $20 per sf with triple-net expenses significantly lower than in downtown Denver, making it a great location for companies looking to expand their operations.

Another factor in this new lease landscape is that many landlords are asking for long-term leases to ensure returns on the high level of investment in new construction projects. Since some tenants aren’t willing to lock into these rates long term, they are pursuing more flexible options while they wait to see what the market does over the next year.

Enter co-working spaces. Once thought to be a passing trend, these spaces are becoming increasingly popular, and for good reason. These concepts provide operational flexibility for tenants that traditional office spaces simply can’t offer. In addition to built-in community and top amenities fitting for a modern workforce (think kombucha on tap), these spaces also offer month-to-month leases and various space configurations that can accommodate a company’s present and future needs.

Regardless of how tenants choose to move forward in this new landscape, it’s becoming increasingly clear that they are not necessarily going to stick with the status quo. Tenants need real estate options that allow them to continue growing their companies while still being fully engaged members of Denver’s business community.

Featured in CREJ’s March 2018 Office Properties Quarterly.

Edited by the Colorado Real Estate Journal staff.