The Q2 2023 Metro Denver commercial real estate (CRE) data shows that the industrial and office markets are both softening. The turning point is very recent on the industrial side, but the decline in the office market segment represents the continuation of a multi-year trend.
Industrial
We’ve reached the peak in the industrial CRE market and we’re shifting from a red hot market to one that’s merely very warm. Vacancy rates rose from 4.9% to 6.2% in the last 12 months. This is still quite low, and space is still at a premium. (Historically, a 10% vacancy rate represents a stable market in equilibrium).
Sale prices peaked in the past year at $183-$185 per square foot; they’re projected to decline slightly over the next two to three years as new inventory hits the market and is more slowly absorbed. The modest slowdown in the industrial market is healthy and is trending down to what could be considered “normal.” The expectation at this point is that the market will pick up steam again as the economy fully recovers. In other words, there may be a brief window where industrial users can find a deal on a lease or a purchase, albeit still with historically high relative prices.
As we’ve seen in the office market, rental rate declines tend to lag reversals in asset valuation and vacancy rates. Thus, industrial rental rates are not currently in decline, although the annual rate of increase has slowed from 8.7% in Q2 2022 to a more modest 5.0% in Q2 2023. We expect rental rates will continue softening in 2024. Thus, compared to the past several years, industrial tenants will soon have more room to negotiate and sellers that want to capture maximum appreciation while mitigating their “what’s going to happen with economy” concerns will want to act sooner rather than later to stay ahead of that curve.
Office
The Q2 2023 Denver Metro data confirms a continuing slide in the office CRE market, a sector that’s been buffeted by remote and hybrid working arrangements, and, more recently, layoffs that reflect the early stages of an economic slowdown.
A McKinsey report released this month found that office attendance in eight major global cities has stabilized at approximately 30% below pre-pandemic levels. The analysts predicted demand for office space in those locations will decline between 13% and 38% by 2030 compared to 2019 levels, wiping out $800 billion in property value. While Denver was not included in that analysis, the situation could be similar here.
One of the interesting stories we’ve been watching is how over the last two years, landlords have been able to increase office rents despite declining sales prices and persistently high vacancy rates. In the last eight quarters, the office vacancy rate was in the 13-15% range, reaching 15.3% in the last quarter. Sales prices were down 4.8% (or $12 per square foot) over the past year. Yet, in Q2 2023, office market rents were at an all-time high of $29.13 per square foot, increasing 1.0% in the past year.
Most landlords, with the possible exception of newer Class A property owners, won’t be able to sustain these continued rent increases much longer given that sale prices in this sector have been slowly declining since peaking in Q3 2021. Thus, average market rents are projected to begin to drop later this year – a silver lining for an office space tenant’s P&L. If you’re a tenant in the middle of a long-term lease, the next year might be a good time to renegotiate your lease.
If you’d like to dig deeper into this data or if you have questions about what all of this might mean for your commercial real estate investment plans or your tenancy situation, please contact us.
