Best Places for Commercial Real Estate Investments: Office Sector

In place of new construction, numerous renovations, retrofits, and upgrades have been noted, as owners work to attract tenants to their properties with enhanced efficiencies, reduced costs, and a lighter carbon footprint. The recently published Emerging Trends in Real Estate 2013, from PwC and ULI notes that “‘hard-to-retrofit’ (older) buildings, including some ten- and twenty-year-old vintage towers (could become) increasingly obsolete.” Observant office building owners are always noting where renovation will boost the bottom line. In Chicago, the famous Rookery building—built in 1888 as one of the first skyscrapers—has been renovated three times, including once in the last five years. In addition, the Wrigley Building, built in 1924, was renovated with new infrastructure and flexible floor plates in 2013.

Technology and Demographics in Office Market

Office markets have undergone dramatic changes in recent years, as developments in technology and workforce demographics have driven the demand for, and the use of, office space. Ironically, this is not anything new. Office space has been evolving with technology and demographics from the time Burnham and Root and Louis Sullivan built their first “skyscrapers” in the Chicago Loop 125 years ago. It is a fact of life in the office market that change happens.  The difference, today, is that change happens at an increasing rate. And, the nature and pace of change is important in the way we approach office markets going forward.

In the office environment, over time, we have transitioned from steno-pools and banks of typewriters, to teletypes, to faxes, to email and DocuSign®. Law libraries are today decorative, with the real research now managed through online databases, such as LexisNexis® or Westlaw, and other realms of the Internet. Filing cabinets—rooms and rooms of them—have been reduced to an online, virtual “cloud.” Even telephones, at least the hard-wired, landline variety, are beginning to disappear—with one research study suggesting that up to 40 percent of knowledge workers will have abandoned their desk telephones by the end of 2013. 

As employers confront these technological and demographic changes, they are recognizing enormous economic advantages to adjusting the office to meet them. With real estate costs second only to labor in the overall cost of doing business, employers are recreating the office to utilize the space more efficiently and to reduce the amount of floor space required per employee.  One estimate, from Jones Lang LaSalle, suggests that traditional office employers could release as much as 30 percent of their space, with a national average, among all industries and geographies, of about 15 percent.  The JLL study points out that office space requirements have shrunk from an estimated 500 to 700 square feet per employee in the 1970s to a little more than 200 square feet in 2010, and the study projects that the per-employee space allocation could slide to an average of just 50 square feet by 2015.

Although the decline in office space requirements has been underway for several decades, the recent recession helped building owners and their tenants see the light as they redesigned old floor plans to speed productivity, attract young talent, and cut costs. As a result, many major office-leasing employers are cutting back on floor space—even entire floors—while maintaining staffing at essential levels. It is interesting to note that, in some high-value urban centers, such as New York for instance, some older office properties in less than Class A locations are commanding higher rents, as employers—especially technology firms—take up space that is considered nontraditional and “hip.”

Tapping into the tech-savvy, urban-dwelling, Millennial generation, a number of tech firms are paying rents that exceed those being paid in many trophy buildings in Midtown and Lower Manhattan. The natural consequence is that traditional landlords are carrying the burden of leasing now-empty space and of offering new tenants the flexibility they require.

What Office Investors Are Looking at and Where

Investors continue to view high quality Class A properties in gateway urban centers—24-hour cities—as highly attractive for an office portfolio. For the most part, these are in the larger metropolitan areas in the country with well-developed office markets in the CBD, in quality suburban areas (e.g., Irving, TX; Denver’s Tech Center; Belleview, WA), or both, that have demonstrated relatively good population and job growth dynamics. Many of the jobs that are created in those cities are tied to technology (still a job creation machine), energy, and banking. Employment growth in the San Francisco area (San Francisco and San Mateo counties) outpaced the nation last year, for instance, with job gains exceeding 4 percent. San Francisco is among the top tier of cities in which a solid mix of job-creating industries is concentrated.

Other Pacific Coast cities, including Seattle and Portland, also exhibit high concentrations of job-creating industries, driven in large part by technology. As a recent Forbes article by Joel Kotkin and Mark Schillreminds us, “no place on the planet can boast so many top-line tech firms: Amazon and Microsoft in the Seattle area, and in the Bay Area, Intel, Apple, Facebook and Google, among others.” Other metropolitan areas, including Washington, DC, with its still-substantial government employment base (despite sequester) and growing financial services and technology sectors, and Houston, with its enormous energy sector and export machine, promise to be near the top of any list for investment—and not just in the office sector.

Figure 2.7. 20 Best Large Cities (Population over 450,000) for Job Growth in 2013

A number of advisory firms (Jones Lang LaSalle, Integra Realty Resources, and Dividend Capital, for instance) regularly offer their take on commercial property performance and where various geographic markets stand in the real estate cycle for the several property segments. Recent releases are remarkably similar in their view of recovering, expanding or slowing and declining markets. Generally speaking, Office, both CBD and suburban, is viewed as being in the very early stages of recovery, with occupancies still below long term averages and rent growth still at or below inflation. Strong CBD markets with asking rents rising more than 1.5 percent in the second quarter of 2013 (according to JLL) include, especially, New York, San Francisco, Los Angeles, Seattle. Strong suburban markets with rent gains of about 1 percent during the most recent period include the San Francisco MSA, Seattle, Austin and Denver.

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