What will happen to office lease rates?

The volume of office leases being signed in Denver is so low that judging the market it difficult. It’s not fair to say that the market is declining, rising or even staying steady – it’s only fair to say that the market has disappeared for the moment.
David Shirazi

David Shirazi
Vice president, tenant
representation, JLL

Are office lease rates dropping?

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I get some version of this question every day, from clients and colleagues as well as from friends and family who generally have little interest in the commercial real estate market. It seems like it should be a given, right? Unemployment is sky high, the stock market is down, many companies have not returned to the workplace yet and may not do so for some time, and, to top it off, oil and gas companies are facing unprecedented headwinds. So, have office lease rates in Denver crashed as well?

As it sits today, it’s not fair to say that the market is declining, rising or even staying steady – it’s only fair to say that the market has disappeared for the moment. The market is only as good as the latest transactions tell us it is, and right now the volume of office leases being signed in Denver is so low that defining the “market rate” is just not feasible. What transactions that are being consummated are mostly short-term extensions on existing leases. Landlords and tenants seem to be coming to the table so that both sides can have more time to make long-term leasing decisions.

What does history tell us on this topic? You might be surprised at the amount of lag time between a stock market crash and the corresponding decline in Denver office rental rates. After the dot-com bust in 2001, office rates in Denver didn’t hit their low for 15 quarters, and they didn’t make a full recovery for over seven years. When the economy crashed in 2008, rates did not hit their low for nine quarters and didn’t fully recover for five years.

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After the dot-com bust in 2001, office rates in Denver didn’t hit their low for 15 quarters and didn’t make a full recovery for over seven years. When the economy crashed in 2008, rates did not hit their low for nine quarters and didn’t fully recover for five years.

As of now, there just isn’t enough evidence to say how far rates have dropped or how far they will drop, but you’d be hard pressed to find someone in the industry who doesn’t see rates declining in the coming months. To give some perspective, we need to understand what ultimately drives lease rates down: An increase in vacancy. It’s only been about 75 days since most of us left our offices and started working from home, not enough time for tenants and landlords to really evaluate their situations. Smaller companies still may be enjoying the benefits of their Paycheck Protection Program loans, and using those funds to pay rent, but that money will run out soon. Some other companies have withheld rent (or have been unable to pay rent), but Gov. Jared Polis’ temporary ban on evictions is artificially keeping vacancy low for the moment.

There is one major indicator that points toward a decline in Denver’s office lease rates – the amount of sublease space coming onto the market. Today, we have over 1.5 million sf of office space on the sublease market in the central business district alone. This is more sublease space on the market than we’ve had for at least 20 years, up from just over 1 million square feet at the beginning of 2020.  Sublease opportunities traditionally offer tenants the ability to secure a below-market lease rate, and, indeed, most sublease opportunities on the market right now are quoting rates that are below the rate that the building owner is asking for – sometimes far below. The sheer volume of available sublease space is going to force landlords to compete at rates lower than they’d like.

From the tenant point of view, there will be good options in the marketplace right now, and you’ll probably get a better deal today than pre-COVID-19, but there almost certainly is an advantage for those who can wait a little longer before transacting. Tenants should be keeping an eye on the “total vacancy” figures. At the end of the first quarter, total vacancy in Denver’s CBD was 14%; once that figure creeps up to 18% most landlords are going to become significantly more aggressive.

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Featured in CREJ’s June 2020 Office Properties Quarterly

Edited by the Colorado Real Estate Journal staff.