Office investors continue to ask themselves where they can find opportunity in the metro’s rapidly developing markets. It isn’t lost on anyone who has been active in Denver over the past several years that we continue to see a breadth of new developments take root in our urban and suburban markets. The city is growing, that much is clear. But among this growth, there is a divergence in leasing and rent performance for some classes of assets over others.
To better understand why we continue to feel incredibly bullish on the investment approach behind newly built and newly renovated office buildings, it is helpful to get some historical context on our office market.
The Denver stock. Many of the cities Denver competes with have developed their office market in multiple phases over the past 40 years. Denver, however, has a highly pronounced age of its building stock, with nearly two-thirds of the overall square footage in the central business district 30 years or older.
Conversely, only one-fifth of our stock in the CBD is less than 10 years old, showing the relative scarcity of newer buildings. This is an incredibly important point to understand and is demonstrated in another statistic: Between 1970 and 1985, 38 projects were constructed in the CBD. For the period between 1990 and 2005, there were only four projects delivered.
The southeast suburban market does not have as starkly concentrated a development history; however, like the CBD, it does have a preponderance of its development clustered in the 1980s and comparatively few projects less than 10 years old.
With the increasing amount of Denver office leasing being driven by new-to-market tenants, and now with enough new projects having delivered in the market that “show off” to Denver’s existing users the difference offered by new product, we are seeing new buildings lead the way in absorption and rent growth.
The case for new development. Due to the limited supply of newly constructed office space, tenants are competing for space in ways that are achieving high levels of occupancy and rent metrics for the developers. In the CBD, buildings that have delivered in the last five years have an average occupancy of almost 93% versus a citywide average of 87%.
In the southeast, there have been numerous examples of successful development, including the fully leased Village Center Station II, CoBank Center, One Belleview Station and Granite Place at Village Center. In those cases, most of the assets leased to one or two large corporate users, thus enabling the developer to achieve substantially lower cap rates and drive high values on their sale.
But new doesn’t have to mean newly built. With the recent successes of newly constructed buildings, where does that leave the rest of Denver product? Does “vintage” automatically inhibit the success of the real estate investor who owns a legacy asset?
The success of Denver’s new construction only creates more opportunities for older Denver product to reinvent itself and continue to maintain attractiveness in a rapidly developing submarket. In Denver, existing tenants who vacated Class A assets to move into new construction saw an average increase of their total rent obligations exceed 40%. Thus, existing Class A buildings have a substantial cost advantage to new construction.
Importantly, many investors are realizing that such a broad gap in rents between new and legacy Class A product can allow them the opportunity to invest in their building and drive higher rent increases. In other words, there is still room to narrow the pricing gap between new buildings and those that are a few decades old.
There have been some notable “vintage” assets in our market that have undergone substantial renovations and completely changed the momentum and achievable rents at those properties. Brookfield Properties’ outstanding renovation of 1801 California is a great example of this, but other buildings, including 1660 Lincoln, Denver Place and Tabor Center, have all seen high levels of investment in the past couple of years that has generated increased leasing velocity and rent growth.
Over the last 24 months in Denver’s CBD, those owners who invested considerably in capital improvements at their buildings have seen their rents increase 44 cents per square foot annually for every $1 per sf they spent on such improvements.
Not only are these building owners able to achieve higher rents than their peers, but also they can do so while enjoying higher occupancy since tenants continue to favor a highly amenitized work environment. In Denver’s CBD, the average occupancy rate is 87%, yet the occupancy rate at Class A improved assets is closer to 90%.
Denver continues to enjoy substantial economic and residential growth, so it stands to reason the number of potential tenants out there will continue to grow. And while the data supports the real estate developer to “build it and they will come,” it also clearly shows that if you own an existing building, you can drive greater value by making it better.