CRE Is Spending Big On Office Amenities. Will It Matter And What Does It Mean For Old Properties?
1000 Main is not an old building. The prominent downtown Houston skyscraper boasts major oil and gas tenants and is located near major attractions, like parks, retail, transit and the tunnel system. Still, it shelled out cash for a new tenant amenity center last year, including a 12.5K SF lounge area, a conference center, a gaming area and a fitness center.
Consensus is forming that the post-pandemic office market will center around a flight to quality, prompting even relatively recent, Class-A buildings to spruce up their amenities to herd workers back to the office. In downtowns like Houston, which took a massive hit when pandemic restrictions locked most of it down, renovation money is flowing in hopes raising the standard will herd workers away from dens and sofas.
But huge swaths of Houston offices were built in the 1970s and 1980s in its real estate boom and are now considered out-of-date Class-B or Class-C properties. They may face a much harder time renovating sufficiently to reach the new standard for workers.
"If there's not any improvements, capital improvements, that are made to the buildings, those buildings are going to be left behind," said Ariel Guerrero, senior vice president and director of research and market analysis with Madison Marquette.
"Those owners are going to have to consider repurposing that to a different use, or what have you. That's the reality."
The first quarter of 2022 in Houston office saw higher direct vacancy compared to the rest of the U.S., according to new Transwestern data, which pointed to a rising stock of older properties with high vacancy and availability as one cause. Transwestern said buildings completed between 1980 and 1999 have the highest vacancy in Houston, at 26.6%, three times that of properties completed since 2010.
Houston isn't alone. Chicago office vacancy, for instance, rose to a record high of 21.2% in the first three months of 2022, according to CBRE, up from 19.7% at the end of last year and 20% in Q3 2021 — the previous high-water mark for emptied-out offices. CBRE attributed part of the rise to tenants moving out of older buildings as their leases ran out.
"The vacancy rates are rising now, and will continue to rise as office leases mature over the next couple of years," Jim McGrath, executive vice president and head of commercial banking for Evergreen Bank Group in Oak Brook, Illinois, told Bisnow in an email. "They would have hit these highs much sooner had the tenants not been obligated under their current leases."
"If you are a purely commodity building, it's going to be tough for you to compete long-term," he said. "If you're bordering on the edge of it, you better invest in your building now."
Class-B properties, despite having fewer amenities or less popular locations, are usually snapped up due to price, and Class-B rents in Houston are still much lower than Class-A, according to Avison Young data; Class-B properties are currently priced at about $22.46 per SF. But it's becoming harder to sell Class-B properties solely based on affordability, according to Guerrero.
"In this environment, I don't think tenants are as conscious about price, per se, as they used to be," he said. "I think most companies are looking for the better space that's available."
To attract workers back to the office, companies are leaning on the presence of tricked-out offices with leisure areas, modern technology, fitness areas, outdoor spaces and other amenities. Nationally, large companies are hosting parties, pop-up events, free food and even celebrities to paint the workplace as more appealing than home, according to The New York Times.
In turn, the vast majority of Houston's office space under construction is Class-A, according to Q1 Avison Young data, with nearly 900K SF currently under construction, compared to about 250K SF of Class-B. Avison Young reported no Class-C property currently under construction. Property owners are turning around massive renovations on existing properties to meet that standard, too.
Yet according to Gensler data shared with Bisnow, whether that is a winning bet remains to be seen: The amenities commercial real estate believes workers want — high-tech game rooms, bars with hard seltzer on tap and the like — might not align with their actual, more prosaic wish lists.
“As workers look to the future, the most desired amenities are highly pragmatic — and workers are focused on parking,” report authors said of Gensler’s survey of 2,300 U.S. workers, which cited parking, a technology help desk, coffee or tea service, gym or exercise space, and outdoor space as their five most sought-after post-pandemic office amenities. Parking, a frustrating and expensive experience in many urban areas, was most often cited by baby boomers, with younger generations prioritizing gym and exercise facilities. Childcare, which ranked only 10th on the list behind sit-down eating, carryout food, and health and well-being services, ranked high on the list for Gen Z and millennials.
Gloria Mattere, managing director for Chicago-based EnTrust Realty Advisors, said she has noticed a raft of companies adding amenity floors and lobby renovations, but was uncertain about their value in luring workers back, especially in older buildings.
"They're trying to do something, but I would definitely say the vacancy rate is very high here now," Mattere said. "And those older buildings can't compete ... and then there are a lot of subleases out there that are available because people have just walked away."
Houston-based Boxer Properties manages Arena Towers in Westchase among its large portfolio of simple office buildings outside the CBD. CEO Andrew Segal touts Arenta Towers' new music venue between its two towers, its pizza restaurant and other amenities. Segal dismisses the Class-A or Class-B label, instead calling such properties "Class-X," explaining they are beyond old-fashioned description.
"The days of walking into a lobby and throwing up marble on everything, it's not exciting to people anymore," Segal said. "They want interaction, you want to be able to interact with people."
If an older building is unable to be renovated or the landlord is unwilling to spend the money, experts say their fates are up in the air. Elsewhere in the country, office is being repurposed for multifamily development. New complexes have risen from former offices in Washington, D.C., The Wall Street Journal reported, citing CoStar data indicating there are about 1,000 office properties nationwide that could be turned into residential properties.
For the rest, their use beyond a simple teardown is uncertain.
"It would be great if we saw some of that here, but I don't think that, at this point, it's economic. It's going to take some time to work through the oversupply situation," Guerrero said.
As the office market shambles toward stability and attempts to catch up to the rest of the real estate industry, which has mostly recovered, most experts who spoke to Bisnow are still unclear on the future. Future stability could be indicated by new, long-term leases signed. But large tenants, who tend to sign the longer leases, aren't signing right now.
The most notable recent newsworthy transactions in Houston were limited to Shell's 259K SF lease in 2021, which was an early renewal, and Hewlett Packard Enterprise's new Houston headquarters, which was announced in late 2020 but didn't require workers to move to Houston, favoring remote work during the pandemic.
With workers still visiting retail and entertainment but not the office, Garrett says it will take years for the office industry to find a new normal. Experts said getting 100% of the office back at one time is unlikely.
Houston has been ahead of most U.S. cities in terms of luring workers back, hovering between 50% and 60% in office at least a portion of the week for many months. But those numbers haven’t budged much in recent weeks — and may not for some time, no matter what flashy amenities are brought to bear.
According to Gensler’s latest U.S. Workplace Survey, about 55% of Americans were working in the office in some capacity as of the beginning of the year, though only 19% were in the office full time — the same percentage that expected to continue working full time in the office going forward. The data makes it clear workers are strongly in favor of hybrid schedules, with most — 19% — saying they would prefer to work in an office two days a week, and one day a week coming in second at 15%. About 3 in 10 of those surveyed said they would ideally prefer permanent remote work.
In other words, getting employees back to full time in-person work is going to be a tough sell: “These work preferences of employees do not align with company expectations, which skew toward a focus on in-person work in the coming year,” Gensler said noting, two-thirds of workers expect they will be required to work in the office for at least the majority of the week.
"I don't think it's going to be 100% of the time like it was pre-Covid, where you're expected to be in the office every single day, but I think there's going to be a lot more participation in an office space for a company than there is right now," Garrett said.
UPDATE, APRIL 18, 2:30 P.M. CT: This story has been updated to include comments from Evergreen Bank Group Executive Vice President and Head of Commercial Banking Jim McGrath.