CREJ

December 2018 — Office Properties Quarterly — Page 7 www.crej.com EVERYDAY FLEXIBILITY 2901 Blake Street, Suite 100 Denver, Colorado 80205 303 861 - 8555 info@davispartnership.com THE INTERIOR DESIGN STUDIO AT DAVIS PARTNERSHIP ARCHITECTS C ATA LYS T O F F I C E B U I L D I N G R I NO 2017 FIRM OF THE YEAR Market Insights W hile trophy and value-add office properties have led Denver’s investment mar- ket for the past several years, there are good rea- sons why more investors should be looking at Denver’s stabilized/Class B multitenant office product. • Stabilized, Class B office product is well supplied in Denver. First, there are many more investment options for mature Class B multitenant office product in Denver compared to trophy/value-add assets, which are becoming increasingly scarce. By building count, Class B proper- ties represent 50 percent of metro Denver’s total office inventory, with Class A and Class C each claiming around 25 percent, respectively. However, build- ing count alone doesn’t accurately reflect investment opportunity. If you look at multiten- ant office property trades from the beginning of 2017 through the end of November this year, you can see that roughly 65 percent of trades and 90 percent of total sales volume is attributable to trophy or value-add properties (sales volume percentage is skewed higher due to the higher sales prices associated with trophy prop- erties). Knowing that these properties rep- resent the minority of Denver’s office inven- tory, we can deduce that the number of remaining trophy and value-add properties not yet traded this business cycle in Den- ver is notably low. Further contribut- ing to the scarcity of trophy properties is Denver’s development pipeline. The end of the third quarter saw the lowest level of office construction activity in metro Den- ver since the fourth- quarter 2015, accord- ing to CBRE research. While there is healthy demand in Denver from office occupi- ers for new prod- uct, it is typical for development pipe- lines to slow as we get this late into a real estate cycle. This means we will see fewer new construction proj- ects delivering, at least in the imme- diate near-term. • Mature proper- ties face less com- petition. The imbalance in demand for multitenant Class B office prop- erties versus trophy and value-add assets has the potential to create a unique opportunity for those investors willing to look outside the box. Denver’s highest-profile properties naturally garner the most attention, resulting in more competition from investors and, therefore, higher prices. Anecdotal evidence from CBRE’s Investment Properties Group reveals that, on average, trophy/high-profile value- add properties result in 119 percent more confidentiality agreements and up to 200 percent more bids than stabilized Class B offerings. Correspondingly, the going-in yield for these stabilized B assets often are considerably higher than those of the more in-demand trophy and value-add assets. Average cap rates for multitenant office trades from January 2017 through this Novem- ber were 6 percent for trophy/new construction/stabilized Class A, 4.94 percent for value-add, and 8.21 percent for stabi- lized Class B. The truth is investors who only focus on Class A and value- add offerings may be missing out on overlooked oppor- tunities in the stabilized Class B sector that offer promising returns with minimal competition. • Class B proper- ties have limited need for capital improvement. It’s well-known that investors pay more for new construction properties, because they are paying for all of the Class A features that have been incorporated into a project. On the flip side, when an investor purchas- es a value-add property, the return is only realized after the party has spent a significant amount of capital on improvements. Class B properties often fall squarely in the middle. To remain competitive in attract- ing office occupiers, most own- ers of Class B properties already have invested in strategic capital improvements. Typical upgrades include adding amenities like food service and fitness facilities, making cosmetic enhancements that give a 1980s building a much-needed face- lift, and revising layouts to appeal to more progressive tenants seek- ing open floor plans. All of these improvements are expenses a new owner of a Class B property doesn’t Midmarket offices: An untapped investor sector Please see Brady, Page 19 James Brady First vice president, CBRE Capital Markets Campbell Davis Senior associate, CBRE Capital Markets Rachel Shanahan Client services specialist, CBRE Capital Markets CBRE