Office vacancy rates nationwide are at their highest level since 1994, according to a 2022 report from CBRE Group, which found the third-quarter vacancy rate for downtown office buildings at 16.3 percent.
In many metro areas, there was an office construction boom in the prepandemic years, and already high vacancy rates were exacerbated when remote workers fled their offices.
Repurposing those empty spaces as industrial facilities or even housing has become a national trend. In 2021, more than 150 buildings in U.S. cities formerly used for other purposes were converted to apartments, and 41 percent of those originally were office buildings, according to an Oct. 6, 2021, report from RentCafe.
The city of Denver is planning to hire a consultant to study the potential conversion of about a dozen downtown office buildings into condos or apartments, The Denver Post reported on Feb. 17.
But Colorado Springs is not following that trend, local commercial real estate agents say.
“I’ve not heard of that happening in Colorado Springs,” says Peter Scoville, principal at Cushman & Wakefield, which specializes in offices and investments.
“We didn’t have the problem that a lot of markets had throughout COVID,” Scoville says. “We had a defense world that was COVID-proof,” he says. “We’ve had some call centers that have vacated space, but we never got the same type of shutdown that other markets did.”
Holly Trinidad, at Hoff & Leigh, says demand remains high for office space in Colorado Springs, which did not overbuild as some other cities did.
But the pressure for multifamily housing in Downtown Colorado Springs has led some developers to eye existing buildings as sites for new apartments.
“There’s a couple buildings that were purchased and are going to be bulldozed and new apartments are going to go in their place,” she says. (One such building, at 120 W. Cucharras St., which formerly housed the Piano Warehouse, was sold to multifamily housing developer Greystar Real Estate Partners last fall. Sixty35, formerly the Colorado Springs Business Journal, covered that story in October 2022: tinyurl.com/33baveu4.
Trinidad says Hoff & Leigh has one listing, an old office building on North Nevada Avenue, that’s being looked at by potential buyers for possible conversion to apartments.
But Downtown “is probably the only place in Colorado Springs where we’re seeing that,” she says.
Overall, the Colorado Springs office market remains healthy, Scoville and Cushman & Wakefield Principal Greg Phaneuf write in their fourth quarter 2022 MarketView report.
“At the end of 2021 we declared, ‘We do not anticipate any meaningful changes to the market statistically in 2022, but we do foresee a great deal of activity occurring in the market throughout the year,’” they write. “With 2021 having been a better year than expected, despite the disruption of COVID-19, 2022 did end up to be a year of mild fallout but healthy overall leasing activity.”
Vacancies that did occur in 2022 were quickly backfilled, and the year ended with a vacancy rate of 11.87 percent and a positive absorption of 73,000 square feet, the report says. (Absorption is the difference between space tenants have vacated and space tenants have moved into within a certain time frame.) Those figures compare with a 2021 year-end vacancy rate of 12.68 percent and a negative absorption of 67,500 square feet.
“Fundamentally, Colorado Springs continues to fare well, with apartment construction, retail and industrial all showing very positive signs for 2023,” Scoville and Phaneuf write.
They expect new office construction, although they anticipate that higher interest rates will have a dampening effect during the first half of 2023.
“But with the overall health of the market, we would expect the second half of the year to provide for some exciting plans and the overall growth of our city,” they state.
“There’s been a tip in Colorado Springs from being a sleepy military town to a really hip, cool place.”
— Peter Scoville
RISING LEASE RATES
One overriding factor is that office lease rates are continuing to rise, Scoville says.
Scoville and Phaneuf’s report breaks down statistics for Class A and B office space into three major submarkets: the north Interstate-25 corridor, the airport (Southeast) area and the central business district.
For the fourth quarter of 2022, vacancies were highest in the north I-25 corridor, with a vacancy rate of 14.03 percent, compared with 8.62 percent in the Southeast and 9.42 percent in the central business district.
Average lease rates were highest in the Southeast area, at $18.41 per square foot, compared with $17.58 in the north I-25 corridor and $17.13 in the central business district. Citywide, the average lease rate was $17.63 PSF. Class A properties are leasing for $20 PSF or more, Scoville said.
He expects rates in the central business district and north I-25 markets to remain flat in the first half of this year, but “smaller blocks in the nicest office properties are commanding increases as demand for higher quality space is strong,” the MarketView report states.
Lease rates in Colorado Springs used to be much less expensive than in Denver, “and now, it’s caught up,” Scoville says, although there is a fundamental difference in the two markets.
“Denver tends to be a full-service lease market, and we’re triple-net down here,” he says, explaining that triple-net leases include both base rent and operating expenses, taxes and insurance, with the tenant responsible for paying those, whereas the landlord pays operating expenses with a full-service lease.
“If you put those on an apples-to-apples basis, we’re relatively comparable to Denver,” Scoville says, although downtown Denver buildings are more expensive because of construction costs there.
“Colorado Springs was always in the shadow of Denver,” but “there’s been a tip in Colorado Springs from being a sleepy military town to a really hip, cool place,” he says. “That’s happened over the last 10 years or so, and it’s the biggest and most material impact on the office market.”
The medical office market was one of the strongest components of the overall office market in Colorado Springs in 2022, Scoville and Phaneuf say.
Two new medical office buildings in the north area — the recently completed four-story Woodmen Medical Plaza adjacent to Penrose-St. Francis Hospital and the Interquest Medical Office Building, projected to open in May — have added inventory and are an indication of the strong demand, Scoville says. Rental rates for medical offices are 30 percent higher than the current overall market.
“Medical office buildings on hospital campuses continue to thrive as the hospitals expand and need additional space,” the MarketView report says. The obstacle facing the medical office market is the cost of tenant improvements, which has risen substantially.
Medical office buildings are an attractive investment opportunity. Although medical office acquisitions slowed in the second half of 2022 due to rising interest rates, Scoville and Phaneuf expect investment activity to pick up as interest rates stabilize later this year.
“Overall, we expect a healthy medical office market in 2023,” they state.
SALES STILL STRONG
Hoff & Leigh is seeing the most demand for sales in owner-user office space, Trinidad says.
“We have a couple of office buildings that have been on the market for a little bit longer, but inevitably, they end up selling for close to list price,” she says. “Sales aren’t happening as quickly, but they’re definitely still happening, and there’s a strong need for owner-user space.”
That demand crosses all size ranges, she says, from small medical facilities to larger offices.
“This user is sick of leasing and wants to own,” she says. Overall inventory is low, which keeps demand high.
The office sector has slowed down a little bit overall compared with other sectors, she says.
“The industrial market has not really slowed much at all,” Trinidad says.
In the retail sector, “we have seen some defaults happen on leases, from small businesses that can’t sustain, which I think is an indication of a slowdown.”
Inflation has started to affect leasing costs, she says, “simply because costs are more expensive. When you go to build out a space for a retailer, when it used to be $50 a square foot, it’s now $90 or $100 a square foot. That probably has the biggest impact on deals happening on the north side of town, because it’s all new construction.”
But despite inflation and increased lending and borrowing costs, “Q1 will probably be pretty strong,” she says. “It just goes back to the time it takes to get deals done. There’s still a lot of money in the marketplace.”