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Is Office Conversion an Answer?

One solution to the paucity of warehouse space could come from converting unused office buildings, according to a report from the global real estate services firm Newmark.

“The pandemic has only accelerated obsolescence of some older, less-amenitized product,” the company points out. “This divergence among asset classes is increasingly driving investors and developers to consider industrial redevelopment opportunities for some unproductive office properties.” And it’s not all due to Covid 19.

Even before the pandemic caused some office properties to be abandoned during the widespread lockdowns, the need for distribution facilities had already sparked the conversion of other kinds of properties, including retail facilities like shopping malls, department stores and big box stores into warehouses and distribution centers.

Since 2018, at least 45 office properties totaling 11.3 million square feet have been redeveloped or are in the process of redevelopment into industrial use, Newmark points out.

This activity has been predominantly concentrated in markets where density and land constraints are the driving forces that created perennially tight industrial vacancy, it said.

“While office space generally costs significantly more to build than industrial and yields higher rents when occupied, the economics supporting industrial redevelopment in these regions are buoyed by exceptionally strong market fundamentals, particularly when compared to each metro’s office market, where office vacancies are roughly 10 to 18 percentage points higher as of third-quarter 2021.”

Office-to-industrial redevelopment involves a complex scenario, Newmark explains. Being able to identify potential conversion projects could prove invaluable for investors and developers looking to meet increased tenant demand for modern industrial space, the company notes.

Newmark says the most likely office candidates for industrial conversion are older suburban assets with an average land area of roughly 15 to 25 acres, located within four miles of a major highway.

Layering in zoning considerations, existing land availability, industrial and office submarket fundamentals and other geographic attributes also will inform strategy. “Not all obsolete office buildings present opportunity,” Newmark stresses.

Challenges can include community opposition and zoning restrictions, rising development costs, competing uses; such as, multi-family, healthcare and life science reuse, it admits.

Chicago tops the list of areas in the U.S. where office conversions have taken place since 2018, racking up a total of 3 million square feet.

It is followed by Los Angeles with 2.1 msf, Boston with 1.7 msf, Northern New Jersey and Orange County, CA, both with 1.5 msf, and Washington, DC, with 0.7 msf.

While it is not always that easy to identify appropriate properties that make good candidates for this kind of conversion, opportunities will continue to exist in many markets.

Newmark pointed to the wide disparity between office and industrial rates in various markets. These include Atlanta, where the vacancy rate for offices is 22.2% and IRE is just 5%. Others are Chicago, 20.6% vs 5.7%; Northern New Jersey, 20.2% vs 3.4%; Los Angeles, 19.2% vs 1.2%; Washington, DC, 18.3% vs 4.8%; Orange County, CA, 16.1% vs 2.3%; and Boston, 14.6% vs. 4.5%.

“Near- and long-term outlooks for industrial demand are strong, and many supply-constrained markets are facing limited development opportunities,” Newmark says. “The trend, while niche, will grow and offer industrial tenants needed space while tightening existing office inventories by removing no longer competitive properties.”

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