Houston has the most available Class-A office space in the U.S., according to a recent CBRE report. Following last year’s drop in oil prices, Ten-X predicts that office space vacancy in the Bayou City will reach 20% in the next three years. Prime office spaces occupied by the city’s prominent energy industry players, like One Shell Plaza, have been vacated after a decades-long presence. Properties like Wedge Tower have undergone multimillion-dollar renovations to their lobby, parking garage and retail space to attract more tenants.

Property owners are clamoring and competing with each other to renovate these spaces and equip them with state-of-the art amenities in the trendiest neighborhoods, but developers could be missing out on a value-add opportunity with Class-B and C office buildings.

While the distinctions between categories are loosely defined — and often contested — Class-B buildings generally lack high-quality finishes and a prime location. In Houston, these properties make up the office buildings constructed in the ‘80s that are in need of an update. Class-C’s are older and are further from desirable neighborhoods.

These property types make up for their lack of amenities by attracting a diverse tenant demographic. “By and large, deals are smaller and the building is more diversified; you don’t have to have the whole building based on one or two tenants," Avison Young principal Doug Pack said.

A spread-out tenant roster can act as a safeguard during shifts in the market. “The multi-tenant side is an insulator. You do spend a lot [of] administrative and management time when you’ve got 35 tenants in a 60k SF building, but you also get the ability to lose five to seven tenants and not have your building half empty,” Pack said. In Class-A buildings, where build-to-suit specifications revolve around one major tenant, a single vacancy can put the entire building at risk.

On the tenant side, Class-B buildings appeal to younger corporations that are either looking for more flexibility or do not have the credit history needed to move to higher-end spaces. “Class-B buildings offer that flexibility to sign shorter-term leases, with less demand on credit and financial history,” Pack said. For companies that are not looking to dazzle visitors with panoramic views, Class-B offers affordable, functional space with room for growth.

Developers can also make gradual upgrades without pushing out their tenant base. More Class-B and C properties are taking a cue from Class-A when it comes to sustainability upgrades; these retrofits not only save building owners money in operating costs, but the curb appeal of an improved building allows for higher rent. There is a caveat with improvements. Older buildings are limited by floor space, and the attractiveness of the building’s submarket could also create an upgrade ceiling.

“The opportunity to add value and push rates in a Class-B or C building is as much a factor of the market as it is with the existing building infrastructure," Pack said. "Real estate is still and will always be location, location, location, so value-add investors have to be aware of over-improving, as return on investment is the goal and not all improvements create the opportunity.”

For Avison Young principal Sam Hansen, the decision boils down to a trade-off between amenities, location and price. “Tenants are not just saying, 'Go find an A building,’” he said. “Tenants are telling brokers, ‘Go find us opportunities to do the deal that we want to do.'” The brokers at Avison Young make it a point to put all the cards on the table. Rather than highlight only the flashiest properties Houston has to offer, the firm works to make sure its clients find the deals that meet their companies' needs.

To learn more about this Bisnow content partner, click here.