Denver’s office market: the tenant landscape for 2011…

As the economy stands up from its crawl and begins to slowly step forward, tenants in the Denver office market will be at a crossroads in 2011. As they gradually add new jobs, and as their leases approach expiration, business leaders will have some key decisions to make.

• Renew and use surplus space, or extend and downsize?
• Commit to a lease renewal and expand, in the tightening market?
• Relocate, taking desirable vacant space before rate increases really kick in?
• Move to less expensive space, and continue to hedge against an unstable economy?

The bottom line for a healthy office market is job growth. There was negative job growth in the recession in Colorado, as 104,700 jobs were lost in 2008, and 34,000 in 2009. The office market followed suit, with negative absorption in both years.

Many businesses adopted the do-more-with-less approach during the recession. For downtown office space usage, that often meant less square feet per employee. Pre-recessionary figures were about 250 square feet per employee, and Grubb & Ellis research is seeing a trend towards 200 square feet per employee at the end of 2010.

At the same time, these and many other companies found themselves stuck with more space than they needed during the last three years. Some were able to sublease, but many either couldn’t find subtenants or chose not to.
For this and numerous other reasons, vacancy did not get quite as high in this recession as it did in the two most recent recessions. This difference in historic vacancy rates can be explained for several reasons.

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There was a lot of new office supply delivered to the market from 2001 to 2003, a hangover from developers and investors over-optimistically fueling a bubble. By comparison, there was very low new supply added in 2008-2010, so any new tenant growth was absorbed largely by existing properties.

Another reason for the lower vacancy rates, specifically downtown, at the end of 2010 is federal construction and its domino effect through the market. Copious new government (GSA) building projects temporarily displaced thousands of federal employees, many of them locating into downtown office buildings for short-term leases until the projects are complete. Thus, the CBD 2010 net absorption of approximately 1,000,000 million square feet is somewhat misleading, a somewhat large portion of which was from 3-year-term GSA leases. In 2013, when the economy (theoretically) rebounds, jobs are added, and GSA users move back into owner occupied properties, there will be lower net absorption than there might have otherwise been.

That said, the Denver office market in its entirety outperformed expectations in 2010, and in fact had as strong of a year as in many non-recessionary periods. Net absorption through the third quarter stood at 968,007 square feet. The metro area should exceed 1,200,000 square feet absorbed by year end. This matches performance through much of the 1990s, and also equals absorption in 2004, the first year of the most recent full recovery. This is in spite of the fact that many in Denver are not feeling a sense of ‘recovery’ and growth just yet.

Indeed, unemployment in Colorado and metro Denver is much higher than in the most recent recession of 2001-2002: Colorado is at 8.4 percent as of October 2010, versus a peak of 6.5 percent in 2002. Economists are projecting modestly positive job growth in 2011, of perhaps 10,000 new jobs statewide, with approximately two thirds of that captured in the Denver area. The private sector is expanding, and will add perhaps 16,000 jobs in 2011, but much of this will be offset by continued loss in construction and federal government jobs.

Nationally, there are mixed messages. The Labor Department’s Employment Situation report for November is reminiscent of the reports in May and June. The net gain of 39,000 payroll jobs last month – 50,000 private sector jobs added minus the 11,000 government jobs lost – is in the same ballpark as May (+51,000 private jobs) and June (+61,000 private jobs). These are well short of the 200,000 or so needed to bring down the unemployment rate.

But still, Denver did not overbuild in the last economic expansion. The market has limited new supply and decreasing vacancy, so once new jobs emerge in 2012 and beyond, office market recovery will be quick, and rates, which did not drop as significantly as in past recessions, will likely increase quickly.

Office tenants in downtown Denver in particular will need to respond to these circumstances as demand for their products and services increases, they hire more people, which will converge with expiring leases, the need for more space in an increasing less vacant and more expensive market.
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Categories: Real Estate