Author: Jerry Kempf
When the economy begins to spiral downward, you may hear reports in the news of falling housing starts, increased unemployment, and a reduction in economic output. If this sounds all too familiar, you clearly remember the beginning of our nation’s last recession. How does the economic cycle affect land development and investors? The increase and decrease in land sales is an indicator of a greater picture which is an indicator of the strength of our economy and whether we are in a period of recession, expansion, or somewhere in between.
To determine the present state of the economy and its effect on land sales, we must first understand the business cycle as a whole. These periods can vary considerably in length, but are intertwined in the overall economy.
Peak –The economy is running at full steam. Employment is near or at its highest levels, GDP output is at its upper limit, and income levels are climbing. The economy starts to overheat, and inflation rears its ugly head. This translates to a surplus of land sale activity spurred on by investor confidence. Companies are thriving and therefore expanding, and they are at a better economic strength that allows them to take higher risks. Employment rates are high as well, increasing the need for new housing, retail, industrial, and office buildings.
Recession– The saying “what goes up must come down” applies here. After experiencing a great deal of development, income and employment start to head south. As the prices of goods are slow to change, they will most likely remain near the same level as in the peak period unless it is a lengthy recession. Fewer cars, appliances, homes, and many other items are purchased during a recession, and the return to normal spending levels by consumers can take a while following the official end of a recession. The same occurs with businesses that make cuts on payroll, equipment and facilities. Retail businesses are usually among the first to delay opening new locations while other types of commercial businesses quickly follow. Land sales for retail and all types of commercial development came to a halt for all practical purposes from 2009-2011.
Trough– This period is sometimes referred to as a depression period. Depending upon the length of the trough, this is the time where output and employment are in an inadequate place and where businesses are looking eagerly for the next phase of the cycle to begin. Land sales generally cease to exist by the time the economy hits the bottom of the trough.
Expansion / Recovery – The economy grows once again and moves away from the all-time bottom experienced in the trough. Income, production, and employment all undergo growth and the economic climate is good. The early stages of expansion and recovery allow businesses to acquire empty buildings as they expand. A healthy expansion will result in full absorption of available building supply resulting in land sales for new development to occur.
Where are we now, Colorado?
The recession was finally put behind us starting in 2014 as we experienced a major acceleration. We can confidently say that we have officially entered the economic expansion / recovery period which has resulted in a pickup in land sales and development.
Among the numerous property types, apartment / multifamily building types are typically the initial kind of real estate to require new construction in order to satisfy new demand. Other businesses with larger building requirements such as warehouse, distribution and manufacturing follow multifamily and apartment growth fairly quick. Office buildings are usually the last type of commercial real estate to require new construction to satisfy new demand.
The “cherry on top” for a complete recovery is a major rebound of land sales for industrial and office development since these are a robust indication of a much improved economy for Colorado. Listed below are Q2 2015 observations that indicate a strongly improved market:
- The Denver Industrial market continues to experience strong demand, seeing 627,838 SF of positive absorption in 1Q15.
- Land Sales are up in the Denver metro area. Industrial users are building their own space, since the available supply is of lesser quality.
- Spec building are being fully leased prior to completion. The pent up demand for space has users willing to pay more for new product.
- The Denver Office market experienced another quarter of positive absorption, with a net gain of 92,254 square feet in 2Q 2015.
- An uptick in sublease space has driven the total vacancy rate up to 11.1% from 11.2% in 1Q 2015.
- The Southeast Suburban market is seeing a push in rental rates and activity, since this submarket is not “energy vulnerable”
To the success of Denver, we have several completed or ongoing office developments which include: IMA Insurance at 1747 Wynkoop, the Hines Development located at 1401 Lawrence, and 1900 16th Street. Outside of downtown Denver we have Arrow Electronics (occupied), the Charles Schwab campus (initial building occupied), Mikron Corporation (target occupancy September 2015), Mountain Man Nut and Fruit Co. (target occupancy – 2016), all located in the Southeast Suburban submarket.
There are many variables that indicate the current economic health around the nation, but for experienced commercial real estate professionals in Colorado, one of the strongest indicators to the market’s climate is the volume of land sales that occur, along with the volume of construction activity zoned for commercial buildings.
Denver has recovered strongly from the recession in comparison to other secondary and tertiary cities. Developers, enticed by revenue growth and attractive demands, began to build and develop aggressively which now yields a rapidly growing volume of new construction in the Denver metro area. History shows us that a steep ramp-up in construction typically weakens the market’s fundamentals. Despite this, Denver seems immune to the usual effects of new supply thus far, thanks to a strong local economy that is truly unique to our state.