Office space in downtown Boulder has held steady at $25 to $30 per square foot for the past three years, with vacancy rates stuck at 29%. But with businesses still paying for thousands of square feet that sit unused, the picture is murky. The lack of office workers is straining downtown retailers, restaurants and city sales tax revenue, leaving economic developers and business advocates increasingly concerned.
Business owners like Chris Schwalbach, the CEO of a financial consulting firm, are moving out of their downtown office spaces because of remote work and costs. Instead of having an office, his team will work remotely and rent space when they need to get together.
“Our building expenses were over budget by 40% this year because of inflation and other kinds of wacky incidents. It becomes so prohibitive,” Schwalbach said.
Supply and demand is the economic theory that prices are determined by the relationship between how much of something is available (supply) and how much people want it (demand).
If the theory held true in this situation, downtown Boulder’s commercial office space vacancies would pressure property owners to reduce prices. Yet, that’s not happening and offices are remaining vacant.
City officials are concerned.
“With the vacancy downtown surging to about four times the pre-pandemic average, what’s absent is not just the office space, but it’s the daily foot traffic and the buzz that was defining Boulder,” said Joe Hovancik, vice president of economic vitality at the Boulder Chamber of Commerce.
What factors are keeping prices high?
Many factors are keeping lease rates high in central Boulder, starting with the concentration of ownership by a few local real estate companies.
W.W. Reynolds and Tebo Properties own a significant amount of real estate throughout Colorado, with large holdings in downtown Boulder. Reynolds alone controls approximately 600,000 square feet of downtown space. Much of the property owned by both companies has been held for decades and is likely mortgage-free, giving them the ability to wait out market shifts without pressure to lease or sell quickly.
Industry experts note that this also allows these local owners to work collaboratively with tenants.
“Local groups like Tebo and Reynolds can be more flexible,” said Aaron Evans, a commercial broker with NewOptions Partners.
Tebo Properties’ owner and founder Stephen Tebo confirmed, Evans’ impression. “We’ve adjusted our prices and we’ve adjusted the free rents that we’re giving,” he said. “We are actually now starting to get some of our larger spaces rented. But it’s not without a lot of concessions, to be honest.”
Nine of the 44 offices for lease on the Downtown Boulder website are owned by Tebo Properties, totaling around 35,915 square feet. That’s 7% of the estimated 493,000 square feet of vacant office space in downtown.
The financing terms of mortgaged properties may also be keeping rents artificially high and contributing to the vacancy rates, some city officials and national media investigations say.
A look by Business Insider at vacancies in major metro markets explained that when groups borrow money to buy commercial space, their financing agreements sometime stipulates that their lease rates must be a certain amount. If the owners want to lower rents, it would constitute a default on their loan agreement. This can lead to the the so-called “doom loop,” where empty office space causes a slump in nearby retail activity and a desolate retail landscape makes office buildings less appealing.
“I’ve certainly encountered that over the years, where we start going down the road on a deal, and at some point the landlord says, all right, now look, I’ve got to get this cleared by my lender because due to those clauses in the mortgage itself, they’ve got to be able to say, ‘Yes, you can do this deal, or no, sorry, you can’t do it,’” said Nate Litsey, a commercial real estate broker with Market Real Estate in Boulder.
Chris Melin, director of community banking at First National Bank of Omaha (FNBO) in Boulder, explained that banks don’t influence commercial lease terms: “Banks are not dictating leases for borrowers and landlords. It is simply out of our wheelhouse.”
While banks are not dictating leases, the terms laid out in borrowing agreements can keep rents from dropping. For example, Melin says that borrowing for commercial property from a bank requires that the property’s net operating income must be at least 125% of its annual debt-service obligations. If a lower lease rate would violate the borrowing agreement, owners might not want to reduce the rent.
“Vacancy affects a debt service coverage ratio more negatively than a below-market lease. Some income is usually better than none,” he said, noting that property owners could be holding out for accredited companies to lease their space. “If you have a high-quality tech tenant that’s going to be in there for 10 years, a credit tenant where they’re not occupying the space, but technically they’re under lease, they’re still going to pay that payment. Not every tenant is of that quality. And so landlords have to manage that risk.”
Waiting for less risky tenants can take time, Litsey said, but some owners and investors can wait. “Institutional groups, they’re playing the long game of property appreciation.”
Institutional investors can wait it out
Both Evans and Litsey say that institutional investors play a role in the vacancies. “In the last 20 years, corporate Wall Street has come into Boulder in a big way and bought up a lot of real estate, especially downtown,” Litsey said. “It doesn’t make any sense at all, but they would rather have 20 to 30% sitting there vacant…rather than do a deal at half of their rate because it devalues the building.”
Evans summarizes the approach: “Their game is to try to hold property for five or seven years, flip it to the next guy, get out and make your investors that return.”
Some examples of downtown buildings owned by institutional investors are 1050 Walnut, 1900 15th St and the Canyon Center buildings. Clarion Partners bought the portfolio of properties from JP Morgan, which bought them from Blackstone, the Colorado Real Estate Journal reported in 2020.
These buildings total 235,316 square feet. Of that total, 20,226 square feet in the Canyon Center is listed for lease on the Downtown Boulder website.
Yet, the amount of space listed for lease doesn’t provide the full picture of the real estate that is vacant. On a recent visit to 1050 Walnut, the entire fifth floor was empty, though maintenance workers said the space is regularly cleaned because it is currently leased.
“The vacancy rate is not reflective of how much space is being occupied or used. A lot of space is actually vacant, but companies are still paying rent on it and landlords are collecting that rent. So it’s not reported as being vacant space,” Evans said.
Accounting for the rented, empty space means that the office vacancy rate is higher than what’s reported.
What does the future hold?
Schwalbech thinks that lease expirations might change the equation. “When these leases that started in 2019 start expiring, you’re going to have more and more of these vacancies. And if you have more vacancies … then the values of the buildings go down and maybe it all comes back.”
People like Hovancik, from the Boulder Chamber, aren’t waiting for vacancies to fix things: “I don’t think the market is going to fix this.”
In the absence of market solutions, the Chamber is taking action. The organization is working with members of the business community to find ways to get companies into office space.
“How do we proactively market Boulder as a business destination, that we’re open for business and that we’re easy to do business with?” Hovancik wonders. “That’s something that the economic development arm at the chamber is taking on and engaging with all our partners out there. It’s really about analyzing our existing office spaces and then what type of companies would fill those office spaces.”
The Chamber established a task force to focus on business recruiting, permitting and adaptive reuse, and they have joined forces with the Commercial Brokers of Boulder advocacy group to strengthen support of businesses and property owners. “We have this brain trust of leaders that we’re talking to every couple of months in order to see how we create better momentum,” Hovancik said.
In the meantime, offices sit vacant and that has an impact on downtown. “Fewer office workers means fewer customers. We have lack of affordable space, which threatens our startup ecosystem, our creatives, our nonprofits. And the downtown experience is challenged by this,” Hovancik said. “It’s not really about the buildings, it’s about community. It’s about connection, it’s about economic momentum.”