R.O.I. Real State – Commercial Newsletter- March 2022
Posted on March 1, 2022
The pitfalls of aging office buildings are not new, but the COVID-19 pandemic put concerns about obsolescence front and center. The acceleration of work from home (WFH) and work from anywhere (WFA) trends has led businesses owners to reassess how much space they truly need to operate efficiently. With tenants who can afford to be selective, plus a focus on healthy spaces and stricter environmental regulations, office assets may be sailing into a perfect storm of challenges.
Current office leases are renewing, but for shorter terms until businesses figure out how their employees will really use offices when they come back. In order to secure longer leases, office building owners will need to significantly invest to overcome obsolescence. Tenants are increasingly showing a preference for newer buildings with more flexibility and modern amenities such as fitness rooms and food courts. At the same time, more-stringent government green standards are forcing building owners’ hands.
A new economic analysis by Zisler Capital Associates details some of the implications. (See pg. 4, “Articles of Interest” for the full story.) Nationally, prices for newer, amenity-rich offices are up about 15%, while smaller, older properties are down 20%. The Zisler report concludes that “as much as 70% of the total inventory faces an alarming period of repricing due to fast-paced obsolescence” and “for 30% of the existing office stock, retrofitting and upgrades may be economically unfeasible.” As GlobeSt. notes, the potential impacts may extend to financing, valuations, and loan covenants.
By the Numbers: Greater Phoenix Office Space
- The vacancy rate is estimated to be in the 14.5% to 15.5% range by different market observers, close to the national average. In Class A properties, the vacancy rate is higher, in the 20% range. Phoenix is faring better than some secondary markets; Atlanta, for example, is estimated at over 22%.
- Tenants who experienced good performance by remote workers during the pandemic are relinquishing unused office space. As a result, sublease availabilities have surged from about 1.7 million SF in Q4 2019 to a record high of more than 5 million SF.
- Development has slowed in the past 12 months, partly due to the uncertainty of office demand moving forward. The amount of office space under construction is at its lowest level since 2017, reducing supply-side risk in the near term. Marketwide, about 1.6 million SF is under construction, half of which is available for lease. Construction is concentrated in Tempe and Scottsdale Airpark, high-demand urban submarkets with a large and high-quality talent pool.