Suburban Office Markets Enter Post-COVID Endgame
Developers have settled on aiming for either magnetic metroburbs or teardowns and creative destruction — and little in between
By Patrick Sisson September 11, 2023 6:00 am
reprints![](https://commercialobserver.com/wp-content/uploads/sites/3/2023/09/Bell-Works-exterior-GettyImages-1325143591.jpg?quality=80&w=734)
For many suburban offices in Chicagoland, there won’t be a return to office as much as a return to the drawing board. That’s because for vacant, underutilized and undervalued commercial real estate there, the wrecking ball is coming.
In fact, suburban offices nationally face a stark choice: Become part of a dense, multiuse cluster attracting high-end shoppers and workers, or get torn down to make way for warehouses and alternative uses.
Outside of Chicago, the starkness of the choice is already taking shape in numerous suburbs: A former Sears HQ in Hoffman Estates is being transformed into data centers, and a Deerfield office complex that once housed a Walgreens office is being razed to make way for a mixed-use entertainment hub. One office owner in Rolling Meadows even bought the building next to its HQ to tear it down, preventing something it didn’t like being built next door.
“It’s a monumental shift in suburban office,” said Daniel Haughney, chief investment officer at LG Group, which is under contract to purchase the Deerfield site. With 37 acres to play with, and a village open to ideas, the site, and the deal, offer Haughney and his colleagues a way to give a vacant property a profitable second life.
“A lot of these buildings are functionally obsolete,” he added. “In our opinion, there are a lot of office buildings where it doesn’t matter what you reset the basis to.”
At the same time — and adding urgency to the evolve or die ethos — there is perhaps unprecedented demand for suburban space done the right way, which can include the redevelopment of that obsolete space. For the first time in modern history, the vacancy rate of suburban offices sits below that of downtown offices, a shift that occurred in the middle of last year, per CBRE (CBRE) data, and it is still the case.
In addition, urban retail availability outpaced suburban retail availability for the first time in a decade, and close to half the nation’s coworking space is now suburban.
Even the value of suburban office has grown as downtown office declines. This year, the value of suburban office space rose a small 0.2 percent and 0.1 percent in the first and second quarters, respectively, versus a slight 0.1 percent drop for downtown. This downward trend of core business district office value started in earnest in 2017, noted Jim Costello, chief economist at analytics firm MSCI Real Assets, when Chinese investors started pulling out of the big trophy deals that previously drove up asset value.
But the slide continues. Suburban and downtown office deal volume has typically been 50-50. Now, it’s swinging hard toward suburbia.
“Suburban office is outperforming downtown and core business district office for the first time in decades,” said Jason Stanley, head of research at local logic, an intelligence platform for real estate. “That’s something we haven’t seen for quite a long time.”
Generalizing the vast swath of U.S. suburban workspaces, from office parks to campuses to multiuse projects, remains challenging. Broadly speaking, the market continues to diverge, with urban-like cores of activity attracting upscale investment and new types of density, while numerous offices that lie fallow, especially the isolated and under-amenitized 1980s-era properties, are ready for adaptive reuse in the eyes of many developers.
Whereas the cost and zoning barriers to demolition in downtown areas remain numerous, suburban offices are benefiting in some cases from both demographic growth and plummeting value, enabling creative destruction and reinvestment.
“You’re not going to take a 60-story prewar office building and turn it into a warehouse or light manufacturing,” said Ralph Zucker, president of Inspired by Somerset Development. “But in suburbia, it could happen, and is happening.”
In New Jersey, the massive 2 million-square-foot Bell Works complex in Holmdel, a former Bell Labs research and development center which had a starring role in the Apple TV series “Severance,” has been reborn as a tech office hub. Zucker, whose firm operates the massive mixed-use project, said it exemplifies the firm’s metroburbs concept, one Somerset is in the process of replicating at another Bell Works site outside of Chicago.
In spite of the massive footprint of the New Jersey development, Zucker said he’s benefiting from employers realizing that, as they downsize their office footprint, they should invest in a more inspiring place to work. (Both the New Jersey and the Chicagoland locations have medical offices, retail shops, restaurants and even pickleball courts.) He needs to fill roughly 1.2 million square feet of office in Bell Works Chicago, and because tenants have shrunk their requests, he’s doing it 50,000 square feet at a time. But because he can charge higher rents than he expected, Zucker said he needs to fill less of the overall building to break even.
“The numbers are exponential,” he said of the increased rent he’s taking in due to this dynamic.
In New Jersey, the Bell Works space was picked up for roughly $15 a square foot from a special servicer, and required about $100 a square foot to redevelop, but it’s fetching great lease rates, in some cases over $50 feet a square foot, and nothing less than $40. Zucker argued you can probably find millions of square feet in Manhattan right now for less, underscoring the inversion being seen in the market.
The closure and downsizing of offices and office parks often has as much to do with their lack of nearby amenities as it does the age or quality of the buildings, said Local Logic’s Stanley.
Yet newer Class A suburban office buildings, located near retail — especially those in more suburbanized, fast-growing areas of the Southeast and Southwest — offer an overall package that appears to be driving better performance.
In the Atlanta region, Toro Development Company just broke ground on Medley, a 43-acre mixed-use destination in Johns Creek, Ga., a rich suburb to the north, that will turn an old State Farm insurance complex into offices, restaurants and 880 apartments.
For CEO Mark Toro, creating an urban experience in a suburban setting has brought in top-tier tenants, and will have a positive effect on nearby real estate. He called it a “flight to energy.” It’s a lot more than office buildings with a bean bag chair. There’s a reason, Toro said, that developers with retail DNA are the ones who are succeeding with these kinds of mixed-use redevelopments while others stumble (and why Medley has already signed a number of retail tenants).
Most communities don’t have the demographics to support this kind of project. The best suburban office buildings and redevelopments will benefit from current workplace dynamics and demographic shifts. The rest, Zucker argued, won’t be able to compete.
“It’s a culling of the herd,” he said. “Survival of the fittest. I hate to sound so Darwinian about it.”
The other extreme — demolition and reinvention — has also shown signs of life, or, more specifically, rebirth. Older 1970s and 1980s offices on the fringes of suburbia, with small floor plates surrounded by parking lots — what Toro calls “egg yolk buildings” — are increasingly being demolished for new uses, such as logistics and warehouse space. The pace of office conversions nationally set records in 2021 and 2022, and is on pace to set an all-time high this year, per JLL data. From 1995 to 2019, an average of 6 million square feet of office was demolished every year; in 2023, 14.7 million square feet had been removed through late July.
On Long Island, the first floor of an office building at 26 Harbor Park Drive in Port Washington was converted into 40,000 square feet of industrial space. According to Lee Brodsky, CEO of BEB Capital, a firm investing in office-to-industrial conversions including the Port Washington property, demand for office space in the region pales against the hunger for industrial space. The entire floor was pre-leased months before crews started work.
It’s simply more difficult and costly to convert office environments in urban markets like Manhattan and San Francisco due to lot sizes and residential requirements. Those limits just don’t exist in suburbia, making it easier to turn to a Plan B: self-storage, assisted living, student housing, educational facilities, or, especially near highways, warehouse space.
“A lot of these suburban buildings, it’s land value, not office value,” said Aaron Jodka, Colliers (CIGI)’ research director for U.S. capital markets. “What’s the price of land, and what does that price need to be in order to become whatever that future plan is?”
Population growth and poor housing production in the last decade has created a strong tailwind for new housing, said Jodka. Underutilized offices with lots of soon-to-expire leases, or those in areas with low housing production, are therefore especially attractive as candidates for residential redevelopment. Offices with below-ground parking offer the added benefit of allowing developers to build housing on top of surface lots, offering more profit potential with fewer development costs.
Say a suburban office campus owner has three buildings, all with 60 percent occupancy. Pushing all of the tenants into two buildings, then selling the third to redevelop into a multifamily or hotel project is very feasible, said Mike Watts, CBRE’s president of investor leasing in the Americas, and can lead to complementary developments that add value to each other. And most suburban office buildings are within 10 minutes of a residential population.
“You’re already halfway there in terms of a viable location for multifamily,” Watts added.
The suburban surge does face a few hurdles ahead. Colliers’ Jodka noted that some municipalities have been holding back on rezoning and redevelopment, clutching to a past in which office buildings contributed to tax revenue, and failing to seize the opportunity to evolve with changing market demands.
Others see transportation issues potentially hindering some of the new, more far-flung office developments. The rapidly rising cost of car ownership, said Local Logic’s Stanley, means households face higher burdens getting behind the wheel and may increasingly be wary of suburban offices that aren’t well connected to active public transportation networks. There’s also the historic pattern of young people wanting to be in downtowns, as well as a tougher financing environment due to higher interest rates.
Conversely, with more creative destruction and transformation of outdated suburban office, it may actually make the remaining stock more valuable.
“In a few years, you can look back and you’re gonna see that the survivors are doing better than ever, because you’re no longer competing against the B-minus or Class C office spaces,” said Zucker. “They’ll simply be gone.”