Developers Say They Have Trouble Making Money Converting Suburban Offices To Other Uses
Northern Virginia's office vacancy rate, which continues to hover around 20%, could be improved if developers convert older, obsolete suburban offices to other uses, but several of the region's most active developers say they have had a challenging time making those deals work.
Conversions of vacant office buildings to apartments, private schools, self-storage facilities and other uses have been launched in D.C., Tysons, Alexandria and other areas, but developers say those projects remain few and far between. While some Northern Virginia jurisdictions have considered incentivizing such conversions to bring down the office vacancy rate, there continue to be significant hurdles for developers looking to close the deal.
"Our perspective is that repurposing, although it sounds good and would seem to be great to take inventory out from one use that's oversupplied and convert it to an undersupplied use, it seems like that's probably not going to happen as much as people want," Rubenstein Partners Director of D.C. Metro Stephen Evans said at Bisnow's Fairfax County Forecast event, held at Rubenstein's Centerstone at Tysons building.
Rubenstein has considered repurposing some of its own office buildings or even acquiring office campuses to convert to residential, but Evans said it hasn't been able to make the math work.
The floor plans, column spacing and building systems differ greatly between offices and apartments, he said, so conversion projects can be logistically challenging and expensive. Additionally, he said the "low-hanging fruit" buildings that make the most sense for conversion have already been taken and the remaining properties are more difficult.
"At some point you realize it feels easier just to start over and blow up the structure," Evans said.
Georgelas Group Managing Partner Aaron Georgelas said his company has also looked at potential conversion projects, but it was difficult to overcome the uncertainty associated with the cost of repurposing an old building.
"A lot of times when we're building these $50M to $100M buildings, we try to put the cost risk on the contractor and say 'this is what it has to cost, here are the plans,' but it's impossible to do that with an existing structure; they don't know what they're getting themselves into," Georgelas said. "So it's really hard to finance something that doesn't have a solid, understandable cost structure. I think that's why it's going to be really challenging to see a vast number of buildings convert from what they are today."
KLNB principal Joshua Simon, who works with Northern Virginia office and industrial owners, said the cost of conversion projects often outweighs the benefit, and it usually makes more sense to keep buildings as office and put money into renovations.
"At the end of the day it comes down to basis," Simon said. "One of the challenges when it comes to conversions, let's say a building will sell for $100/SF, but the cost to convert it is $250/SF. The numbers don't really match up. If you can buy for $100/SF, put in another $100/SF and your basis is $200/SF, it starts to make sense from an office perspective moreso than converting to a different product type."
But if landlords are going to heed that advice and try to lease up their suburban office buildings, they need to employ certain leasing strategies to help attract tenants. One strategy Simon suggests is building out spec suites, a growing trend across the D.C. region that helps draw tenants looking for quick move-ins.
"If you own a building and you're not breaking them up into smaller blocks and spec-ing them out, you're probably making a mistake," Simon said. "Tenants in the 1K SF to 7K SF range want to move in tomorrow, they don't want to wait four months for you to design and build it out."
PS Business Parks head of D.C. region Chris Auth said his company builds out spec suites from roughly 1K SF to 6K SF, and he said it is important to offer as much flexibility as possible.
"Our twist on it is to offer them flexibility of term, which is attractive to folks just starting out who don't want to bite off a five- to 10-year lease term," Auth said. "For us, that's been an attractive proposition for luring folks to lease our buildings."
Companies moving toward smaller, open office plans and allowing employees to work remotely has created headwinds for landlords trying to fill large blocks of office space. But the speakers on the event's Future of Fairfax County agreed that the office isn't going away any time soon. JBG Smith Senior Vice President Bailey Edelson said she expects the trend of tenants shrinking footprints will soon reverse course.
"I think you'll end up seeing a moderating of some of the really open, dense plans that a lot of tenants are looking at now," Edelson said. "There's research coming back saying that it's not making people as productive as everybody thought. So it's really about trying to pick and choose the right mix of space and technology for your business."