By Eric Shaw, Principal at Pinnacle Real Estate Advisors

Originally published in Colorado Real Estate Journal’s Office Properties Quarterly – September 2017

As a commercial real estate broker for the past 19 years specializing in office leasing and sales and a Denver native, I have seen several boom times as well as busts, but I have not seen such a sustained period of prosperous times as we are currently in right now. Colorado has one of the most educated populations in the country. Combining high education with great weather and a plethora of outdoor activities makes the state an attractive place to live and work.

New employers are entering the Denver metro market to capitalize on the highly educated and savvy workforce. At the same time, existing employers are expanding operations and growing their office space. The office market is benefiting from job growth from a diverse industry base, resulting in low unemployment.

The question I am often asked is, “How long will this market continue?” My response is that now is the time to position your assets and businesses for long-term growth and stability.

Increased professional and industrial diversification has allowed the office market to withstand some of the issues that were devastating in decades past. When oil and gas prices recently dropped, the office market was able to offset these losses and remain strong because of the influx of technology, financial, health care, bioscience and aerospace companies entering the market. This diversified industry base along with a thriving economy has led to speculative office development that is in full swing, with most projects concentrated in the lower central business district with projects like the 671,101-square-foot, 40-story, Class AA office tower currently under construction at 1144 Fifteenth St. by Hines and the 290,000-sf, 22-story office tower at 1401 Lawrence St., developed by First Gulf. Other development in the downtown market and the suburban markets close to light-rail stations are in high demand. Secondary markets like Cherry Creek and emerging markets such as River North have seen a significant amount of new office construction relative to their size.

One of the drivers for the spec office development is a “flight to quality” from tenants. Employers are competing for educated employees and the office space they occupy often is a huge selling point to attract talent. The professional workforce, which consists of the millennial generation as well as older generations, wants more of an experiential work life. They want to live, work and play in the same areas. That is why so many new projects have a mixed-use component or are within close proximity to amenities to enhance the work-life balance.

Suburban office developments such as Village Center Station I and II and One Belleview Station are prime examples of transit-oriented developments that offer excellent amenities, including close proximity to mass transit as well as being walkable to lots of restaurants and entertainment.

On the flip side of the flight-to-quality trend are tenants who are tired of continual rent increases year after year, who are deciding to purchase their office space rather than lease it. Purchasing is a great option for businesses that remain relatively steady year over year and don’t fluctuate in size dramatically. Lending institutions like to make loans on owner-occupied real estate and offer very competitive programs for this type of buyer.

Certain segments of the office market – such as the office mansions in Capitol Hill and the smaller office buildings in areas like Littleton, Lakewood, Arvada and Highlands Ranch – have greatly benefited from office users looking to mitigate rising lease rates and take advantage of the benefit of ownership. These types of buyers tend to be professional companies such as insurance agents, attorneys and medical practitioners. Purchasing is not only beneficial because of the equity created through principal reduction and appreciation, but also because it offers benefits from depreciating the asset as well as the tax deduction of the mortgage interest. Furthermore, these properties can serve as profitable passive investment properties upon retirement. Many of my clients sell their business after structuring long-term leases, while holding onto the real estate as an income-producing property during retirement.

Although the office market is thriving, there are challenges to a robust economy. For both landlords and tenants, construction costs for tenant improvements have raised dramatically. This is partially due to a shortage of construction labor, which has led to fewer and higher bids across the board. In a down market, landlords typically had to provide turnkey tenant improvement packages to compete for tenants. Landlords are more bullish and tenants, in turn, often contribute to their own improvements. Alternatively, tenants are signing longer-term leases with higher tenant improvement allowances or amortizing the cost of the improvements into the lease rates.

There are challenges on the sales side for office product as well. Valuing properties can be challenging, primarily with regard to properties sold to owner occupants. As demand for owner-occupied office properties has increased, property values have gone up. The gap between buyers and sellers seems to be widening, and I have experienced several instances where appraisals have come in low because the pricing continues to rise, in some cases faster than the market can keep up. It is important to work with an experienced real estate professional who can convey to the seller and buyer the true value of the property.

Is change on the horizon? The answer is yes, but probably not dramatic change thanks to our diverse economy. Rent growth has slowed down to approximately half of what it was last year. The supply is beginning to catch up with the demand. The office market will continue to be a vibrant market but perhaps at a slower pace than we have seen over the last few years. Now is the time to plan, prepare and execute to get the most out of a strong office market.

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