NGKF: Office Obsolescence and Opportunities

Roughly one-fifth of suburban U.S. office space is at least somewhat obselete, reported Newmark Grubb Knight Frank, New York. 

“Based on a study of five representative suburban submarkets from coast to coast we conclude that 14 percent to 22 percent of the suburban inventory is in some stage of obsolescence,” Gregory Leisch and Sandy Paul said in Suburban Office Obsolescence: Quantifying Challenges and Opportunities, a new report from NGKF. 

Leisch is NGKF’s senior managing director of market research while Paul serves as managing director of national market research for the real estate services firm. 

Leisch and Paul calculated that if more than 20 percent of suburban inventory is obsolete, that suggests that up to 1 billion square feet in the 50 largest U.S. metros is not competitive in today’s market, equivalent to 7.5 percent of the entire U.S. office inventory.

“Obsolescence of office space is a natural process, underway since modern office buildings were introduced in the Nineteenth Century,” the report said. “However, this process has accelerated in the Twenty-first Century due to rapid changes in the way tenants use office space, in part brought about by technology and changes in the organizational structure of the office environment and accelerated further by economic considerations coming out of the Great Recession.”

Paul and Leisch identified six factors that lead to office space obsolescence, amenities, age, parking, location, floor plate size and building size. “We believe that curable factors include amenities, age–via renovation–and parking,” the report said. “Incurable factors–or at least incurable without massive expense–include location, floor plate size and building size.”

For owners and investors, NGKF suggests determining where the property falls on the “obsolescence spectrum” and learning more about its tenant base. “If there is some feature of your property that is less than ideal for the broader market, is there a unique tenant type that might better fit the product you are offering?,” the report said.

Then, assess the property’s curable obsolescence factors. Is there some amenity or improvement most tenants seek? Since it generally costs less to renew current tenants than to market space, negotiate new leases and fund concessions to retain current tenants and then pursue improvements that will pay off in the long run.

“If your property is incurably obsolete, consider the highest and best use of the property,” the report said. “Do market fundamentals in your area support re-purposing to residential or retail, or to some form of a mixed-use development? In some cases and in some markets, the land may be more valuable than the existing improved asset.”

Once the owner or investor determines the business case for completing a renovation, they should examine economic trends to determine ideal timing for renovating the building, NGKF said. The firm forecasts an overall office tightening in coming years with a peak U.S. landlord market in 2017 and 2018.