CREJ - Office Properties Quarterly - March 2016
Between 2010 and 2014, over 100,000 people moved to Denver, with many of these new transplants consisting of the millennial generation. Widely recognized as the most-educated workforce in our history, these young people are changing the way we live and work. Go into any grade-school classroom and you won’t find rows of individual desks, but clusters of desks intended to facilitate collaboration and sharing. With over 3,200 businesses opening over the past four years, rising rents in traditional office space and the boundaries of the central core of Denver pushing outward, several office developers are responding with a new way to conduct business that appeals to the younger, collaborative, tech-savvy generation – the creative office. Pioneering developers target old warehouses and convert them to cutting-edge office space, with several expanding to cluster retail and multifamily uses in order to create highly diversified live-work-play projects. The intention of many of these developments is to create a synergy between tenants, and developers maintain a hands-on style of management long after the last concrete seal dries. Creative office users are looking for space that incorporates sustainability with re-use of older buildings, energy efficiency and support for the latest technologies. Proximity to public transportation is important, and on-site amenities and neighborhood characteristics are strong considerations. When developing opinions of value for this type of property, appraisers are entering into uncharted territory where the particulars that drive value vary from property to property, and there is very little hard data from which to draw conclusions. Rental rates for creative office space have increased at paces that far exceeded expectations. Properties that six months ago were achieving rental rates in the high $20s to low $30s per square foot, are seeing new deals signed at $45 per sf, triple net. National brands are setting up corporate and regional headquarters alongside new startups. Outside brokerage and third-party management services are less common, making research on lease trends more difficult to track. The flexibility of the space, with an open concept, movable walls and month-to-month desk rentals, can change the overall layout and rentable area within a matter days. Large open areas, common conference and huddle rooms, and kitchens stocked with kegs and gourmet coffee machines can lead to higher operating costs. Developers of these properties are heavily vested in ensuring the continuing success of these projects. Many are Colorado natives and are active in community organizations and governmental initiatives to target future redevelopment areas. The relative newness of this property type means there are few, if any, sales of similar properties. The success of existing projects has encouraged more proposed development, which could easily lead to an over supply of similar space with a limited tenant pool from which to draw. Capitalization rates and discount rates for this type of specialized property are generally 50 to 100 basis points higher than well-located Class A office buildings. Land costs for these new developments can be significantly lower than core areas of downtown. And while it’s not always cost beneficial to repurpose old buildings, the open floor plans and exposed building components desired by creative office users cost significantly less to build out than traditional Class A office space. Construction costs are significantly lower than market values. Even general office users are tapping into the design concepts of creative office space. The classic model of perimeter offices around an open cubicle pit is changing as telecommuting, co-working and flexible hours become the norm. Digital data storage and cloud-based technology are eliminating the need for in-suite file storage and server rooms. Multitenant office buildings are incorporating common collaborative spaces that include a variety of conference and meeting rooms, open work areas and outdoor space. New suburban office buildings are designed with higher open ceilings, hotel-style lobbies with clustered seating areas, and outdoor components such as balconies and rooftop terraces. As a result, tenants have less need for communal space within their suites. Operating expenses can be expected to increase, though much of that will be recovered with triple-net lease rates. Investors in Class B office buildings are looking at the integration of these modern space designs desired by tenants as a value-add opportunity. Changing office dynamics driven by a younger, more collaborative workforce are opening opportunities for local developers and investors to provide adaptive space that will continue to drive the small- and medium-sized employers who helped make Denver one of the leading destinations for a strong inmigrating workforce. Institutional investors and value-add opportunists are capitalizing on the changing requirements of traditional office users, and Class B office properties stand to benefit the most from adaptive redesign initiatives. Market values of office buildings will continue to be influenced by design considerations, changing tenant space requirements and overall supply.