Major retrofits and the repurposing of older buildings have become leading trends as urbanism and millennials drive transformative change.
As 2014 winds down, we find the real estate industry in the throes of transformative change thanks to economic recovery and a fast-evolving workforce that continues to redefine corporate space requirements.
For companies with ambitious recruiting and expansion plans — and for real estate owners, developers and investors faced with the pressing need to upgrade older holdings to meet next-generation demand — this is a pivotal time. All stakeholders must focus on positioning themselves for long-term growth, change and competitiveness. The challenge is accentuated by the fact that much of the existing office inventory is antiquated, with decades-old features designed to accommodate a different generation of users who had different priorities and work habits.
Why the sense of urgency? Economic and related real estate recoveries are on track to accelerate over the next 24 months. Already, the office market is gaining solid traction. In the first three quarters of 2014, central business district (CBD) leasing and absorption reached the pre-recession levels of 2008, and overall vacancy fell to its lowest level in five years. Rents are creeping up in hot markets like New York, Chicago and San Francisco. With projections looking positive as we head toward 2015, the demand divide between older and new buildings is growing as tenants seek space that accommodates new workplace models. The questions on many minds are 1) how will older buildings compete and 2) is a bifurcated market emerging in which new towers will ultimately outperform older Class A stock? Here is a look at some of the trends and issues behind this transformative period.
Demographics and Demand
Two well-documented shifts related to human capital are having profound impacts on the office market. First, the sudden rise of urbanism over the last 10 years has resulted in explosive growth in many central urban markets. The exodus of millennials and empty nesters from suburban to urban markets shows no signs of letting up and, in turn, companies are seeking modern space as close as possible to this concentration of intellectual capital. A shortage of modern office product has ramped up competition for Class A space and is triggering new office development cycles.
Second, the labor pool is shrinking as baby boomers retire. By 2022, millennials — who today represent a much smaller population of workers — will make up more than 40 percent of the workforce.
Such influences are converging and are major reasons why companies are moving quickly to position themselves to compete for talent in central urban markets. Senior managers know that in order to attract and retain a millennial-based workforce they must offer updated workplaces that support collaboration and offer ample lifestyle amenities. Today’s custom-designed environments provide lots of light and fresh air, supporting employee work habits with both open and private work areas. Never before have workplaces played a more important role in reinforcing brand, culture, employee morale, productivity, corporate social responsibility and retention/recruiting objectives.
New efficiencies are also being delivered and, as always, cost control remains a priority. As labor costs rise, companies will work to lower other major line items — including real estate, effectively switching focus from cost per square foot to cost per seat. To that end, and also because of changed work habits that have rendered large offices unnecessary, average square footage per employee continues to decrease.
There are many examples of firms growing with less space, but one major accounting firm comes to mind. It reduced its space at a premier Class A office tower by 22 percent and incorporated a “virtual office” hoteling concept. This enabled it to increase its head count by 36 percent and support its larger staff in just 75 square feet per employee.
Aging Inventory, Modern Environment
The majority — 82 percent — of Class A office buildings in U.S. CBDs were constructed prior to 1990, and 53 percent were built before 1980. Can yesterday’s buildings support today’s workplaces? The answer, in most cases, is no, which raises the question: What can be done with that product? In a growing number of cases, owners are extensively retrofitting buildings and/or converting them to other uses. Others are being taken down altogether and rebuilt to suit the needs of specific tenants.
Within these projects, the traditional layout of cubicle farms surrounded by corner offices is disappearing in favor of open architecture and collaborative work areas. Formal glass and steel finishes are being replaced with exposed brick and timber. Technology and systems are being upgraded to the latest, fastest and most efficient standards.
New office designs are also blurring the lines between work and play. When it comes to lifestyle amenities, companies are incorporating bars, game rooms, rooftop gardens, gyms and more. It all comes down to corporate branding and the fight for talent. Adobe, which focuses on giving employees an “awesome experience,” is a well-known leader in this area. Its major sites incorporate bistro restaurants, locker rooms, basketball courts, fitness classes, dental and other health care facilities, hair stylists, dry cleaning and ATMs.
Some of these more “extreme” lifestyle amenities may stay within the technology industry and creative sectors. However, even law, financial services and insurance firms are being influenced by new workspace trends. While there may never be a pingpong table in the break room at a large law practice, we are seeing more open floor plans and collaborative areas, as well as careful consideration of locations near areas with amenities and urban context. Again, all of these shifts are aimed at attracting and retaining younger professionals.
CBD Renovations on the Rise
As more companies buy into updated workplace models, renovations to older buildings have skyrocketed. In New York City during 2013 and 2014, 24 buildings totaling 8.3 million square feet were or are being renovated. This compares to nine new construction projects totaling 7.5 million square feet that were built during the same period.
The burgeoning Midtown South submarket, which is home to 10 of these property renovations, is a direct beneficiary of this trend. Long considered a residential part of the city, as well as home to smaller and less traditional office space users, Midtown South is now drawing household-name corporate tenants. The famously quirky office of one of its best-known occupants, Google, serves as a prototype for the office-meets-company-culture movement.
Examples of the renovation/con-version trend in Chicago include 1000 West Fulton (now known as 1K Fulton), a former cold storage building that Sterling Bay is converting to creative office space. (See “Edge Markets Go Mainstream” on page 60.) Nearby, Shorenstein is renovating a 64,000-square-foot former meat packing facility at 210 North Green Street. Shorenstein also recently completed the 1.2-million-square-foot River Point North (formerly the windowless Apparel Center), which caters to tech tenants. In 2013, 3.3 million square feet of space was renovated in Chicago and, as of late 2014, an additional 735,000 square feet of space is under renovation/conversion.
In San Francisco in the last two years alone, more than 3.1 million square feet of space has been renovated and upgraded to meet the demands of the region’s robust tech growth. Shorenstein’s 2012 renovation of the former Furniture Mart, which became the home of Twitter, helped gentrify the Mid-Market area and attracted additional tech companies, including Yammer, One King’s Lane, Square and Uber. Another noteworthy renovation involved the transformation of 680 Folsom from a vacant former PacBell building into the home of Macys.com and Riverbed Technologies.
Not Just an Urban Phenomenon
The renovation craze is not confined to central urban markets. In fact, the country’s suburban markets — particularly those outside major urban hubs — are home to some of the most creative property reinventions. These projects are bringing urban lifestyle amenities to non-CBD markets.
San Francisco’s 425 Market Street interiors exemplify the contemporary design and communal gathering spaces that appeal to today’s office tenants.
In New Jersey, corporate downsizing, aging inventory and the growing popularity of new workplaces have left sprawling suburban campuses vacant or struggling. At the same time, however, many are finding new life as mixed-use, “live, work, play” environments. A great example is the 472-acre, 1.8 million-square-foot former Bell Labs research facility in Holmdel, where Somerset Development is planning an indoor “town center” featuring a pedestrian promenade and a blend of uses. Foremost in the plan is a health and wellness component, including an ambulatory surgery center, doctors’ offices and assisted living and skilled nursing facilities. The balance of the space is being marketed to include retail and dining outlets, office space, a hotel and conference center, educational facilities and an upscale spa.
Across the country in El Segundo, California, Pacific Corporate Towers is a 1.6-million-square-foot, three- building office complex. A recently completed renovation positioned the 1970’s-era property as a lifestyle-rich, multitenant campus. The ownership, an investment management client of BlackRock, converted indoor and outdoor areas into lively communal gathering spaces with a contemporary design aesthetic. This included the addition of breakout rooms with lounge seating, flat screens and high-top tables, as well as outdoor decks with heaters for seasonal comfort and electrical outlets for computer use. New outdoor recreational amenities include bicycles, a pingpong table and an outdoor exercise area adjacent to a full-service gym. Today, the complex is home to a community of 80 tenants ranging from creative start-ups to Fortune 500 companies.
In the Chicago suburb of Northfield, Kraft Foods Group wanted to create an open workspace that would spark innovation and reflect its “startup” spirit following the company’s launch as a new, independent Kraft in October 2012. Renovation of its 715,000-square-foot, 88-acre suburban campus eliminated private offices and incorporated a new collaborative office layout. The company added amenities like shuttle service, massages, retail, health care and pet care. Kraft has proudly exceeded its talent and recruiting objectives.
America’s tallest building, the 104-story, 3 million-square-foot One World Trade Center, offers smaller buildouts to attract smaller creative office tenants as well as space for larger tenants. The building is 62 percent leased to Condé Nast, Vantone China Center and the U.S. General Services Administration.
In Silicon Valley, Google is using innovative ways to retain and attract talent to the suburbs while competing directly with tech companies expanding in San Francisco’s urban hot spots. The company transformed a more traditional 525,000-square-foot, four-building campus into a mini-urban environment known as “the Googleplex,” a 2.3 million-square-foot campus that now spans a large portion of Mountain View. In addition to providing a dense concentration of complimentary amenities, Google is pioneering a “version 2.0” of the live, work, play concept. Cutting-edge flexible internal space is supplemented with outdoor cafeterias that serve food prepared by renowned chefs, organic gardens, sporting venues, sculpture parks, fitness facilities, massage rooms and even sleeping quarters known as “nap pods.”
Google is also tackling one of the broader challenges many suburban areas face: undersupplied mass transit. In addition to providing bikes that workers can use to navigate the sprawling campus, the company offers electric car charging stations and Google buses equipped with Wi-Fi and workstations to foster a working environment while employees commute from San Francisco and Oakland. Google continues to think ahead of the curve, acquiring additional property rumored to be as diverse as corporate housing to offset the lack of affordable housing near the campus. The functionality of real estate at the Googleplex is an essential element in the company’s plan to “captivate” employees, elevating their standard of living by blurring traditional work/life barriers and dwarfing a typical employer’s competitive advantage.
Simply put, retrofit activity in both urban centers and suburbs responds directly to demographic and technological change. It is happening in places where the people who make up the evolving labor pool want to live and work. How developers respond will have a direct impact on asset pricing and value. In turn, the investment community will be paying increasingly close attention to these shifts. Investors are already altering allocations for certain markets and property types. In the short term, this will translate into some fairly notable transformations. As for the long-term outlook, it is safe to say that this is not a passing phase and that these trends will continue to redefine the office real estate landscape for the next 10 years or more.