The pandemic has shaken commercial real estate markets to the core, creating more demand in some areas, like industrials, and destroying others, like office space. But 30 months after the first lockdown orders were issued, not all the dire predictions have come true.
Take the rebound in demand for retail space, which is far tighter than expected after consumers have shifted more of their purchases, even groceries, online. Although renters fled densely populated areas during the outbreak, developers continued to expand city housing at a robust pace, raising concerns about flooding.
Vacancy rates in Denver for retail, multifamily and industrial properties are in the 5% range, but they’re a little under 20% for office space, Hessam Nadji, president and CEO of Marcus & Millichap, said at a meeting of the Denver Metro Commercial Association of Realtors earlier this month.
Demand for office space remains low as employees fight for the right to continue working remotely, and it could be a few more years before the fog lifts. And as companies grab industrial space, signs of a cut are mounting as online retailers pull out. But Denver doesn’t look as vulnerable as other markets.
Below is what area brokers are predicting in a forecasting panel compiled by DMCAR in the areas in which they specialize:
Office: An uncertain future
When employers closed their offices and sent workers home early in the pandemic, most probably had no idea that more than two and a half years later they would struggle to bring them back and face uncertainty over how much space they would have need rent.
Tenants in office buildings are signing shorter leases for less space, trying to come up with the magic formula that will make their employees forego commute shifts and home-cooked lunches to come back. Many still don’t know what their workforce will look like in the coming months, and that makes planning their office needs difficult, said Lee Diamond, senior vice president at CBRE.
A tight job market has discouraged a return to previous work in office supplies. With labor shortages and high churn rates, some employers are afraid to push the problem. However, a recession could give management the upper hand again and demand that workers show up and be seated.
Another major problem for the office market is the large amount of space that tenants sublet because they no longer need it. That was about 5 million square feet in the Denver metro area in the second quarter of 2021. More recently, it had fallen to 4.7 million, but Diamond predicts it will rise back above 5 million square feet soon. The flood of squares is getting worse, not better.
Landlords need to get more creative with the concessions they offer and the amenities they offer to lure workers back into the office, including more on-site restaurants, fitness facilities, and collaborative workspaces.
Office markets continue to see a flight to quality, Diamond said. That’s a problem for older and less desirable Class B or C rooms. They need to renovate to stay in the game, but construction costs have skyrocketed, from $100 to $120 per square foot before the pandemic to $280 per currently square foot. That has led some building owners to hit the pause button until they are sure they can rent out anything they improve.
According to Diamond, Cherry Creek is a hot office market and downtown Denver is split in two, with the newer West End being much more popular than the East Side.
Retail: Stronger than expected
Retailers took a hit during lockdown orders in the early weeks of the pandemic in 2020, and some forecasts predicted it would take years for brick-and-mortar retail to recover. You were wrong.
Metro Denver is seeing strong demand for retail stores, particularly new grocery stores, said Courtney Key, a partner at SullivanHayes Brokerage in Greenwood Village. Retailers actively looking for space include King Soopers, Whole Foods, Target and Costco. The problem is that there aren’t enough locations available to meet the strong-than-expected retail demand.
“The cost of construction is disrupting new business,” Key said. “There’s incredible competition for pad space.”
Pads that might have cost $90,000 to $115,000 in 2019 are now $120,000 to $150,000, she said.
National chains – think fast food, gas and banks – crush local competitors when it comes to winning the bidding war. And Denver is attracting ‘new entrants’ renters from unexpected places like the UK. They’re targeting what they see as more vibrant neighborhoods like Cherry Creek, River North and parts of downtown Denver.
Industry: Denver could brave a slowdown
Online retailers have aggressively built distribution centers to stock their products closer to consumers and speed up delivery times, and this trend accelerated as more shopping shifted online during the pandemic. Demand for warehouse space also rose as supply chain disruptions caused by the pandemic prompted businesses to start stocking up on items to keep them from running out.
But as the recovery took hold, physical retailers reclaimed their share of purchases and consumers shifted spending more towards services than goods. Amazon, the leader in creating new warehouse space, has gone from expanding to contracting, subletting space in some of its distribution centers and canceling plans for others.
Tyler Reed, general manager of Stream Realty in Denver, said the Front Range should fare better than other areas as Amazon pulls back. The online retailer remains committed to 4 million square foot facilities in Colorado Springs and Loveland.
“Amazon is healthy here, there is no gloom and doom,” he said. And while the transition to online retail has slowed, it’s still happening, and that will require more warehouse space.
Industrial space along the US 36 corridor between Boulder and Denver that cost $8 to $8.50 per square foot before the pandemic is now renting for $14 per square foot, Reed said. And rising industrial rents are happening across the metro area as demand continues to outstrip supply by millions of square feet.
“Rent growth is real and it’s happening,” he said. “It’s a pretty rosy picture.”
Apartment building: A glut in the making
Residential rents in the Denver metro area typically fall a bit in the winter, but they’ve risen this year, contributing to a 16% year-over-year increase in average rents, said Josh Newell, a director at Pinnacle Real Estate Advisors in Denver.
Even with rents rising, apartment renters in the Denver metro area spend about 22% of their income on rent, which is below the statewide income share of 23%. A large influx of workers from pricier markets, some working remotely and dragging down higher wages, are better able to afford rising rents and the construction of luxury housing.
“Housing fundamentals are still strong,” Newell said. “There’s fear, but everything on paper says this is a great thing.”
Interest rates are rising sharply, causing more buyers to be pushed out of the market and kept for rent. And barring big savings in the tech sector, remote workers should continue to play the spread, earning San Francisco-level wages and Denver-level rents.
So why the fear? Developers are expected to bring about 15,000 apartments to market in the Denver metro area this year, but it looks like only 12,500 of them will be “absorbed” or occupied by new tenants. While the overall vacancy rate is a reasonable 4.75%, it should rise as these new units come onto the market.
This is where the view gets dicey. Metro Denver has 40,000 homes under construction and another 72,000 in the planning stages, Newell said. Developers are looking to put 112,000 homes on the market, and there are concerns if the market can accommodate that, especially if people stop moving to Denver like they’ve done over the past decade.
Much of this new housing development is concentrated in the central business district, where vacancy rates already appear to be in the 7.5% range.
This new supply accounts for about a quarter of the existing housing stock, Newell said. And while some projects may be canceled, the housing shortage in the Denver metro area could quickly turn into a housing glut if developers’ projections don’t materialize.
