Denver, like many large cities, continues to struggle with a lot of unoccupied office space. But the city may soon have to cope with a different kind of surplus — apartments.
“There will be a knife fight for tenants over the next 24 months,” predicted Andy Hellman, a senior vice president with CBRE, speaking at the Commercial Real Estate Symposium and Forecast Panels hosted Wednesday morning by the Denver Commercial Association of Realtors.
About 46,000 apartments are under construction in metro Denver, while another 75,000 are in the pipeline, according to estimates this summer from Apartment Insights, which closely tracks the multifamily market.
Competition to fill those new units will keep a check on rents, or even send them lower, especially if the economy slows down. But the reprieve for apartment renters isn’t expected to last long, at least compared to what office tenants face.
High vacancy rates could plague the office market for years because of the shift to remote work and reduced demand for space. Repurposing some of the city’s largest skyscrapers to other uses, like residential, could take years.
The apartment market in Denver, by contrast, could quickly swing from surplus to shortages in the second half of this decade.
“Short-term we will see a softening. Long-term another conversation is to be had,” Hellman said.
That’s because most of the multifamily projects now underway were assembled before interest rates spiked and before Denver’s inclusionary housing ordinance took effect in the middle of last year.
“Behind the next supply, new projects have come to a screeching halt,” said Marty Roth, a senior vice president with CBRE specializing in land services.
Denver had around 24,000 new apartment applications in the first and second quarters of 2022, Roth said. But in the second quarter of this year, applications for only 70 units were submitted.
The surge in the first half of 2022 was off the chart as developers rushed to get ahead of Denver’s new inclusionary housing ordinance, which requires developers of 10 or more units to set aside between 8% to 12% of all units built as affordable for a period of 99 years.
Developers who don’t want to add affordable units can pay a fee ranging from $250,000 to $478,000 per unit depending on a building’s location and the kind of units being built.
Higher interest rates explain some of the declines in applications, which are at their lowest level since 2011 when the country was crawling out from the housing bust. Creditors and investors are simply much less willing to fund new construction of any kind. And even if financing can be arranged, the costs are often too high.
But Denver’s decline in multifamily applications is more extreme than that seen in surrounding cities, which suggests the new ordinance could be deterring new projects.
That matters, because Denver alone accounted for about half the new apartments built in the metro region since 2010, and the region remains 100,000 housing units short of what is needed based on population estimates, said Mike Kboudi, an executive managing director with Cushman and Wakefield.
Any kind of disruption to the flow of new housing supply, which has failed to keep up with demand for the past decade, carries severe consequences in a market where home prices and rents are already elevated, Kboudi said.
“We need more supply for pricing to come down,” Kboudi said.
The median price of a single-family home sold last month in metro Denver was $650,000, according to the Denver Metro Association of Realtors. Denver is one of the most expensive housing markets not located in a coastal area.
Brokers expect apartment construction to shift from Denver to the suburbs, pushing up rents in the urban core. Once rents there get high enough, developers can clear the added costs associated with Denver’s new affordable housing requirements and start building again.
Delays in obtaining entitlements and other government approvals remain ongoing headwinds, brokers said.
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Commercial projects that can generate tax revenues for a local government have received approval within six months. But residential platting, an early step for building homes and apartments, can take 3.5 years, said Kboudi.
An emerging area of concern, one that has received less attention, is the strain on the electric grid and the difficulty that utilities are facing in supplying enough power in a timely manner to new developments, said Jessica Ostermick, a senior vice president with CBRE specializing in industrial properties.
A few years ago, a lack of trailer parking was a big hurdle for industrial construction, which enjoyed a boom during the pandemic. Now, the problem is getting enough electricity.
“It is killing deals,” she said. “Power will become more and more of the conversation.”
The problem isn’t just about supplying energy-intensive manufacturing plants, which are becoming more common as more production returns to U.S. shores, but includes connecting new apartments and even small restaurants.
Ostermick noted that construction of industrial space, which has been the bright spot in commercial real estate, has “fallen off a cliff” with starts down 80% this year compared to the peak seen in 2021. Huge demand from e-commerce companies for distribution centers, combined with a desire by firms for more warehouse space to get ahead of supply chain disruptions, drove the surge.
Glenn Mueller, a real estate professor at the University of Denver, estimates that metro Denver’s office market has entered a recession, while the apartment and industrial markets are in the early stages of “hypersupply” which leads to a recession. Retail real estate and hotels are still expanding.
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