Office-space investors still bullish on Boulder

BOULDER — Despite some record-setting commercial real-estate deals in recent years, the office market nationally continues to reel from effects of the COVID-19 pandemic. However, despite its high vacancy rate and large blocks of subleased space, national investors who spoke at BizWest’s Boulder Valley Real Estate Conference last week say Boulder still seems to be full of opportunity.

“We’ve always been excited about Boulder,” said Ben Molk, senior vice president of Fort Worth, Texas-based Crescent Real Estate LLC, which has an office in Denver.

“Crescent’s a firm that tends to invest in high-growth markets where there’s population growth, where we see a lot of dynamic employment,” said Molk, whose company has been involved in Boulder since 2011 and recently acquired a portfolio of properties across three Boulder business parks. “Boulder obviously doesn’t have population growth by choice. A lot of people want to live here; it’s a lifestyle market, it’s a popular place to go to, but they control it pretty tightly. That said, it has a highly educated workforce; it’s very unique in that, and there’s a lot of people that want to be here.

“You talk to the Googles of the world, and they’ll tell you constantly that at various times Boulder is their No. 1 requested location for people transferring, and that’s always incredibly appealing to us.”

Rebecca Arnold, senior vice president for asset management at ScanlanKemperBard Cos., based in Portland, Oregon, hailed Boulder’s “quality of the tenancy here as well as the supply-and-demand metrics that we’ve seen in the market. We have good-quality tenants here, and what we think is a pretty good value play relative to what others are offering in the market.”

Arnold’s company has invested in such properties as the Walnut Business Center and the former Mile High Labs space in Broomfield.

“Boulder is in a strong position,” she said. “We like to see life science-type users in our buildings. We’re not experts in the life-science space. We want to be, but it’s hard.”

Dan Sorrells, director of research for Real Capital Solutions in Louisville, said he is cautiously optimistic that the office market will rebound.

“We’re biding our time because right now we do see a lot of opportunity to emerge, particularly in office,” he said. “That’s where we’re looking to deploy capital more and more.

“Work from home has always been the thing that everyone has been terrified of in office,” Sorrells said, but added that “that’s actually gotten really stable. The worst is done, and now it’s pretty much a status-quo thing.”

Noting that around 20% of people nationally still work from home in the wake of the pandemic, Sorrells said “we believe that will continue to trend down, but it’s never going to go back to the way it was. It was already trending up pre-COVID, It just got ramped up, and now it’s going to slowly fall a bit.

“We believe it’s going to hit bottom around the end of 2025, but it’s going to be very specific to certain markets,” he said. “Not all markets are going to be hit as hard. A lot of the Class A buildings are typically going to do better than the C buildings. The C buildings, a lot of those, are going to become functionally obsolete.”

Arnold noted that the “Boulder demographic seems willing to invest in Class C; outside not so much.”

That’s because many Class C buildings are “not code-compliant,” Molk said. “They don’t have adequate egress. [Governments} can relax the codes to make these projects viable, but I don’t know that that happens.”

The problem for investors, he said, is that “a lot of these buildings are worth less than the land value, and getting from a lot with a building to a lot is expensive. Demolishing an older product actually ends up costing a lot of money. You’ll hear quotes anywhere from $100 to $200 per foot on the actual building itself. So when you’re talking about a 30-story project, that’s pretty meaningful. It’s a very complicated demo process. I don’t think it’s as simple as people think. It’s not just putting a bunch of dynamite in and the thing falls down in a circle in the middle of it.”

Such demolition is extra risky and expensive, he said, “especially if you have tight lot lines in the middle of downtown areas.”

That’s why his company is highly focused on investing in Class AA office space.

“We’re looking at the best product in the best locations in the top submarkets” in any given metropolitan statistical area, Molk said. “Typically those assets are replaced by new AA assets as the product is delivered. The reality is, given the trouble in the financing world, those products aren’t coming on line and new construction is not penciling. When rents aren’t moving at a meaningful rate and costs go up and debt goes up in terms of capital, those projects are put on pause. Your AA projects are staying newer longer. 

“The one thing that Boulder does have to resolve is one of the bigger issues that has faced a lot of the tech-heavy markets, and Boulder’s certainly one of those, is that a lot of the tech companies did very defensive leasing,” Molk said. “They took down more square footage than they needed in anticipation of growth, and now that square footage is coming back on the market, and that tends to be very good building. We’re certainly seeing some of that in the Boulder market. It’s not as prevalent as what we’re seeing in, like, Austin or Nashville because Boulder makes it very hard to build. So I think these tech companies would have delivered a massive amount of square footage, but Boulder’s policy protected it.

“So from my perspective, I think that Boulder doesn’t have an ‘overbuilt’ problem. Boulder’s still a highly desirable market. I think that we won’t see quite as much pain there as we’re seeing in other areas. If you look at the uptown market in Denver, that’s a disaster. A lot of Class C space, functionally obsolete. It’s really problematic.

“Boulder has protected itself with its constraint of not allowing as much overbuilding,” Molk said, “and I think that because of that, Boulder is better suited to weather the storm.”

Getting loans to buy those buildings can be challenging, however, all the panelists agreed.

“Financing has been tough, generally,” Arnold said, “and frankly we’ve had a lot of luck recently with sellers willing to finance. That’s been a nice, helpful thing to get us purchase prices that sellers want to see.”

Although acknowledging the difficulty in obtaining financing, Sorrells said that “over our history, we’ve maintained a very good relationship with 19 or 20 banks that we work with and one of the big investment banks as well.”

Referring to Marcel Arsenault, founder of Real Capital Solutions, Sorrel added that “we also have a CEO who is very unusual in that he’s willing to put up a personal guarantee on loans. That helps bring down the rate and helps get the loan in many cases.”

Overall, he said, “as rates come down, as the recovery occurs, banks will come back. Despite that, it’s still been difficult to get loans.”

One challenge Molk’s firm has, he said, is that “we’re not able to exit at the rates we’d like, so we’re holding assets longer. That’s typical, but a byproduct of that is that investors aren’t getting their capital back. So capital is staying invested longer in the vehicle. And that means that fundraising is challenging.”

Sorrells predicted that 2025 “should be a decent year. What goes beyond 2025 is where it starts to get interesting.

“A recession would be bad news and good news,” he said, “because rates could come down even further.”

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