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Colorado boasts mile-high mountain of activity

Colorado boasted one of its best commercial real estate years ever in 1998. Despite the turmoil in the capital markets, which put the brakes on a record buying spree by REITs, there were a number of extremely positive events last year:

* Indianapolis-based Forest City was chosen as the developer of the former Stapleton International Airport, the largest in-fill development in the country.

* Sun Microsystems and Level 3 were on a hiring spree to fill their huge office campuses under construction in the Interlocken Business Park in Broomfield.

* Developer Bill Denton opened Denver Pavilions, a $130 million, 350,000 sq. ft. development on two blocks that breathes life into the upper-end of downtown with tenants such as Hard Rock Cafe, Barnes & Noble and a United Artists Theatre.

* Beaver Creek, Colo.-based East West Partners was picked as the developer of the $1 billion-plus Central Platte Valley residential development, the largest in-fill tract adjacent to a major downtown.

Denver dashes to records The outlook remains strong for 1999 in almost every sector. Colorado was the third-fastest growing state in the nation in 1998, trailing only Nevada and Arizona. Unemployment remained low at only 3.3%.

The downtown Denver office market, the strongest in the metro area, already is showing signs of record rates in 1999. Unlike during the energy boom of the early to mid-1980s, when the state was counter-cyclical to the rest of the nation, the Denver area and Colorado's more diversified economy now moves with the same forces that impact the rest of the nation.

Real estate experts agree that the problems in the capital markets during the second half of 1998, helped the Denver-area market. Indeed, there is little dissension on this point - brokers and developers insist they are not simply making the best of a half-full glass.

"The thing is, we were starting to look down the barrel of possible over-building in this development cycle," says Mike Winn, a Cushman & Wakefield broker who, with his partner, Tim Richey, have sold $500 million worth of real estate during the past two years.

The pullback by REITs and in the capital markets halted potential overbuilding. "The real estate markets, for the most part, are very good and in balance," Winn says. "The timing of the pullback could not have been better. While the 'flight to quality' in the capital markets has meant that some sales transactions have been put on hold, the underpinning of supply and demand has been extended two or three years because of the pullback."

Richey says the Denver market is much better in balance than others, such as Houston or Dallas."And the capital markets still remain focused in terms of Denver. The city is still very much in the 'buy box.'"

Diversified real estate company Mile High Properties in early March opened the $50 million Colorado Center II office tower, the first high-rise built in Denver in more than a dozen years. The 12-story, 260,000 sq. ft. building is located at the intersection of Interstate 25 and South Colorado Boulevard between the heart of downtown and the Denver Technological Center - the premier office park along the southeast corridor.

Lease rates at Tower II range from $24 to $28 per sq. ft., which would have been the top of the market in late 1997 or early 1998. But in today's market, Republic Plaza in the Central Business District has signed some deals for a record $34 per sq. ft.

"My take on the market is that it is pretty healthy," says George Thorn, president of Mile High Properties."I think the capital market blip of last fall stopped a lot of projects on the drawing board that would have been spec. We had too many projects on line.

"Because of what has happened with the REITs and CMBS funds, it immediately dried up the financing," Thorn adds. "It's a mechanism in the new world order of institutional financing."

Because less supply is on the market, rental rates will continue to rise, although not as much as they did in the mid-1990s when the market was still recovering and starting from an extremely low base, he says.

"The one exception to that will be downtown," says Thorn. "The central business district will see larger lease increases than southeast Denver."

Dave Morrison, vice president of Brookfield, the largest downtown landlord, agrees. Brookfield's portfolio includes the 56-story Republic Plaza, the tallest building in Colorado. This year, the company plans to start a 385,000 sq. ft. high-rise on a parcel it owns behind the Denver Pavilions.

"Downtown rents increased 15% last year," says Morrison. "We broke the $31 barrier, and we now have some deals at $34. This is an all-time high, and they are real deals."

Larry Grace, one of the founders of LaSalle Partners, came out of retirement a couple of years ago to head Trillium Corp.'s land holdings in the Central Platte Valley behind Union Station and LoDo. He currently leases space in 17th Street Plaza, which he built for LaSalle in the early 1980s.

"When we first leased 17th Street Plaza in 1982, it was getting $26.75 per sq. ft.," Grace says."The market is just not coming back to those rates in the high $20s."

David Warren, senior vice president of CMD Real Estate, says Denver is as healthy as any city is his region, which includes Seattle, Phoenix, and Southern California. CMD owns 2.3 million sq. ft. of space in Denver and Colorado Springs.

Last year, CMD paid $46 million for the Stanford III building in the Denver Technological Center. Warren noted that they paid $135 per sq. ft. for a building that would cost at least $160 per sq. ft. to replace. Warren likes the market because of limited supply and low vacancies.

"The vacancy rate, overall, is very low, around 7% in all of the Denver submarkets," says Warren, adding that a lot of people are concerned about the number of projects that continue or are under construction despite the pullback in the financial markets.

That, combined with companies such as Lucent Technologies, which is centralizing all of its space into a 600,000 sq. ft. office campus under construction in Highlands Ranch, will lead to huge jumps in the vacancy rate.

"But if you step back and look at it, that is still very small in relation to the whole suburban south market," says Warren, adding that the problems in the capital markets opens buying opportunities for CMD and other non-REITs. "Really, it helped everybody," he says. "It helped just by applying some discipline to the development cycle. It probably slowed down new construction.

Jon Marold, a First Vice President at CB Richard Ellis, says the rents along the southeast corridor grew at an average rate of 11% from 1992 to 1997.

"The Southeast market is at equilibrium, at the top of the bell curve," Marold says. "Now, rental rates will match replacement costs, so there's no reason for significant growth. This year, we'll see growth more in line with inflation, 2% or 3%. It will stay like this for the next three to five years."

Quality of life is one of Colorado's big drawing cards. Tom Bahn, senior vice president of PM Realty Group, which manages 2 million sq. ft. in Denver, is a testament to that. Like others, he is pleased Denver did not fall into the overbuilding trap.

"A year ago, I was afraid we were growing at a rate that was unhealthy," he says. "We had developers with unlimited sources of capital, and they looked like they were going to be building without stop. I'm confident we'll continue to grow, but not at such a frenzied pace."

Doug Bakke, first vice president of CB Richard Ellis, says one of the hottest submarkets is the northwest corridor between Denver and Boulder. He noted 1.7 million sq. ft. is already under construction - 36% of which has been pre-leased. Level 3 is building 800,000 sq. ft. for its own use, while Sun is building an office campus that will exceed 1 million sq. ft.

"This is just one indication of how hot this market is right now," Bakke says. "This means there is great opportunity for developers and new construction in 1999."

San Francisco-based Catellus is shaping up to be a major player in the area, he says. Catellus also has constructed 400,000 sq. ft. of industrial space at the former Stapleton International Airport. The industrial market also is doing well.

"The industrial market is extremely active across the board, especially for those requirements above 100,000 sq. ft.," says Jim Bolt, senior vice president at CB Richard Ellis. "Concerns of overbuilding in mid-1998 are gone. The fourth quarter of 1998 was a record, and the fist quarter of 1999 is shaping up to be another record."

Bolt pointed to a couple of recent deals as evidence. Samsonite leased another 324,000 sq. ft., and letters of intent have been signed, but not yet announced, for two undisclosed users for 200,000 sq. ft. and 120,000 sq. ft.

"Denver has now grown to a critical mass, and this puts us on the map of large users," says Bolt. "This was not the case 10 years ago. Denver is now a first-tier city."

Colorado Springs forward The industrial market in Colorado Springs also was strong. More than 460,000 sq. ft. of new construction was added to the inventory in 1998 and more than 1 million sq. ft. of industrial space was leased, according to Colorado Springs-based Palmer McAllister/Frederick Ross Co.

The market suffered a setback, however, when Rockwell International announced it was closing a 450,000 sq. ft. semi-conductor plant that it never occupied. Still, the industrial outlook remains bright, says Kathleen McCoy, director of marketing for Palmer McAllister.

"The total inventory of industrial space continues to grow with the diversification of Colorado Springs' economy," she says. "Since 1980, over 10 million sq. ft. has been added to the inventory, bringing the current total of industrial space to more than 28 million sq. ft.

"Companies seeking new industrial flex space for office use will find lease rates ranging from $7 per sq. ft. to $10 per sq. ft.," McCoy notes."Vacancy rates are expected to rise significantly market wide due to the negative absorption anticipated with the addition of the Rockwell facility."

If anything, the Colorado Springs office market was even better than the industrial market. The office market shattered several records in 1998:

* More than 400,000 sq. ft. of speculative office space was added in 1998.

* Investment sales averaged $74 per sq. ft.

* For the first time since 1988, new spec construction exceeded owner-occupied construction.

"The city vacancy rate is likely to decline through 1999 as new construction is absorbed by tenants," says McCoy. "Demand will continue to be high for the tight supply of Class-A space citywide. Lease costs will continue to escalate given the decreasing vacancy and the continued demand for quality space."

McCoy adds that, despite financial uncertainty, the deals are out there to be made. "Sales of quality Class-A buildings will continue to command record per-sq.-ft. prices, but perhaps finding investors will be a little tougher than in 1997 and the early part of 1998," she says. "Despite the capital market crunch and uncertainty of REIT performance on the stock market, there will still be investors eager to purchase good, quality projects."

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