Posted on December 7, 2021 · Posted in Industrial / Flex, Investments, Land, Multi-Family, Office, Retail

Conversions have been a hot trend in commercial real estate as developers and occupiers work to figure out new demand drivers as a result of the Covid-19 pandemic.

There’ve been hotel-to-apartment conversions, retail-to-industrial conversions and office-to-apartment conversions — none of which are new since the pandemic but, perhaps, have become more prolific as hotels, shopping centers and office buildings continue to face uncertainty. Although not as common, at least not yet, some commercial real estate observers are taking note of office-to-industrial conversion plays.

A recent report by Newmark Group Inc. dug into the trend, finding that since 2018, at least 45 office properties totaling 11.3 million square feet across the U.S. have been redeveloped, or are in the process of being redeveloped, into an industrial use. While it’s not impossible for office buildings to be adaptively reused into a warehouse, most of these types of conversions involve razing an office building to develop new warehouses.

It’s not exactly a hot trend yet but for certain office properties with good access to highways and a lot of land, converting those sites into a warehouse project may not be such a stretch.

“Now that we continue to see really strong industrial demand across nearly every market, this is the next frontier, I guess, in that redevelopment trend that we’re seeing,” said Liz Berthelette, Newmark’s research director in Boston and a co-author of the report.

She said most office-to-industrial conversions being tracked by Newmark are for older suburban buildings with average land area of 15 to 25 acres, within 4 miles of a major highway. Having the ability to expand on land adjacent to the existing office building can be an important factor, Berthelette said.

Office buildings that’ve faced high vacancy for some time, and single-tenant rather than multi-tenant properties, also seem to be the best candidates for industrial conversion, she added.

Nick Siegel, partner at real estate developer Bridge Industrial’s Chicago region, said Chicago’s overall industrial vacancy rate is below 3%. Meanwhile, suburban office submarkets in Chicago had 24.6% direct vacancy at the end of Q3, according to Jones Lang Lasalle Inc. research.

Siegel said Bridge has pursued suburban office sites in Chicago and other parts of the country for industrial redevelopment even prior to Covid-19. But, given new dynamics in both the office and industrial markets since the pandemic, the trend has only been exacerbated.

“I think, right now, industrial land is worth about the equivalent of an existing (Class) B, second-generation office building,” Siegel said.

The Newmark report examined several markets where the trend is playing out, including Chicago; Los Angeles; Boston; northern New Jersey; Orange County, California; and Washington, D.C.

“While any market could, theoretically, see an office-to-industrial conversion,  the markets identified in the report might be seeing a greater number of such projects because of their fundamentals,” Berthelette said. “Northern New Jersey and southern California, for example, are densely populated markets, making land availability for new warehouse development a challenge. Especially in a market like Boston or D.C., we don’t have a big cargo port like New Jersey or LA or Long Beach, but we have competing use. We have a lot of lab development going on, a lot of competitive multifamily product. We have density, limited development sites and we have all of these other uses that are also vying for those same location. While it’s perceived a market like Chicago would have more land opportunity, there are limited options in prime submarkets within that metro area.”

Siegel said Bridge does a lot of infill industrial development and, in a place like Chicago, there simply aren’t greenfield sites in areas proximate to the airports and population centers to add new warehouse inventory. Broadly speaking, Bridge targets properties east of Interstate 294 in the Chicago metro area.

“Bridge looks for office sites that are at least 10 acres and rectangular-shaped to target for new warehouses,” Siegel said.

The pending sale of The Allstate Corp.’s headquarters in Northbrook, Illinois, is a particularly high-profile office-to-industrial conversion example. Dermody Properties LLC out of Reno, Nevada, is buying most of the campus for $232 million and is expected to raze the office buildings to make way for new logistics development, The Glenview Journal reported.

Similar to other conversion plays, it’s challenging to not only find the right site, but to actually pull it off successfully.

“Many such projects require a rezoning, and how much it costs to do such a redevelopment largely remains to be seen” Berthelette said. “As long as the industrial market continues to see soaring demand and tight vacancy, and office continues to face elevated vacancy, it’s likely the trend will continue to gain traction, We just heard the other day of some other projects that might be coming down the pipeline in southern California. I do think it has some teeth. There are legs to this trend.”

Siegel said he sees potential for more suburban office sites to become good industrial redevelopment plays. But conversions of office sites and shopping malls happen less in practice than they could theoretically, he added. There are many limiting factors to pulling off such projects successfully, namely around entitlements.

Siegel said there are negative perceptions associated with tearing down a suburban office building and turning it into a warehouse use, including the quality and types of jobs that would occupy such buildings. Many warehouses Bridge develops have some amount of office space built out as part of a tenant’s warehouse facility.

“There’s a lot of high-value office space in these industrial buildings,” Siegel said. “Some companies add offices as part of their warehouse facility as a way to save on rent. It’s not a knock on the municipality. People tend to get offended when developers want to build industrial instead of office here.”

 

Source: SFBJ

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