The supply imbalance in the office market has been stark the last few years, but panelists at NAIOP’s CRE.Converge conference this week identified bright spots and emphasized the possibilities for creative investors.
Rich Gottlieb, president and COO, Keystone Development & Investment, moderated the panel that featured John Weidner, AIA, NCARB, LEED AP, principal, Global Media Practice Area Leader, Gensler; Adam Showalter, managing director at Stream Realty Partners; and Connor Greissing, founder and managing principal, Brick Row.
Showalter said he hoped to “talk about some green shoots in office and not just a bunch of crabgrass.”
“There’s been a pretty big supply and demand imbalance over the last four years,” Showalter acknowledged, adding that this was exacerbated by the COVID-19 pandemic but has been on the rise for decades as developers took advantage of low interest rates and available land.
“It’s created a structural shift in which most owners of office markets across the country faced some really big challenges, and now it’s been felt by a lot of lenders,” he said.
Showalter said office is facing the same types of disruptions retail did.
“The structural change with this work from home and flexible work schedule is very similar to what e-commerce did to retail two decades ago,” he said. “At the end of the day, we believe that people still need to be together. People still need to converse, have impromptu meetings.”
Weidner said Gensler employees are in the office five days a week.
“It’s a mentorship-based business. You can’t mentor people over a [Microsoft] Teams call,” he said.
Weidner added that as companies lure workers back to the office, landlords are helping, providing multi-use perks that could re-energize urban centers.
Amid the gloom, there are up markets. Greissing said Dallas and Austin are just now starting to experience positive absorption in certain submarkets, with increased demand for 15,000-square-foot or smaller spaces.
“It’s tenants that are rightsizing, looking for make-ready space,” Greissing said. “Or they’re upgrading their space to a better-quality asset or better neighborhood, just taking a smaller footprint.”
Weidner said he’s seeing loyal clients happy with how they’re treated who stick with developers but reduce square footage. He gave his own company as an example.
“Our Los Angeles office continued to grow, even during COVID-19. When our staff count ramped up, we were doing a one-for-one seating. We realized that instead of taking more space and leasing it, we reset our thoughts and our process on how we work, and that has enabled us to accommodate the quantity of staff that we need to in less square footage.”
Showalter said while much of the market is down, trophy offices are enjoying their lowest vacancy rates on record and they’re achieving the highest rents on record, which could lead to positive forecasts for the future. Tenants who can’t get into the trophy space because it’s unavailable or unaffordable may start looking at the next tier of office space.
“I think it’s just taking a lot longer than any of us, maybe in this room and outside of this room, wanted it to take,” he said.
Weidner said in Los Angeles, companies are pushing out of downtown and to the coast.
“We’re starting to see a little bit of energy behind buying properties that maybe have been out of reach a couple of years ago that are now starting to be tangible in terms of cost,” he said.
Gottlieb explained the rent math.
“Tenants are affording these trophy buildings that are so highly priced because they’re making the easy leap that they used to have 100,000 feet, and now they need 50,000 feet, so they can easily afford to pay 40% more per square foot.They’re still saving money.”
Gottlieb said he’s seeing a trend in Philadelphia where companies will sign a lease but then realize they can’t get by on less space.
“Now these people are calling and saying, I want an office, or I want my space, and I’m not sharing it with everybody.”
Weidner said he’s seeing a need for “me space” combined with other flexible spaces starting to drive people back to the workplace.
Greissing said developers need to consider more than just the workspace. “That doesn’t mean that everything needs to have whiskey lockers and golf simulators.”
He said it’s not just what’s inside of the four walls, it’s the tenant engagement and experience. He cited a recent office project with concierge-level property management providing perks like live music, trivia nights, yoga and a coffee shop that flips to serving cocktails in the evening.
Showalter suggested a solution for oversupply many aren’t ready for: demolition.
“Oversupply is really, in my opinion, underdemolished,” he said. “I sit in Chicago, and we are definitely underdemolished there, and we’re underconverted.”
Gottlieb cautioned against demolition unless developers have a use for the land lined up. But conversions aren’t easy. Keystone is working on four projects converting office to multifamily.
“It’s the hardest thing we’ve ever done,” Gottlieb said. “It should be easy, and it’s the opposite… but we’re taking office space off the market, which is a good thing.”
Showalter said conversions are focused on risk.
“Whether it’s cost, whether it’s what’s behind the walls of this old building, whether it’s zoning, whether it’s market demand… there are a lot of unknowns and a lot of risks for us, where you’re better off knocking the building down and building a new one, or you’re better off going to a more mixed-use residential environment.”
This post is brought to you by JLL, the social media and conference blog sponsor of NAIOP’s CRE.Converge 2024. Learn more about JLL at www.us.jll.com or www.jll.ca.
