Denver's industrial market is facing challenges, with many big box developments currently sitting vacant. Increasing construction costs and high-interest rates are impacting underwriting, and there is a lack of options for smaller tenants. Additionally, vacancy rates are on the rise.
“Denver’s vacancy rate – at 8.7 percent as of 4th quarter 2023 – is deceiving,” stated Dan Dokovic, co-founder and managing principal at Artori Group.
Dokovic joined panelists Ryan Lack, project director at Brinkmann Constructors; Erik Frandsen, CRE team leader at Huntington National Bank; and Brian Dietz, VP at Evergreen Devco, last week at Huntington National Bank’s DTC location for MetroWire Media’s 2024 Industrial Summit. CBRE industrial broker Brinete Chavez moderated the discussion.
“A deeper dive shows the vacancy rate for assets over 100,000 SF is 10 percent; however, industrial buildings under 50,000 SF have a vacancy rate of 3 percent,” continued Dokovic. “It’s also important to note that the average leasing time for a building over 100,000 SF is 23 months, compared to a four-month average leasing time for assets under 50,000.”
Denver's geographical position was considered advantageous for the establishment of major distribution centers and large-scale developments leading up to and during the COVID period. However, the current vacancy of these developments contributes to the rising vacancy rates.
Dietz expanded on Dokovic’s statement, “Major distribution centers need to be near population centers, but Denver is isolated. The user pool in Denver is primarily made up of local/last mile delivery, light manufacturing, food and beverage companies, local contractors, and companies who are based here. There isn’t a lot of demand for 600,000+ SF buildings with 40 foot clear heights. Rather the ‘sweet spot’ is front park, rear load buildings that demise down to 50,000 to 60,000 SF.”
Dokovic noted there is more ‘bang for your buck’ on returns with large-scale developments. “Contrasted with a small flex-building development, returns are smaller, and sometimes the rents don’t work out, especially in today’s environment,” shifting the conversation to underwriting challenges impacted by high interest rates and increasing construction costs.
Frandsen and Dokovic predicted interest rates will begin to decrease in 2024 although Frandsen clarified he expected no movement in March. Lowered interest rates will help move assets off balance sheets, creating more liquidity to help with underwriting new projects.
“Five to ten years ago, one could get five banks answering calls for funding. The competition was fierce,” added Frandsen. “Now, liquidity is difficult after investors have been sitting on assets throughout 2023. Banks are getting smarter now and want to see relationships with their clients before lending money. We look for ways to keep our clients ‘sticky,’ which helps our liquidity and provides more ways to serve the client.”
Lack added, “The labor shortage drives rising construction costs locally and nationally and we need to get a handle on that. Wages are now 30 percent higher than pre-COVID and that is having an enormous impact on underwriting.”
Denver’s high living cost (driven partly by increasing construction costs) is also a significant factor.
The discussion then moved to Energize Denver’s not-so-positive impact on underwriting. “Energize Denver’s goals for carbon neutrality is lofty and admirable, but I wonder if the financial impact to building owners was considered,” asked Dietz. Energize Denver’s building performance policy includes energy efficiency improvements and strategic electrification of all existing buildings and homes to achieve net zero energy by 2040. “Owners of vintage product that do not retrofit their assets will receive substantial fines. This makes retaining and selling vintage assets difficult,” he added, noting that there are legal challenges to this policy upcoming.
Looking more at strategies to overcome challenges, Dokovic said, “Intelica’s focus during the last quarter has been on micro-investments (under $20M). I know my peers sometimes scratch their heads while looking for deals with the highest returns, which are typically large development projects. But our investment returns are completely beating everyone else because we are willing to put the work into doing smaller deals.”
Dietz concurred and noted Evergreen is also shifting the paradigm. "We asked our colleagues in the industrial market, 'What is the hardest asset to find in Denver?’ The answer was smaller buildings with yards. If you look at the developers that are successful time and time again, it’s the ones focusing on front park, rear load buildings in infill locations.” he said. “With that in mind, our next project will fit this mold.”
In the next 45-55 days, Evergreen Devco will commence construction on a new project in Commerce City: a 55,000-SF building, constructed at ground level, featuring a three-acre outdoor storage area. “No one is building smaller buildings with outdoor storage, but so many smaller businesses need outdoor storage. They can be difficult to underwrite, but we think it is worth a shot,” Dietz said.
Out-of-the-box thinking is the key to mitigating underwriting concerns for smaller asset classes.
“From the general contractor perspective, we run multiple pricing updates and refreshes,” noted Lack. “For example, I will be hard bidding a job in a couple weeks, but I have been playing with the numbers for three years now, and I’ve seen it spike 10 percent in six months, drop 2 percent, get put on hold, and hopefully it will drop another 5 percent or so in the next couple weeks. Brinkmann constantly helps with updated proformas and models.”
Dokovic mentioned Intelica’s current strategies for mitigating underwriting include a longer contract process and longer financing, “almost like an installment sale on ground to take the ground cost out of it while also providing more flexibility. Being resourceful in today’s environment is the name of the game because it is hard to make it work.”
Frandsen agreed the industrial real estate industry needs to be creative while we wait for interest rates to decrease to free up the capital markets. “I think there will be opportunities for buyers while interest rates remain high, potentially creating a lot of wealth for those positioned well.”
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FEATURE PHOTO: Artori Group’s Dan Dokovic prepares to speak at MWM Denver’s 2024 Industrial Summit held at Huntington National Bank on January 25, 2024. Photo credit: Artori Group.