Page 4 — Office & Industrial Quarterly — June 2023 OFFICE — BOULDER BRYANCONSTRUCTION.COM 855.391.5355 DELIVERING PERFORMANCE EXCELLENCE EVERY. TIME. TAKE A LOOK AT OUR RECENT PROJECTS W e are all wondering about the same thing. What is happening to the office market and what does the future of office space look like? Rising interest rates to combat ongoing inflation concerns have continued to play a role in the already volatile capital markets. The recent failure of many regional banks only adds to the pressures already facing investors and tenants alike. Tightening monetary policy combined with the recent regulato- ry issues suggest we are headed in the continued direction of an eco- nomic slowdown and further mar- ket uncertainty. Add in the grow- ing trend of the work from home model and what we are left with is an office market that is trending toward continued disruption. The Boulder market’s saving grace is that it has always operated in a bubble – relatively stable market pricing and immune to long-term economic downturns. However, the economic challenges we see in the office market across the country are also happening right here at home. With each challenge we face, also comes opportunity. Let’s dive in. The not so pretty: n Vacancy. At the end of the first quarter, vacancy rates for down- town Boulder office hovered around 30% including sublease space. This is a record high since the turn of the century. East Boulder is per- forming slightly better than down- town with vacancy at 20%. Central Boulder is stable at 12%, but that does not account for large chunks of new construc- tion delivering later this year, which will increase vacancy rates. n Property taxes. Across the board in Boulder the recent property valua- tion notices have sent shockwaves among property owners and ten- ants. Property taxes, which in most cases account for the majority of a building’s oper- ating cost, have skyrocketed to an average increase of 20%-25%. Most typical lease structures allow land- lords to pass through property taxes and any increases directly to the tenant. It is a double-edged sword for landlords that on one hand need a performing asset that keeps investors and lenders satisfied, and, on the other hand, the tenant is most impacted with the burden of increased property taxes falling squarely on their shoulders. While institutional and high-credit ten- ants may not balk at the increase, it is safe to say the most significant impact will be on small, locally owned and operated Boulder busi- nesses. With downtown Boulder office space already struggling, it will not be surprising to begin to see inverted lease rates – meaning the base lease rate dropping below the estimated operating costs. The Boulder business community has not been silent on this issue, and the chamber of commerce is mak- ing it a high-priori- ty conversation. n Lending. The pencil has been put down for many investment groups as interest rates continue to climb. In turn, demand has slowed consid- erably for acquisi- tions. In the first quarter, Boulder County recorded $252 million in sales, but that num- ber included very little in office product and we expect to see a big decline in sales for the balance of the year. However, there are a few larger transactions in the works, but given the ever changing market conditions, these deals could easily die a few times before getting to a closing. In addition, It has been very common this quarter to see deals fall out of contract and sellers cir- cling back to previously interested buyers. The Fed recently ranked commercial real estate the fourth- largest stability concern, which in and of itself should be a warning sign as the year progresses. Opportunities looming? Have you ever heard the story of the Chinese farmer? If not, we highly recom- mend you look it up as it is a great thought experiment on the compli- cated relationship between cause and effect, good and bad luck, and persevering through moments of uncertainty. The overall lesson that the Chinese farmer teaches us is that we don’t have to subscribe to the bad news. n Subleases can help solve problems by allowing one company to stop the bleeding on rental payments while simultaneously allowing another company to downsize or pay a below-market rate. In this office environment, many com- panies are looking to slowly bring employees back to the office but are unable to commit to a long-term lease. From larger dilemmas and pressures companies face on the corporate level to as small as mak- ing the decision to purchase new furniture, the sublease market will help accommodate many compa- nies in limbo. n Sublease space aside, let’s talk about landlords with high vacancy rates. As potential default letters loom, landlords are starting to get more aggressive. We are seeing more tenant-friendly lease rates being offered, more free rent being offered, and larger broker bonuses being presented. Landlords are spending money on spec suites and adding amenity space to their buildings as tenants coming back to the office are looking for incentives to get employees back in the work- space. If owners are unwilling to spend dollars on building upgrades or get vacant spaces to move-in ready condition, don’t be surprised if these spaces sit vacant for quite some time. The cheapest space isn’t always the best – companies com- ing back to the office are valuing quality and amenities! Some risks will be rewarded but patience required Beau Gamble President, Dean Callan & Co. Kevin Nelson Broker associate, Dean Callan & Co. Please see Gamble, Page 16