Denver’s retail real estate environment has never been healthier, regardless of the media coverage on e-commerce and its impact on retail. Retail rents in our market have increased since the middle of 2014 at a rate of 4% annually. Between the years of 2013 and 2017, Denver was the strongest of the 50 largest metro areas in the United States. Currently the vacancy rate is in the low-4% range, which is the lowest rate in 15 years.
Ironically, the “retail apocalypse” has strengthened the retail market, especially in Denver. The overreaction to the impact of e-commerce has kept construction in check, and, although new construction has moderately increased recently, it is still considerably below the historic average. The construction we see now is more disciplined and is largely pre-leased or single-tenant focused.
Denver had averaged 3.6 million square feet of new construction annually over the past 35 years. Since 2012, Denver has experienced only 7.5 million square feet of new retail inventory, an average of less than one million square feet annually. Moreover, the 7.5 million square feet does not account for a reduction of 2.5 million square feet of demolished or repurposed inventory, a phenomenon created by fall out from the “apocalypse.” Denver has experienced over the last 12 months a net absorption of 1.2 million square feet, which is in line with the five-year average. Strong net absorption and below average construction numbers are creating a tightening in the market.
The anticipated effects of e-commence have also influenced the way companies invest in retail. With the extra sensitivity, investors are hedging their risk with a lower basis in retail assets. Cap rates have settled over the past three years down nearly 20 basis points. During the prior three-year period from 2014 to 2016, cap rates dropped 80 basis points. Amazingly, this is over a time of historically high lease rates and low vacancy. Investors that have continued to buy have benefited greatly from the “apocalypse,” which has been enhanced by an advantageous debt market.
Lenders have unprecedented amounts of capital to lend but are keeping control over retail assets. Although overall debt terms remain favorable, lenders are spending more time analyzing retail assets including targeting lower leverage relative to other product types. As an example, lenders are focused on debt yields that are 50 to 150 bps higher than other product types. Lenders are digging deep into tenant analysis, evaluating credit quality of major tenants and looking at void analysis to best understand the viability of a replacement tenant. Lenders are cautious of retailers with greater vulnerability to online alternatives, thus preserving a more favorable view of grocer, service and entertainment retailers.
The dichotomy is that leaders still have allocations in their portfolio for retail and will aggressively pursue targeted, core assets to keep the portfolio in balance. This allows for pricing on certain grocery-anchored and single-tenant assets to be aggressive in the Denver market, even though generally cap rates have increased.
It’s important to note that the health of the retail environment does not necessary translate to robust investment sales activity. Twenty-eighteen's $1.5 billion in sales was the second highest in this latest cycle, bolstered by M&J Wilkow and MetLife’s $142 million acquisition of Southlands. In contrast, transaction activity is markedly down in the beginning of 2019, and the second quarter could be the lowest in recent memory. Transaction volumes prior to 2018 were also low compared to historic averages. In 2017, sales volume for retail was down nearly 20% nationally and nearly 30% in Denver. Twenty-seventeen was the peak of apocalyptic concern, highlighted by the Amazon purchase of Whole Foods, which was finalized in August of that year.
In Denver the low volume in sales is accentuated by several the market’s largest assets being owned by portfolio-minded groups that traditionally hold their assets for cashflow. Only 11 assets more than $20 million sold in the Denver market in 2018, many of these to owners that will once again hold long term. This factor creates a dilemma for retail owners in Denver. Although capital desires Denver, it is perceived as a difficult market that does not trade. While there are opportunities for current retail owners to sell, there remains a concern with where to place the money on the other side of the transaction; therefore, assets offered to the market garner wide market attention.
Over the last several years, the landscape in retail has been changing. Through this change, the Denver retail environment has evolved and become more disciplined. It is performing at its highest levels, as evidenced by the fundamentals. An unprecedented amount of capital late in the cycle is looking for a place where it can outperform in case of a potential slowdown. As the emotion surrounding the “retail apocalypse” continues to wane, Denver’s retail will become even more desirable, reinforcing the investment market. The newfound disciple will support Denver’s bid as a top market nationally for retail investment.
Jason Schmidt is a managing director with more than 20 years of experience in the commercial real estate industry. He focuses on both retail and office investment advisory transactions in Denver and the Rocky Mountain region and co-leads HFF Denver’s office private client/middle market investment advisory team. Throughout his career, he has closed more than $1 billion in transactions for a variety of institutional investors and REITs, including AEW, Blackstone, Evergreen Devco, Inc., Franklin Street, Piedmont Realty Trust, Weingarten Realty and Westwood Financial.
Mr. Schmidt joined the firm in January 2019 from JLL’s Capital Markets Group, where he was an executive vice president responsible for the disposition of office, retail and industrial buildings in the region. He has a wide range of experience in the industry and has held positions at Signature Equities, Pace Properties, Cushman Wakefield and Cassidy Turley. Mr. Schmidt has been recognized as a “Heavy Hitter” by the Denver Business Journal and holds a Bachelor of Arts in Psychology and a Master of Business Administration from Drake University as well as a Master of Real Estate and Construction Management from the University of Denver.
Chad Murray is a director in the Denver office of HFF with more than 14 years of experience in commercial real estate and finance. He focuses primarily on retail investment advisory transactions throughout Denver and the Rocky Mountain region. Since joining HFF, Mr. Murray has participated in more than $1.25 billion in investment advisory, debt and equity transactions.
Mr. Murray joined the firm in July 2013 from the General Services Administration (GSA), where he managed leasing activities for the GSA throughout Colorado. Prior to the GSA, he worked at a boutique Denver firm capitalizing commercial real estate transactions throughout Colorado.
Originally published in Colorado Real Estate Journal.