in Exhibit 4 demonstrates the demand for centrally
located living. The preference to live near work, in
mixed-use environments, is high and increasing and
leading to premium rents in these locations. This is
fueling apartment development that will further accelerate population growth near many downtowns.
Downtown office locations are preferred by young,
talented, tech-savvy entrants to the workforce. In response to this, major tenants such as United Airlines,
Google, and BP (Chicago suburbs to downtown);
UBS (Stamford, CT, to New York City) and Roche
(New Jersey to New York City); and Nektar and Fox
Interactive Media (San Francisco), among others,
have relocated to CBDs.
Some suburbs will adapt to this shift in demand,
particularly those that provide a mix of uses and are
walkable and transit-accessible; suburban town centers, as they are known, are attracting tenants and delivering strong investment performance. These include
areas such as Greenwich, CT, Kendall Square and Harvard Square in Cambridge, MA, and nontransit-served
walkable areas such as Reston Town Center in northern Virginia and Newport Center in Orange County.
Even in such markets as Dallas and Houston, mixed-use, walkable developments are showing strong demand from tenants, as shown in Exhibit 5.
Exhibit 5: Vacancies and Rents in Walkable, Mixed-Use Developments
Town Center Overall Market Rent Premium
Vacancy Vacancy in Town Center
3.4% 16.2% 133.6%
Source: Jones Lang LaSalle Research
The impact of obsolete office buildings will vary by
location. In urban settings, older office buildings
that don’t meet tenant needs are being converted to
apartments or hotels. This trend is most apparent in
downtowns, especially Downtown Manhattan, increasingly in Chicago and Los Angeles, and emerging
in such markets as Philadelphia, Minneapolis, and
Baltimore. These conversions create a more vibrant,
mixed-use environment, which is a boost to the remaining office buildings. Suburban office buildings
are infrequently converted and instead, these buildings put downward pressure on rents.
Office buildings matching tenant needs will remain in high demand. As always, this will lead to
high occupancy and rising rents. New stock will
also be needed, and construction of state-of-the-art
buildings is expected to accelerate before it is justified by overall market fundamentals. And office market analysis will focus on specific segments of the
market. Thoughtful and nimble investors who adapt
to this environment should find attractive investment opportunities. Market-level statistics will show
office with higher vacancy rates and lower returns,
but there will be opportunities for investors to outperform with effective strategies. n
Current office market trends do not mark the end of
office as a major focus for commercial real estate investors, yet they help return real estate to its founding principles—location and space. This shift means
a suburban office building that is inaccessible by
transit and lacks nearby amenities will be increasingly challenged to maintain occupancy and grow rents.
Well-located buildings need to offer spaces that suit
the needs of today’s tenants. Investors still need to
balance the positives (large buildings, diversified
lease rolls, established third-party management) and
negatives (high capex, volatility) that accompany office investments. But along with this balancing act,
investors need to add new screens in their evaluation
of office buildings.
In this environment, obsolescence will be an issue,
as more buildings see lower occupancy and stagnant
or falling rents and underperform as investments.
Rich Kleinman is a Senior Vice President in the Research
and Strategy Group for LaSalle Investment Management.
John Sikaitis is a Senior Vice President in the Research
Group for Jones Lang LaSalle.