Commercial Real Estate Values

You want the good news or bad news first?  

Behind the global dramatic headlines about it, it’s important to understand that the commercial real estate market in Northern Colorado has good underlying fundamentals, with a relatively balanced supply and demand. We do see positive trends in rent growth, available capital, and even small office activity, but can’t ignore the other less desirable trends that ARE making the headlines, namely construction costs, occupancy expenses and lending.  

First, overall we are seeing low vacancy rates in our market that are pushing rent growth, particularly as new supply is limited.  

Second, in the capital markets, products that appeal to cash heavy exchange buyers are experiencing multiple competitive offers, particularly properties under $3,000,000, and automotive and automotive-adjacent properties.

Third, while the office market is facing challenges in financing (more on that in a minute), we do see strong activity with local businesses returning to office. With financing constraints and remote workforce challenges, we’re not surprised to see a downsizing of corporate users with large footprints, as well as users in the tech industry, and real estate complementary users such as mortgage/title firms. It’s important to note that while that downsizing is impactful, we do see much of that vacancy being backfilled by local regional firms, particular in smaller class A leasing.

Now for the main act: construction costs, occupancy expense, and lending.

When looking at existing vs new build costs, things don’t really make sense. In the industrial segment, the cost to build new is hovering around $200 per square foot, when existing product is selling in the mid $200s per square foot, and even higher for smaller footprints or buildings with a yard. Compare that to the office segment, in which class A office construction is coming in at a whopping $600 per square foot, yet valuations for Class A office are coming in at mid $200s per square foot.  

It’s no surprise that construction costs in Colorado have skyrocketed in recent years, driven by population growth, labor shortages, increased material cost, and permitting fees. In addition to the challenges faced by developers and builders, rising construction costs directly impact tenants and buyers of commercial real estate in Colorado, driving higher rents and sale prices for new properties, thereby limiting the affordability and accessibility of commercial real estate for many businesses. Given construction costs and increased interest rates, we expect the current pipeline to deliver, but the development pipeline to pause.

Other rising costs impacting commercial real estate users are coming through in increased NNN expenses, putting pressure on both landlords and tenants, with projected increases of 25-30% in tax assessments and large increases from service providers such as a 20% increase in trash removal services. putting pressure on both landlords and tenants. Landlords are feeling the squeeze as they are unable to pass on all these costs to tenants. Meanwhile, tenants are facing rising costs that can eat into their profit margins and make it more difficult to remain competitive.

The lending environment for office users has become increasingly difficult in recent months. Banks and other lenders have become more cautious in their lending practices due to concerns about the potential risk of defaults. This caution has led to a tightening of credit standards, with lenders requiring higher credit scores, more documentation, and greater down payments from borrowers. This makes it more challenging for office users, particularly smaller businesses, to secure financing for their real estate needs. This tightening of lending practices by banks, coupled with rising interest rates is also shrinking the pool of buyers. However, there is still a lot of capital in the market; it's just conservative capital, and some of which is still subject to the difficult lending environment.  

Despite these challenges, there are still lending options available to office users. Smaller regional banks and credit unions may be more willing to lend to office users, particularly those with strong credit histories and a proven track record of success. Private lenders may also be an option, although they typically charge higher interest rates than traditional lenders.

While the global headlines are not wrong, it’s not reflective of the whole story in our market. While challenges remain, Northern Colorado’s commercial real estate market has a strong foundation, and promise to weather the challenges ahead.  

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