Conversion calculus: How investors are approaching a battered office market

The covid-19 pandemic might have dealt a death blow to the suburban office market, but commercial real estate investors and lenders are finding way to breathe new life into old properties by repurposing these assets as industrial, apartment or life sciences assets.

Jeff Heller, a managing director at Avison Young, tells Real Estate Capital USA that in his home market of New Jersey, industrial and apartment conversions are the future of many former office assets.

“On the office side, there’s no demand, no leasing velocity, and big [downward] pressure on rents,” Heller says. “The industrial market is the hottest market ever in the state of New Jersey – it’s a bold statement, but it’s true. The vacancy rates there are sub 2 percent or 1 percent, and rates continue to appreciate quarter after quarter.”

Avison Young is finding lenders are supporting value-add plays and similar capital investment projects that aim to modernize the white elephants dotting New Jersey’s highways, Heller says. And that’s good news, because the live-work-play communities that were thriving prior to the pandemic are less viable, given a slow return to office.

“The industrial market is the hottest market ever in the state of New Jersey – it’s a bold statement, but it’s true”

Jeff Heller
Avison Young

According to a report from CBRE, the availability rate for New Jersey office space was at a high of 26.6 percent at the end of the third quarter. The brokerage firm also found that there was about 8.6 million square feet of office space in the state that is slated for a new life. About 4.4 percent of that is geared toward a residential use, with another 2.3 million square feet will be converted to industrial space.

Prior to the pandemic, the economics were such in Southern California that it didn’t make sense to convert offices to industrial properties, says Joham Tavera, a regional manager for the West Coast at lender Capital One. But these conversions are being taken more seriously as the return to the office slows.

“Pre-pandemic, the office market was just very strong, so you had multiple years of increasing rents for absorption of new supply,” Tavera says. “In many instances the highest and best use was office, so to convert away from that just didn’t make a lot of economic sense.”

Life sciences allure

But even though that companies know that office work will change permanently because of the pandemic, it is still difficult to draw meaningful conclusions about the future of office work, Tavera says. Still, the life sciences sector has shown great resiliency.

“Life science conversion [were occurring] pre-pandemic in the clusters where life sciences is very prominent – parts of San Diego, parts of Boston, parts of San Francisco,” Tavera says. “Post-pandemic, that market is a little bit immune to work from home.”