Office-to-logistics conversions are tough—here’s why.

1800 Tapo Canyon, Simi Valley, CA. Image courtesy of Griffin Capital Essential Asset REIT Inc.

With industrial facilities in record demand, it makes perfect sense to take underutilized office buildings and turn them into state-of-the-art warehouses.

But don’t expect the trend to sweep the country. Only certain office buildings in certain locations are viable for such businesses. And that’s just a short list of criteria.

“A lot of the office conversions we see are for older office buildings or buildings purpose-built for a single company,” said Nancy Shultz, president of Duke Realty Corp.’s West Region, says commercial real estate director. “Re-letting these buildings would require enormous capital to bring them up to modern standards for office space, which would make industrial conversion more cost effective.”

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At the end of 2021, Duke Realty Corp. acquired the two-story office structure located at 2727 E. Imperial Highway in Brea, California, by paying Healthcare Real Estate Advisors approximately $35.4 million for the Orange County asset of approximately 105,000 square feet. The leading purely domestic logistics real estate REIT has no intention of deviating from its core strategy; the company will begin converting the Class B office building into an industrial facility shortly after the current tenant’s lease expires.

Goodrich Corp. has leased space at 2727 E. Imperial, originally built in 1984, since 2012, and currently uses the facility to house Raytheon Technologies Corp.. subsidiary company Collins Aerospace. Duke has already submitted a preliminary proposal to Brea’s Planning Division for demolition of the existing structure and development of an approximately 117,900 square foot warehouse.

The size of it

Duke’s Orange County project meets the criteria for a successful conversion, as noted in a recent report by Prologis. Office-to-industrial conversions are costly endeavours—buildings usually have to be demolished to begin with, as they don’t lend themselves well to adaptation—so a project must be located in a location that can achieve higher rental rates to make economic sense.

These locations include large coastal markets with high land values ​​and poor logistics supply, including southern California and San Francisco and, on the east coast, Whittington, DC and suburban New York. According to a report by Cushman and Wakefieldand conditions were even stricter in Brea, Calif., which had an overall vacancy rate of just 0.8%.

“We are certainly seeing what we call the covered land game in these markets where there are high barriers to supply, especially in southern California, northern New Jersey – areas where you are close to population, you have a voracious tenant appetite for demand, very high replacement cost and no real opportunity to go down to the next exit and expand. Areas where supply is effectively limited,” said Jason Tolliver, Cushman & Wakefield’s head of logistics and industrial investors for the Americas. CPE.

Tapo Canyon Commerce Center, Simi Valley, California.
Tapo Canyon Commerce Center, Simi Valley, California Image courtesy of Stream Realty

In Simi Valley, California, about 40 miles northwest of downtown Los Angeles, Real estate flow and joint venture partner QuadReal real estate group acquired the 275,000 square foot office building at 1800 Tapo Canyon Drive from Griffin Capital Core Assets REIT Inc. at the height of the pandemic, and instead of re-leasing the one-story asset, the partners are now in the process of redeveloping it into the Tapo Canyon Commerce Center, a five-building industrial complex. The approximately 356,300 square foot park will include structures ranging in size from approximately 26,000 square feet to 138,000 square feet and will provide parking for more than 500 vehicles.

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On the other side of the country, a 105,000 square foot office building in New Jersey was traded in late 2021 to an unidentified team of “seasoned investors” who are planning a conversion. The property, located on 24 acres at 1001 S. Grand Ave. in Hammonton, was originally developed in 1980 as a light manufacturing and industrial complex, and under its new owners will undergo a process that will convert the property back to an industrial facility. Simi Valley, part of the North Los Angeles market, had an overall vacancy rate of 1% at the end of 2021, and South New Jersey’s vacancy rate was just 0.5%, according to a study by Cushman & Wakefield.

Easier said than done

Converting an office building into an industrial facility is much more than an aesthetic transformation, which is why selecting an office building to convert involves a long list of considerations. Most often, office-to-industrial conversions are office-to-industrial redevelopments. In other words, these projects usually require demolitions. However, one of the biggest challenges in pursuing office-to-industrial conversions can involve regulatory resistance, starting with obtaining rezoning permission. “It’s not easy to get a property rezoned, so underlying zoning for industrial use is key,” Schultz said.

And then there is the implicit loss of white-collar jobs with the replacement of an office building with an industrial asset, as the Prologis report notes. However, there is a misconception on this point. “The supply chain industry has become a very sophisticated operation and there are many exciting, high-paying careers that start in a warehouse,” Schultz added. “One example is the prevalence of engineers hired in the industrial and logistics industries who work on warehouse automation.”

While proximity to a large labor pool is just as important for industrial occupiers as it is for office occupiers, proximity to transportation infrastructure is a much higher priority for industrial tenants, such as the indicates the Prologis report.

“The one thing I would say that is true for both retail conversions in logistics and office conversions in industry is that they require a very deep knowledge of that particular asset and the market and of the submarket it’s in,” Tolliver said. . “These are very specific based on local nuances of the market, so having in-depth knowledge of the particular asset becomes far more important in mitigating risk and identifying long-term upside potential than what the covered ground would offer. “

Localized trend

New office-to-industrial conversion projects will continue to pop up in some high-demand markets for the foreseeable future, but there’s no danger that office corridors will tumble into the logistics sector in waves across the country. . According to Tolliver, only a few markets in the United States have both the fundamentals and the balance between supply and demand to turn such projects into a meaningful investment.

Prologis agrees; the trend has limited viability. “Our analysis revealed that the trend to convert office buildings into logistics facilities will be minimal, given the physical, regulatory and economic challenges. This shows how creative developers need to be creative in sourcing industrial land as it becomes increasingly difficult to find it, especially where it is needed most,” said Melinda McLaughlin, Global Head of research at Prologis. CPE.

Even if fundamentals and demand required office-to-industrial conversions in all US markets, space would not permit it. Logistics properties typically require a minimum of 8 acres and only 27,000 office buildings, the equivalent of 1.2 billion square feet on the ground floor, meet the requirements, as Prologis notes in its report.

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Even in markets where office-to-industrial conversions are feasible, or even justified, conversion projects may face another hurdle.

“I wouldn’t want to engrave the death of the office on the headstone yet,” Tolliver said.

“The fundamentals continue to improve quarter over quarter and month over month. The office plays an indispensable role for businesses and societies in creating a culture. that you have to be there five days a week for eight hours a day, but you have to have a place where people can come together to share ideas, develop an idea of ​​what it is and who they are. organization and that remains essential for businesses of all sizes, so I think what we’re seeing is more flexibility in the use of the office and all the different types of work experiences that come with that. But I don’t anticipate, nor do I see this big ‘We’re never going to the office again; we don’t need this space,’” Tolliver concluded.

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