Older office buildings could still show some life

Opportunities abound for older office buildings to improve their standing despite new headwinds generated by the coronavirus pandemic and struggles that predate its outbreak.  

Researchers at commercial real estate service firms and brokers acknowledge improving these spaces’ standing in the market isn’t easy. But they said older assets could succeed with upgrades informed by a property’s standing in its market.

“I think there is an opportunity to repurpose. But the question is how? How much are you talking about? How many buildings are sort of on that precipice of needing a next life?” said Owen Rouse, vice president of investment sales and brokerage at MacKenzie Commercial Real Estate Services.

A report titled Obsolesce Equals Opportunity, issued in February by commercial real estate services firm Cushman & Wakefield, highlighted obstacles researchers anticipate bedeviling the office sector through the next decade.  

A substantial imbalance between supply and demand ranks at the top of those tests. Nationwide office inventory is expected to reach 5.68 billion square feet by 2029. According to the report, the primary catalyst for that imbalance is the rise of the so-called “hybrid workforce.”

As more employees split work hours between home and office, demand for space is projected to drop to 4.61 billion square feet through the same period.

That decline in demand is expected to cause 55% higher vacancy in the office sector compared to pre-pandemic levels, according to the report. The oldest office buildings, which comprise 25% of office stock, are forecast to feel that pain most acutely.

Additionally, the flight-to-quality trend, a factor before the pandemic, is anticipated to continue pushing tenants from older buildings into newer assets.    

The persistence of that trend is reflected in the performance of trophy and Class A assets since 2020. Top flight properties experienced 100 million square feet in positive absorption while older properties lost tenants.

In Baltimore, commercial real estate services firm JLL’s most recent market report found leasing activity at top-rated office properties along the waterfront spurred “a post-pandemic record-breaking quarter for leasing activity.”

While at the same time, the Baltimore city market as a whole, and its central business district, experienced climbing vacancy, according to JLL.

The city posted negative net absorption of roughly 263,000 square feet, and total vacancy topped 20% last year. At the same time, the central business district recorded a negative net absorption of nearly 87,000 square feet and a total vacancy of about 23%.

Danielle Grimelli, Cushman & Wakefield’s senior research analyst in the Baltimore region, also said flight to quality remains a significant factor impacting local office leasing.

“Post pandemic … it’s over 60% that we’re leaning toward Class A space being leased in comparison to Class B. So definitely seeing that flight to quality, and at the same time, the challenge remains that we’ve had shrinking floor plates because of right-sizing,”  Grimelli said.

Despite all the challenges, Cushman & Wakefield’s report found reasons for optimism about the office sector, including older properties.  

“Just as retail didn’t die in the years following the e-commerce boom, the office sector is not in danger of demise,” according to the report.  

However, to stay competitive, Abby Corbett, Cushman & Wakefield’s head of investor insight and an author of the report, said older property owners need to make deliberate capital investments.

Updates predating COVID-19, such as amenity spaces, improved common areas, and elevator upgrades, are popular ways for building owners to upgrade their property. Owners also need to consider investing in upgrades that have surged in popularity since the pandemic, such as state-of-the-art conference centers that reduce tenants’ footprints along with spec or turnkey office suites.

Yet those investments must be well thought out regarding where a property stands in its market and submarket.

“What is your relative performance, and then where are you within an ecosystem of tenants out there, right? So that’s going to have a big impact on what else out there is happening within the market. And then from there, you can get to asset level, specific asset level considerations, whether that be from a strategic repositioning point of view or repurposing point of view,” Corbett said. “So there’s a lot of options out there, but there’s a lot of challenges that come with all of that.”

At the same time, making capital investments in an older building, particularly one with a history of underperforming, takes work. Rising construction costs and interest rates have significantly increased the cost of improvements.

Rouse said factors that play into deciding to make capital investments given the current economics include debt structure, price and return on investment.

“Are you doing it to save the building, or are you doing it to make it run a little faster and outpace your competition? They’re two different strategies,” he said.