The Denver market exhibited sustainable growth in the second quarter.
These steady gains are sure to lead to fairly substantial numbers by year’s end, as users are already beginning to feel the crunch.
Spaces of all sizes are in shorter supply than just a few months ago, and well-positioned spaces are moving much quicker than before. This activity has been sufficient to jump-start additional construction in many submarkets, providing either new generation distribution space along the I-70 corridor or enhancing the aging stock of small user space in more suburban markets.
Both rental rates and commodities costs continue to climb, squeezing some businesses just as landlords are looking to capitalize on a rising market by improving net operating income figures.
The Front Range continues to outperform the nation in terms of manufacturing activity, though it remains to be seen if a slowdown in consumer spending will impact these figures.
Market Assessment
Absorption for the quarter was fundamentally solid, though some submarkets fared much better than others. Four submarkets witnessed absorption of greater than 100,000 square feet. That includes the Airport/Montbello submarket, which is now on five consecutive quarters of 200,000 square feet or more of positive leasing, with the second quarter being one of the largest at more than 800,000 square feet.
In addition, there was more than 600,000 square feet of additional leases signed during the quarter with occupancies scheduled for the second half of this year.
These transactions included several larger deals such as Crocs and Timberline. A few submarkets had setbacks, especially the far North markets, which tend to have an oversupply as population and business growth catches up with product in that area.
Another positive trend that is not fully reflected in the absorption is the large number of user sales that took place during the quarter, many of which were not truly vacant prior to the sale.
In addition, organic growth within markets, where users traded buildings, often resulted in more fully utilized space, as companies continue to downsize.
In the Southeast submarket, this resulted in the relocation of BMC West into the submarket for 133,000 square feet, pushing Koala to downsize to a more appropriately scaled 50,000 square foot building. That in turn allowed Digicomm to enter the market in search of a 250,000-square-foot build-to-suit opportunity to consolidate its multiple leased locations.
Vacancy rates held relatively steady throughout metro Denver, with the West and Northwest submarkets having a great quarter. The Northwest market continued to take advantage of the improving technology market and has attracted a number of companies to flex spaces in the region.
The West, a small-user market, saw users continue to take down spaces in an already tight market, though several new projects are under construction in the area that should provide additional options for companies in the area.
Rental rates continue to increase, both due to improving market fundamentals as well as a desire by investors and landlords to increase net operating income, either to help their portfolio or to ready for a potential sale.
Rates have now reached a metro-wide average of $6.23 per square foot, on par with the beginning of 2003. The market is at least two years from reaching peak rates of 2000.
Some of the largest increases were seen in the smallest markets, where the Central and Southwest markets had increases of more than 50 cents, contributing to an overall Denver Metro increase of 24 cents per square foot.
The Northwest market also saw rates increase, mainly due to the activity in higher-rent R & D;/flex properties. By property type, both incubator and manufacturing spaces had a good quarter, as small users were very active and landlords were able to raise rents significantly on prime locations.
The cumulative result of this activity was a metro-wide rental rate increase basis with the greatest increase of 47 centers per square foot in the general industrial properties.
Construction projects have popped up all over the metro area, with owner-user projects dominating for many submarkets, though small multi-tenant buildings also are in development.
Some recent build-to-suit projects include Mile High Trim, which just moved into its custom building, while Sopris West Educational Services and Opus just broke ground on their 200,000-square-foot project.
The Airport/Montbello submarket is home to several speculative projects as demand for new distribution space continues to grow.
The 1.4 million square feet currently under construction is certainly a sustainable level, at only one third the activity seen during rampant speculation in 2000.
Forecast
Sale-leaseback arrangements will continue to be popular as companies look to leverage real estate equity and reinvest in their core businesses.
Large companies such as Maxtor and Array BioPharma have recently taken advantage of sale-leaseback scenarios, leveraging the interest of buyers in the market to create cash flows for their business.
Other smaller corporations are doing the same with either single locations or regional groupings of properties. Small businesses also continue to buy property at a fast clip.
Small companies, especially those needing stand alone buildings or yard space, are seeing the value of a purchase while interest rates remain low.
The amount of available space of this type is diminishing, so buying makes sense in the long-run for companies that can secure such properties in desirable locations.
Development continues, with several recent build-to-suit completions as well as ongoing announcements of speculative buildings, especially moving eastward along I-70. Additional land for new parks is hard to secure, leading to infill development such as Samsonite, Marathon Oil, Sheridan Business Center and others.
Other build-to-suit users still are in the market searching for land for projects ranging from 70,000 to 250,000 square feet. There also are several large users looking for existing space who may be pushed into the construction market by a short supply of new space in large-user sizes.
There are slightly more than 40 options for 100,000 square feet or more, with only 25% of those in the main industrial corridor.
For 200,000 square feet or more, there are seven modern options with clear heights of 30 feet and more, with three more under construction. A continuing challenge for builders of the new space is the size requirement of potential tenants.
Opportunities and Challenges
While the U.S. manufacturing sector is showing some signs of slowing after more than three years of continued expansion, the Front Range index continues to climb precipitously, hitting the mid 60s during the second quarter.
It remains to be seen whether slowing consumer spending will temper this activity as gas prices remain high. An added challenge for some manufacturers are commodities prices, which in addition to increasing the cost of construction, also have dramatically increased the cost of production for some manufacturers.
For instance, copper prices are at an all-time high, having tripled since 2003. Other increased costs are associated with cement, steel and other component parts.
Another limiting factor for industrial continuity in the market is merger and acquisition activity. M & A; activity has had a significant impact on the office market, but they also are impacting the region’s industrial users.
The most recent casualty of this trend is Intertape, which is closing its Brighton manufacturing plant this year based on a relocation of its manufacturing operations to Mexico.
Nationally, Denver is one of the latest to the party for industrial, both in terms of development and rental rate growth. It has been one of the slowest moving markets, despite rental rate increases that are growing at twice the rate of inflation, or by 12%, since the beginning of 2005.
However, locally there are some shining stars.
Several of the Majestic buildings recently leased their last available spaces, motivating the developers to kick off two additional buildings for a total of 415,000 square feet.
And an Aurora industrial park that had 450,000 square feet of vacant space just nine months ago is back in the development mode, thanks to some big expansions and a sizable new tenant. Similarly, the Colorado Tech Center in Louisville just launched a 109,068-square-foot speculative building to coincide with positive leasing in the Northwest area.
With all the new activity, many of the larger parks in town are locked up by national developers, driving potential investors to look at smaller properties than otherwise would be the norm.
As a result, the hot investment market continues to see a lot of activity in deals priced from $1 million to $10 million, both for sale-leaseback options as well as multi-tenant spaces.
With the temperature in Las Vegas approaching 115 degrees, even the real estate market is starting to sweat.
Industrial vacancy dropped dramatically from 5.2% in the second quarter of 2005 to 3.3% in the second quarter this year.
While this decline is not unexpected, industrial agents and developers alike continue the struggle to find affordable space for clients and prospective land sites for new projects.
The rising heat does little to slow construction in Las Vegas.
About 3.8 million square feet is under construction, with completion dates ranging from December to July 2007. As newly finished space becomes available, an equal amount of industrial space starts construction, keeping the cycle steady.
There is about 4 million square feet of industrial space planned or proposed, including the 373,000-square-foot Logisticenter Building 6 and the 207,000-square-foot Pacific Industrial Center Phase 4.
Not all industrial building types will continue to be put up at the same rate. Land prices have made it difficult for warehouse/distribution projects, like the two cited above, to be considered feasible for development.
Although that is the case, vacancy will remain low as space is absorbed by the local service industry that continues to flourish along with the gaming industry. Whether in the industrial sections of town, or the outlying areas where land is more plentiful, development in 2006 moves forward as the market remains noticeably active.
The area’s economy continues to improve at a moderate pace with slight improvements in unemployment levels and solid year-over-year job growth in the metro area and the state.
While construction remains the strongest contributor, all sectors of the economy have contributed new jobs in the past year.
The Portland industrial market saw another quarter of solid net absorption balanced out by strong construction deliveries leaving the overall vacancy rate unchanged at 7.4%.
Both the manufacturing/warehouse/distribution and the R & D;/flex sector contributed to the demand with strong performances in the NE Columbia Corridor and I-5 South.
In the R & D;/flex sector, the Sunset Corridor is slowly emerging from this down cycle, recording a slight drop in vacancy.
Developers continue to be cautious with a moderate amount of construction under way, led by speculative and owner/user projects. Rising construction costs are putting a damper on build-to-suit projects and will be the catalyst that finally drives up rental rates for new space.
Overview
Oregon’s economic recovery has moderated slightly, with unemployment rates stabilizing and job growth maintaining its trajectory.
Oregon’s unemployment rate stands at 5.6% while the unemployment rate for the Portland metropolitan area is 5.3%. Job growth continues to fuel this economy with Portland recording a year-over-year employment growth rate of 2.8%, ranking it the 12th fastest growing major metropolitan area.
The state has recorded even stronger growth, with year-over-year job growth of 3.6%, the fifth fastest growth rate in the nation.
Job growth for the metro area as well as the state has been particularly strong in construction, though all sectors have contributed to employment growth in the past 12 months.
Activity in the Portland industrial market continues to ramp up with the market recording solid net absorption this quarter with both the manufacturing/warehouse sectors and the R & D; and flex sectors contributing.
Overall vacancy remains stable at 7.4% due to the 800,000 square feet of construction that was added to the inventory this quarter. The warehouse/distribution market saw strong net absorption of more than 750,000 square feet during the second quarter and vacancy dropped slightly from 6.5% to 6.4%.
The R & D;/flex market saw a return to positive net absorption, recording slightly more than 150,000 square feet, pushing vacancy rates down slightly from 10.4% to 10.3%.
NE Columbia Corridor was the top performing submarket this quarter, with more than 300,000 square feet of net absorption. Vacancy remains steady at 6.8% due to the delivery of nearly 200,000 square feet of space at ProLogis Park PDX and the completion of LaCrosse’s build-to-suit at Southshore.
The I-5 South submarket also recorded a strong quarter, with close to 275,000 square feet of net absorption and the addition of 10 buildings adding 315,000 square feet to the inventory.
In the R & D;/Flex market, the Sunset Corridor was the top performer this quarter with net absorption of 140,000 square feet.
Vacancy dropped slightly in the Corridor, going from 12% to 11.8%. Average asking rental rates have stabilized, bumping up slightly from 73 cents to 75 cents per square foot. Class A flex rates remained steady at 78 cents per square foot.
Activity
Major activity in the quarter included the delivery of Pacific Office Automation’s 100,000-square-foot corporate headquarters, the 62,000-square-foot relocation and expansion of Micro Power Technologies, the relocation of the 28,000-square-foot Netflix customer service center from the Bay Area and the second Nike lease of 90,000 square feet at Woodside.
The construction pipeline remains moderately active with owner projects and speculative development. There is 624,000 square feet of space under construction.
Build-to-suit activity has slowed somewhat as rising construction and land costs are causing sticker shock for users looking for new facilities. Users are opting to lease existing facilities or buy and retrofit, giving them equity and providing them with an improved position to help justify the cost.
Some submarkets saw slight improvement in rental rates, though overall asking rental rates were unchanged this quarter. Manufacturing/warehouse/distribution rates are at 36 cents per square foot. Overall flex rates have gone up slightly from 68 cents to 72 cents per square foot.
Forecast
After several years of decline, land prices for industrial property have been steadily increasing during the past 18 months. This trend likely will continue as demand for industrial land remains steady and availability of prime parcels continues to decline.
Pricing has gone from $4.50 per square foot to $7.50 and higher for shovel-ready sites in key locations.
A major recent development was Phil Knight’s purchase of 30 acres of land in Tualatin for a soon-to-be developed headquarters for Laika Entertainment.
Marine activity should begin to pick up throughout 2006 and this should translate into demand for space in the Rivergate area as well as demand for larger state-of-the-art logistics and distribution facilities along the area’s transportation network.
The Port of Portland recently saw the delivery of its third Post-Panamax container crane. That puts the port on par with other West Coast ports serving these ships, which are the dominant ones in trans-Pacific trade.
The additional capacity at the Port of Portland will enable it to compete more effectively for import/export carriers.
Analysis by Grubb & Ellis Co.
