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Posted: October 01, 2008

Q4 Real Estate report

Shades of gray

David Lewis

_Colorado’s commercial real estate market is fighting the credit crunch like everywhere else, but some hot spots remain_ Real estate, like life itself, just isn’t fair. It isn’t the fault of the commercial real estate market that so many home buyers signed up with so many slick mortgage brokers for so many subprime mortgages they must have known were a long shot at best. But there it is, and now that the mortgage mess has slopped over onto the commercial side, much of that market is stuck looking for a way out, too. But real estate is a funny business. Put aside your telescope and take up a microscope and see the picture change from something that appears to be a huge, undifferentiated mass of depressing gray to a lively landscape whose colors range from torrid (the Interstate 36 corridor) to tepid (Denver industrial properties). » Taking up our telescope, here are a few figures that sketch in Colorado commercial real estate’s big picture: In January a study by the universities of Colorado and Denver for NAIOP-Colorado, the National Association of Industrial and Office Properties, concluded that in 2006, not the best of years, the state’s commercial real estate sector generated $24.3 billion in direct and indirect output, or more than 10 percent of the state economy. Now get this: "In 2006, the three major metropolitan areas in Colorado (Denver Metro, North Front Range and Colorado Springs) contained 83.5 percent of the existing commercial and multifamily stock in Colorado, with nearly 1.13 billion square feet of income-producing property. The Denver Metro region alone represented 57.2 percent of the existing stock of income-producing property," the report said. It is tempting to conclude that as goes Denver, so must go the rest of the state’s commercial real estate. The picture is so much more complex than that. There’s so much going on in Front Range commercial properties — good, bad and ugly — that it’s hard to know where to start. We could start with a bummer. "Sales volume of transactions probably will be down 40 percent this year compared to last year; it has dropped in the course of the entire year," says Patrick Devereaux, senior director of Cushman & Wakefield in Denver and co-author of a widely quoted quarterly real estate report here. "It’s difficult to get a loan, very difficult right now to secure financing for commercial real estate investment. It’s the credit crunch." Or else we could start with the fact that some happy deity has been spreading fairy dust all over the Denver-area commercial real estate market. "Denver is one of the healthiest markets in the country, second only to Houston," says Mary Sullivan, Denver-based executive vice president of CB Richard Ellis. "The underlying fundamentals are what is doing this: We have positive absorption, low vacancy, a stable economy, and we happen to be a part of the energy belt. Also, we are quickly becoming the national center for renewal and alternative energy. That’s not going to go away. That’s here to stay and it’s going to grow." How about the mortgage crisis, the banking crisis, the credit crisis? It’s all relative, Sullivan says, "because the credit crunch is more of a global occurrence — not just local and not just national — and because our market is viewed as fundamentally strong. There are so many markets across the country that have slid backward: Vacancies are up, lease rates are down, and they don’t have the drivers for positive absorption." Think of Manhattan, she urges, with its Wall Street layoffs. Pity Southern California, Phoenix, Las Vegas, South Florida. Recall the former home-building industry and residential loan services and such there. "They have simply evaporated; they are gone," Sullivan says. "It has created huge holes in their market. So many of these markets really have been seriously delivered a blow to their economy." Here in the Denver area, "Our lease rates have held and in a lot of instances, in sub-markets, have gone up. So has positive absorption. Our demand is still there." The only sub-market that has seen "a bit of a stall, and it’s not even bad, because it hasn’t slipped backwards, is the Southeast market, which is in more of a slowdown than anywhere else, " she says. "However, on relative terms it is still not bad. We don’t have a bad sub-market in Denver." Devereaux agrees that, "The fundamentals of the commercial real estate market remain very strong: Office vacancies metro-wide are less than 12 percent; the industrial vacancy rate is less than 10 percent also; retail vacancies are less than 10 percent. They’re rising a little bit because of consumer spending changing some because of the slowdown in the economy. All the commercial real estate markets have strong fundamentals right now. It’s just difficult to get a loan even for those who qualify." These differences in mood largely are due to different sectors in which Sullivan and Devereaux operate. Devereaux sells assets primarily for individual private clients. Sullivan’s clients are big institutional investors with cash. She sells income-producing properties, such as the record-shattering $770 million sale last year of five downtown Denver office buildings, including the Tabor Center, for the New York-based Blackstone Group. As far as Sullivan is concerned, the current banking scene is less a crisis than normalcy. "During the last five years you could financially engineer your acquisition so that you would get 90 percent back, and so you only had to come up with 10 percent equity. Historically, that’s ridiculous," she says. "So we’re basically back to having to come up with 25 percent to 40 percent equity in order to get a deal done. There’s no question those lenders want to make sure that they are absolutely bulletproof. The underwriting criteria are difficult, but that is only because they are going back to lending on the real estate." As Sullivan says, if you need the money, you’re not going to get it. If you don’t need the money you can get it. That goes double for Denver industrial commercial realty, which mainly means the huge and growing swath of giga-normous warehouse and distribution buildings around Interstate 70, the Airport/Montbello sub-market. "This has been a down year, no question about that," says Chris Nordling, senior managing director for Denver-based Frederick Ross Co. The industrial market both in 2006 and 2007 saw more than 4 million square feet of positive net absorption, numbers it had not seen since 2000, he says. "We — brokers, developers, investors — all kind of thought that was going to be tough momentum to maintain," Nordling says. "At the end of this year if I had to guess I would say we may wind up at maybe half of what we’ve done in the prior two years." Yet the metro area’s industrial market vacancy rate increased to just 6.9 percent in the second quarter from 6.7 percent in the first quarter, with about 1.2 million square feet in 20 buildings under construction, according to the Betheseda, Md.-based CoStar Group. Those same kinds of results moved the metro Denver area to 13th place from 19th place in the Marcus & Millichap Midyear 2008 National Industrial Index. And the Grubb & Ellis Co. quarterly survey of Denver-area industrial real estate said the "second quarter brought an unanticipated surge of positive absorption to the Denver metro industrial market," with "a surprisingly strong 1.2 million square feet of net absorption during the quarter." So it’s all kind of relative. Yet, some commercial areas can be considered hot, hot, hot by any standard. Take the I-36 corridor south of Boulder. "Think about ConocoPhillips and their acquisition of the 425-acre old StorageTek site, and their intent to build a campus that is going to employ at a minimum 7,000 employees," Sullivan says. "Think what that is going to do to that area. It is unbelievable." No one argues with that. Not Freeman Myre commercial real estate, which in September brokered the $3.8 million sale of 20 acres near the I-36 corridor, in the Louisville-based Colorado Technology Center, to Irvine, Calif.-based Passco. There, Passco plans in November to break ground on phase one, its One Technology Center, which will comprise an 84,000-square-foot, LEED-certified building. Second and third phases call for the 104,000-square-foot Two Technology Center building, and two 40,000-square-foot multi-tenant office/flex properties, for a total of 268,000 square feet at completion. ConocoPhillips has quickened the corridor’s pace of development, says Andrew Freeman, president of Niwot-based Freeman Myre, which does business in Boulder and Broomfield counties. "In the last probably three or four years a lot of infrastructure has landed on the corridor. With a new interchange, FlatIron Crossing, the Northwest Parkway, a lot of residential has been built around the area, but there actually has been a lack of flex office-type product on the corridor," he says. So if one were cold and 10 were hot, how hot is that 36 corridor? "The entire 36 corridor right now including the Colorado Tech Center, is red-hot. I think it is a 12 and it’s going to go to a 20." Up north, Fort Collins-based Jim Mokler, Realtec broker and partner, confirms the phenomenal effect high-tech companies have on his business, as well as the profound impact the state university system and its spinoffs, such as tech incubators, have on the university towns and their environs. "Northern Colorado has a bit of a different flavor to it than the rest of Colorado. We aren’t in as tough a situation as Denver metro, and south, or over on the West Slope," he says. "We have a bunch of things here that help us: From Boulder going north we’ve got CU, CSU, UNC, Ames (Community College) and a bunch of community colleges, all of which deliver to the employment need that causes a lot of high-tech businesses to locate here." Expanding high-tech companies include Denmark-based Vestas, which now employs more than 200 people at its 400,000-square-foot plant outside Windsor and later plans to employ 600 workers there. Mokler also points to a company formed by CSU scientists, AVA Solar, which recently bought the vacant Applied Films headquarters along I-25. Even long-suffering Weld County is making hay. On the residential side, Weld County continues to yield shocking foreclosure numbers. Yet a growing number of insiders say commercial realty is bouncing back. "It’s on the upswing, finally," says Greeley-based broker Blaine Herdman, with Re/Max Commercial Alliance. "Commercial didn’t take it in the shorts quite as bad as residential did. Still, it’s just in the last two or three months that people are starting to get serious about purchasing or leasing properties rather than just gathering information, at least around the Greeley area. "So it’s finally starting to get fun again, to look as though we might make a buck or two again," Herdman says.

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