Office Makeovers Yield Results

Heartland Real Estate Business

February 2020

By Kristin Hiller

In an effort to attract and retain tenants,
building owners roll out refreshed properties.

02.01.20 Heartland Real Estate Business – Office Makeovers Yield Results

In the fourth quarter of 2019, Accesso Partners inked more than 102,000 square feet of leases at its Towers at West End office property in St. Louis Park near Minneapolis. The owner and manager attributes the leasing momentum to the $1 million it invested in property improvements in 2019. Accesso renovated the property’s lobbies and common areas, modernized its parking structures, boosted its energy efficiency and implemented the Accesso Club, the company’s exclusive tenant amenities program.

This is just one example of a number of office upgrades taking place across the Midwest. Office owners are compelled to either refresh amenities or add features that will attract and retain tenants.

When Accesso purchased the Towers at West End in late 2018, one of the buildings was about 81.5 percent occupied, according to Paul Gaines, managing director of asset management with the Florida-based company. Today, that same building is 94.2 percent leased. The property’s second building has experienced steady occupancy of 84.5 percent.

A unique feature of the Towers at West End is that it is attached to the separately owned Shops at West End, an outdoor shopping mall. In one of the office buildings, Accesso demolished a 1980s-era fountain and replaced it with a staircase that connects to the retail portion. Gaines says that water features tend to give properties a dated look and cause problems such as leaking. The replacement staircase has been well received by tenants looking to take advantage of the proximity to shopping.

The ultimate goal of an office renovation is twofold: increase leasing momentum while at the same time enhance the landlord’s ability to drive up rents. “We often take properties with below-market rents where upgrades haven’t been done,” says Gaines. “We invest capital and create a better atmosphere where tenants will pay higher rents.”The ability to raise rents after a renovation varies market to market, but the typical increase is $2 to $3 per square foot, says Gaines. For reference, the average asking rent per square foot in metro Minneapolis is $26.16, according to fourth-quarter data from Cushman & Wakefield.

Know your tenants

Lingerfelt CommonWealth Partners is a value investor, meaning most of its investments involve properties that require “immediate substantial renovations,” says Brian Witthoefft, managing director with the company, which is based in Virginia.

Lingerfelt’s due diligence to formulate the optimal renovation plan includes surveying local brokers and existing tenants, picking the brains of local architects for proposals and ideas and interviewing local contractors for budget estimates. Witthoefft says that this is a significant amount of work to accomplish within a short due diligence period, but it is essential. The potential success of each investment is strongly tied to the completion of an effective renovation plan.

In Columbus, Ohio, Lingerfelt recently acquired 100 East Broad Street, a 308,337-square-foot office tower also known as Chase Tower, named after its anchor tenant JP Morgan Chase.

Lingerfelt is implementing a multimillion-dollar renovation, consisting of a full elevator modernization, lobby improvements, new HVAC equipment and a new amenity package. The property was 60 percent occupied at the time of purchase.

For Witthoefft, the strategy behind the Chase Tower investment focuses on two major areas of opportunity: building systems and aesthetics. While well located, the tower has antiquated systems and needs substantial cosmetic renovations. “The end result will be a property with new-age technology and modernized amenities and common areas,” he says. “In Columbus, this will set us apart from most other assets downtown.”

When asked if the existing stock of office buildings nationwide is getting fairly old and driving renovations, Witthoefft’s colleague Will Bradford says it’s a combination of aging product coupled with trends in the younger workforce that lead to the upgrades. “If I had to assign percentages, I’d say it’s probably 65 percent tenant demand and 35 percent due to aging product.” Bradford serves as an asset manager with Commonwealth Commercial Partners, Lingerfelt’s affiliated commercial real estate operating firm.

In general, renovation projects address the needs of two groups: existing tenants and potential new tenants. Bradford says that existing tenants are more likely to be focused on renovations that solve issues such as antiquated HVAC systems, poor elevator experiences or parking challenges.

New tenants might focus on more eye-catching items, such as fitness facilities, tenant lounges or coffee shops. In some cases, it’s as simple as providing access to natural light. “We’re seeing interest shift away from flashy amenities to spaces that best support employees and the work they do,” says Janet Lougee, vice president and director of interiors with Chicagobased architectural firm Wight & Co.

A survey of roughly 1,600 U.S. employees conducted by Future Workplace, a human resources advisory firm, ranked natural light and views of the outdoors as the most soughtafter workplace perk, notes Lougee. While difficult to determine the return on investment (ROI) or “breakeven point” on capital spent on renovations, Witthoefft says the investments “correlate to higher renewal ratios of existing tenants, as well as quicker lease-up of vacant space and shorter downtime of non-income-producing space,” all of which leads to less leasing-related costs and more net operating income (NOI).

“At the end of the day, the increase in NOI drives the valuation of the real estate and, based on how NOI is valued from a cap rate perspective from market to market, this typically results in a significant ROI on the initial investment in the property.”

Know who you are

Beyond establishing what tenants want, it’s important to know and understand the market. For example, Witthoefft says there’s a strong amenity competition going on in Minneapolis, but in smaller markets such as St. Louis or Columbus, renovated properties are rarer.

Office brokers such as Adam Johnson of NAI Hiffman recommend knowing “who you are as a building and who’s your competition.” He says office owners need to be cautious about “overimproving” or spending too much on renovations and pricing themselves out of the competitive subset.

Johnson, who works as an executive vice president with the Oakbrook Terrace, Illinois-based brokerage firm, says that creating amenities from scratch can get very expensive. Owners have to factor in buildout costs, furniture, equipment and fixtures. Another consideration is the size of the building, which can often dictate what amenities are possible, says Johnson. The basic amenities are foodservice, conference space and fitness.

But features like covered parking, Wi-Fi lounges, coffee bars and rooftop areas often come into the mix with a larger-sized building, he explains. Some suburban landlords are starting to incorporate coworking into their office buildings, either by bringing in an actual coworking tenant or by replicating a coworking space. “Landlords have gotten smarter over the last few years about adding communal spaces and activating common areas,” says Johnson.

Wi-Fi lounges and collaboration spaces were a major portion of the upgrades that Hamilton Partners implemented during its renovation of Hamilton Lakes Business Park in Itasca, Illinois, in mid-2019. In response to the high demand for “ready-to-go” office space, the company has also started creating furnished spec suites, according to Paul O’Connor, partner with the Itasca-based company. Tenants utilizing these suites have access to a shared kitchen and conference rooms.

Hamilton invested more than $7 million in capital improvements at 500 Park and One Pierce Place, two buildings within Hamilton Lakes. “Capital investment in each building is deal-specific to what is needed to bring the building up to current market expectations,”says O’Connor.

It’s not only important to meet the expectations of tenants, but also the local brokers. “If brokers aren’t impressed, they won’t even put the building on their tour lists,” says Accesso’s Gaines.

In a sense, brokers are essentially responsible for reintroducing a building to the market. Once the makeover’s complete and the building’s back on the broker community’s radar screen, the path to leasing is set.