About 30% of Denver’s downtown office space is vacant — and that doesn’t include “zombie buildings”

Call Marcel Arsenault didn’t mince words at this week’s Colorado Business Economic Summit.

The real estate investor said he’d dumped many of his office holdings by last year as the values seemed unsustainable and interest rates shot up, amid other depressing trends. But he held on to strong clients like Amazon, who “would pay their leases.” Recession is on the way, he said during Monday’s event in Denver that is organized by the Leeds School of Business at the University of Colorado..

“We all got the memo on office so most of us know that office is a four-letter word,” said Arsenault, CEO and founder of Real Capital Solutions, a real estate investment firm in Louisville.  

Marcel Arsenault, CEO and founder of Real Capital Solutions, a real estate investment firm in Louisville. (Tamara Chuang, The Colorado Sun)

The Denver office market continues to struggle more than three years after office workers headed home to work remotely. While some employers now require folks to show their faces on site, the data points to many companies cutting back on how much space they still rent. 

Arsenault, speaking during the hot-topic session on commercial real estate, shared a chart showing a blue line shooting upwards with a red line close behind. The blue represented the substantial increase in subleasing in the Denver-Boulder market since 2020, as tenants in long-term leases downsized and tried to recover rent by finding others to take over leases. 

As workers went home to work remotely in the pandemic, companies began downsizing their office spaces and put a lot on the sublease market. Subleases are no longer growing, but vacancies are, which points to a really bad office market, said Real Capital Solutions CEO Marcel Arsenault, a speaker at the Colorado Business Economic Summit in Denver on Dec. 4, 2023. (Chart used with permission from Real Capital Solutions.)

But now, subleasing is past its peak and that’s contributing to an even higher overall vacancy rate. Add in other factors, such as fewer out-of-state companies looking for space in Denver, and another 2.1-million square feet of office space in the pipeline and the prognosis for next year is bleak.

“Even without a recession, we believe the vacancy will go up,” Arsenault said. “And if you go back to the last recession, the Great Recession, (the rising vacancies trend) is already much worse now than it was in the Great Recession. So it ain’t good.” 

In the third quarter, office vacancy rates in downtown Denver hit a high of 30.6% in the third quarter, the first time it’s been above 30% since 2000, according to real estate brokerage firm CBRE. The overall Denver metro area saw office vacancy rates increase to 22.8%, up 110 basis points from the second quarter and 220 basis points from a year ago. 

Remote workers and zombie buildings

As business recovered from the disruptive pandemic, the real estate industry was already anticipating a new type of office environment. Creating hybrid spaces that required less space and fewer desks but provided more shared conference rooms for in-person meetings became the fashion. But last year, companies from Amazon to Tesla began instituting return-to-office policies because they said there was lack of engagement. 

Since 2022, the percentage of full-time workers who are completely remote has dropped and stabilized around 20%, Real Capital Solutions Director of Research Dan Sorrells said. Meanwhile, the percentage of hybrid workers has been rising, now between 40% and 45%, and may also stabilize. 

In industries where in-person work isn’t absolutely necessary, including arts and entertainment, finance, professional business services and real estate, fully in-person workers make up 30 to 40% of the total, and more people work hybrid, Sorrells said.

An empty list of retail space in front of the Denver City Center buildings on 17th Street, Dec. 6, 2023, in downtown. (Hugh Carey, The Colorado Sun)

But whether companies have adopted a remote or hybrid workforce, or have seen business suffer due to the economic decline, that’s created other issues, like  ‘zombie buildings,’ or office properties that are leased but aren’t being utilized, said Carl Koelbel, chief operating officer at developer Koelbel & Company.

“We’re seeing office buildings that are effectively worth their land price,” he said.

Higher vacancy rates are contributing to the development of new projects. These days, Koelbel said, banks are asking for more liquidity, which is something he’d never dealt with before. 

“There are some asset classes that are just not possible (for us) right now and office is certainly one of them,” Koelbel said. “I think construction financing is going to be a struggle across all asset classes for the next couple of years.” 

Office subleases are expiring

The sublease market is no longer growing — dropping below 6 million square feet in the Denver metro for the first time since December. And that’s kept prices flat. Lease rates were up 1.3% from last year at $32.53 per square foot, although CBRE noted that there’s more behind-the-scenes negotiating going on for free rent or other concessions. There’s still interest in office space. Online gambling company Bet365 took over a 60,000-square-foot sublease in Denver vacated by online stock-trading company Robinhood.

Anthony Albanese, CBRE’s senior vice president, pointed out that there’s still demand, but it’s mainly for the Class A space, which is the newest space with all the amenities. 

“People are painting with too broad of a stroke on ‘the office market’ and it is creating confusion,” Albanese said in an email. “The Denver market has experienced a bifurcation between the struggling Class B and C office product and Class A office product, which is preferred by an increasing number of tenants seeking a ‘flight to quality.’” 

Anthony Albanese, senior vice president with CBRE, at his downtown Denver office. (Olivia Sun, The Colorado Sun via Report for America)

That’s been common in a market like Denver, which seems like it’s been full of skyscraper construction in the years leading up to the pandemic. CBRE’s stats show that the Class A leases for the Denver Metro area were 77% of all transactions in the third quarter, while Class B leases were 23%. In the full year prior, 69% of all leases were Class A, while 29% were Class B through the third quarter.

That said, he added, “Given the increased demand for quality in the face of new construction supply constraints, we expect the Class A office market will continue to experience lower vacancies and increased rental rates as tenants compete for a diminishing number of prime options.”

And yes, he’s seeing a lot of incentives, including “historically high” tenant improvement allowances and free rent to relocate to the newer spaces. Landlords from older Class B buildings are, meanwhile, discounting the rent if they can afford it. Otherwise, those that are “undercapitalized are becoming obsolete.” As for Class C? He predicts those will exit the office space and be redeveloped for another use.

“The investment (of older buildings) into alternative uses presents an opportunity to revitalize our cities and create a more vibrant and diverse environment through all uses that mutually benefit each other, i.e., residential, retail, office, and mixed-use developments,” he said.