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Scott Trench
Pro Member
  • President of BiggerPockets
  • Denver, CO
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A Bird's-Eye View of CO Commercial Real Estate and It's Prospects

Scott Trench
Pro Member
  • President of BiggerPockets
  • Denver, CO
Posted Apr 26 2016, 13:42

Hi everyone,

I plan to move into the commercial space in a few years as I scale my fledgling multifamily investing. 

It seems to me like I am perfectly positioned to do so, as I see the commercial real estate space, especially here in Denver, CO, as one that has a number of red flags signalling a collapse in prices.

I'd like to get some thoughts on this analysis.

The Good - Market Fundamentals: To kick things off, I think that the most important fundamentals of the CO real estate market - both commercial and residential are strong. People are moving here, are getting good jobs, and seem to want to stick around. This seems to be true for both Denver and the front range as a whole. 

So to caveat everything else that I write in this post, I don't think that folks are going to lose their shirts by investing in this market over the long-term. If you stick around, I think Denver will be a great investment over a decades-long time horizon, and I struggle to see the fundamentals of why people love it here diminishing.

The Bad - Pretty Much Everything Else in the short-medium term makes me think that commercial real estate prices are going to collapse, or at least NOT rise relative to the income they produce:

1) Interest rates - They are super low. This makes it possible to buy commercial property at low cap rates and get away with it in the short-term. When they go up, cap rates will rise, and prices will fall. 

2) Cap rates - They are super low. Obviously tied to interest rates, but also tied to the incredible optimism of commercial investors looking at Denver/front range in general. This means that people are stretching thin and getting super weak returns on cash invested. Those who are leveraged are likely struggling to stay afloat and dependent on rents continuing to increase at record pace.

3) Construction - If you don't want to look up the housing starts and new commercial projects, just drive around town and see the multitude of cranes EVERYWHERE. It's going nuts. Lower Downtown Denver actually had so many new units that rents FELL year over year in one of the hottest parts of town. This newer inventory will compete with existing structures. This incredible rate of new construction is, I think, a backlash from the crash - construction stopped and fell far behind demand, and now it is snapping back and accelerating, kind of like a rubber band.

4) Condos - Many of these newer units are apartment complexes that are ripe to be converted to condos. I believe that we are likely to see some political action that enables this transition over the next year or two. This is really a local Denver and CO thing that the rest of the nation isn't seeing to our extent. When that happens, there will be a flood of affordable condos into the market, and that will result volatility in the prices of Denver real estate that will trickle across the state. I think that volatility will be very bad news for those highly leveraged on commercial real estate purchased in the past few years.

5) Dumb Money - It seems like an awful lot of private money is pouring into funds these days, and I'm seeing a lot of folks that are my age (25) or just a few years older purchasing huge amounts of commercial real estate with these private funds. I think that the precedent for this was set over the past 6 years after the crash when anyone COULD make money. 

Now that the market is tough, any rich kid who claims to talk about real estate is able to raise significant amounts of money and use it to buy commercial, which I think a lot of folks view as a stable, well-collateralized investment. I think that with all this dumb money pouring in, especially from out of state investors, and with young, inexperienced kids my age levering up, that we are going to see some big mistakes and some rapid exits. 

Too much money, not enough experience, and an incredibly tough set of market conditions seems to me to be a very precarious position. I think that a lot of commercial management companies, and their investors, are in a position to lose their shirts over the next few years.

Conclusion:

I think that I'm buying small multifamilies which of course will be impacted by these commercial factors, but to a far lesser extent than the true commercial property being run by out of state fund people. I think a conservatively managed small-time portfolio is likely to do just fine over the long-run here in Denver.

I think that over the next 3-5 years, there will be plenty of opportunity for me to get great deals from folks that are overconfidently overextending and out of their territory. I think that Denver investors should plan to transition into commercial when the factors above result in either a tanking market, or at least price stagnation that results in steadily rising cap rates.

I'm very optimistic right now :).

But, we'll have to wait and see. 

Would love some thoughts from other local Denver investors - espeically commercial ones. Or anyone nationwide really - I bet a lot of these trends might be popping up in other major markets across the country.

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