The corporate office market is the key economic indicator within the commercial real estate markets. So, with expanding economic figures, many of our investors ask the same question over and over again – Why are their office properties experiencing high vacancy rates while other developers are constructing new space in similar geographic regions?
With the supply of office property in the current market exceeding demand, it may seem counterintuitive that so many new office buildings are under development. Future demand – even if the economy begins to recover – will not change this excessively high vacancy rate. The working population is only growing slightly, and the introduction of new office concepts and sustainable working environments are reducing the amount of office space required for each employee. Additionally, advanced virtual commuting technology has reduced the physical space requirements for many businesses. The office property market has changed from a growth market to a replacement market and may well become a downsizing market in the long term.
Concerning numbers, the already accumulated stock of office properties (vacant or otherwise) is sufficient to meet future demand. Most metropolitan and suburban areas require little to no additional office space. Regarding quality, however, the current stock of office properties does not live up to all current (or future) requirements. This aging of the supply poses a dilemma for many developers and municipal authorities. New office space is needed to maintain the required quality level in the stock, and many regions continue to engage plans for new office developments. Given current market conditions, however, building a new office property will only serve to exacerbate vacancy rates at the lower end of the office market. As the owners of these lower-end or "obsolete" buildings weigh investment options, the repurposing or demolition of these empty office buildings will become more and more attractive. At some point, these older, less attractive office buildings are replaced by transformative uses, re-establishing the quality and type of office product serving the market.
There are many significant challenges in the office market as it undergoes redefined workplaces, technological advances, and structural changes. The focus needs to switch from quantity to quality and from a supply-driven to a demand driven market. This realigned objective requires a different approach from developers to shift the emphasis away from adding new buildings to the current marketplace. Instead, developers and communities maximize value through the demolition, redevelopment, and transformation of existing office properties.
New office space continues to be built primarily because it no longer meets the needs that it once did. Initially, there was demand and an under-supply for traditional office space because of the types of business in operation years ago, but because of technology and its impact on business and how companies use office space, that same traditional office space has now fallen out of favor for something more useful. Office space, traditional-use office space, cannot compete with the wants and needs of fast-growing technology-based companies that do business in an unorthodox manner, and because the way those technology companies conduct business, they do not lease/occupy traditional space. Developers are responding to the wants and needs of these start-up technology companies by building new, more flexible office space. It is a growing trend that is leaving the old behind and ushering in a new type of office space, flex office space. Even in Palm Beach County, much like in San Francisco and other technology hubs, flex office space has become extremely popular. Start-ups need the flexibility but also the usefulness of office space to maximize their business operations.
If space has value and the developer does not want to keep the property then it can be sold. But, if the site is right, depending on its central location to the audience it serves or uses, the property owner can reposition it by renovating or redeveloping the space. Renovating and redeveloping can save a spiraling asset as developers and asset managers salvage aging office space by converting it into a usable product that best serves a dynamically changing market.
Brad Kuskin is the Managing Agent for KW CRECO.