The Future of Office Development

By Judy Newman

Are businesses shifting from the suburbs to downtowns?

Prestigious addresses at lower prices may be luring companies back to big-city downtown digs for now. But in the long run, price will not be the only factor determining where businesses locate. An easier commute, environmentally-sensitive buildings, and good-quality housing and neighborhood amenities may also play an important role in office market decisions in many cities, experts say.

In the post-recession economy, downtown office buildings are experiencing a renaissance with big, corporate tenants flocking back to city centers, leaving swaths of empty offices in the suburbs, the Wall Street Journal reported in December.

In Chicago, for instance, United Continental Holdings, parent company to the merged United and Continental Airlines, is moving into the 110-story Willis Tower in the West Loop from its sprawling office complex in Elk Grove Village near O’Hare Airport. United Continental has said it will fill 12 floors of the Willis Tower, formerly known as the Sears Tower, and eventually, will have 13,000 employees in Chicago.

In Detroit, Blue Cross Blue Shield of Michigan plans to start moving 3,000 employees from suburban Southfield to the GM Renaissance Center in May, doubling the health care organization’s work force in Detroit’s central city.

“The pendulum has swung the opposite way,” said Victor Calanog, vice president of research and economics for Reis, Inc. “Cities are, basically, back and it’s fascinating.”

But others are not so sure. “We have heard the same thing, that there are big deals going on in downtown markets,” Arthur Jones, senior managing economist for CB Richard Ellis, said. “Nationwide, the data just don’t show it.”

National Association of REALTORS®’ George Ratiu said some cities are seeing a downtown rebound, but many are not, at least, not yet. “There is a shift toward central business districts, but I would not say it is as uniform as it would be portrayed. New York, Chicago and Washington, D.C., to some extent, but other markets are not going in the exact same direction,” Ratiu said.

In his fourth-quarter 2010 analysis, issued in January, Calanog said office occupancy rates improved in 48 of the 82 primary office markets around the U.S.

In New York City, office vacancies dropped during the last three months of 2010, while effective rents increased 1.5 percent. It was the second consecutive quarterly rise in rents, following nearly two years of declines, including a fall of about 20 percent in 2009 — more than twice the deterioration in the 12 months after the Sept. 11, 2001 terrorist attacks that destroyed the World Trade Center, Calanog said. 

With decreases that sharp, the spread between rent rates in the central business district and those in the suburbs has narrowed. “It also means class A office space in New York City is suddenly more affordable now than across the river in New Jersey,” he said. As a result, tenants are finding less expensive space in more desirable locations.

In Washington, D.C., CoStar Group pulled up stakes in Bethesda, Md., last October and bought a 10-story office tower from the Mortgage Bankers Association. CoStar, a commercial real estate research organization, touted the bargain price, at less than half the median market rate, and government incentives such as$6.1 million in tax abatement over 10 years if the company hires 100 D.C. residents.

CoStar CEO Andrew Florance probably summed up the feeling of many companies getting in on recession bargains when he said, at the time, he felt lucky to get “a historic opportunity to secure an exceptional asset at a greatly reduced price.”

Chicago is another city where companies are taking advantage of reduced rates to upgrade their address, said Deena Zimmerman, senior associate with Jameson Commercial. “Absolutely, yes, 100 percent. All the deals I’ve done lately are suburban offices coming into the city,” she said.

In most cases, businesses moving from the suburbs are lured by the cachet of a downtown Chicago location. “The address means a lot. Michigan Avenue or Wacker Drive absolutely helps their business,” Zimmerman said. United Continental’s decision to migrate to the Loop probably was not the catalyst that prompted companies to follow suit, but it may have lent some support to the idea, she said.

“I really think the downtown surge is just a signal of things to come,” Zimmerman said.

Reis economist Calanog said price is not the only reason, though. “On a macro (economics) scale, cities have done a really good job repositioning themselves as highly livable, highly attractive places for businesses and individuals to flourish. This was certainly not the case in the 1980s or early 1990s,” he said.

Denver’s downtown also is seeing new sparks of interest from the business community now that rents have dropped, said John Propp, of John Propp Commercial Real Estate. “It’s most definitely a trend,” he said.

But the downtown migration touched Denver well before the recession hit in late 2008, he said, and has proven to be more of a long-term change. In the early 2000s, executives and young families started to return, renovating Victorian houses, and old warehouses were rejuvenated as condominiums and lofts. “And all of a sudden, preservation and reurbanization of older buildings became hip,” Propp said. 

At the same time, Denver was embarking on a series of public improvements that included turning 16th Street into a pedestrian mall with free buses; ramping up what has become a major light rail system; and building the Pepsi stadium for the Denver Nuggets basketball team and the Colorado Avalanche hockey team downtown. Transit-oriented developments began appearing around light rail stations in the environmentally conscious community, with housing, retail and some offices.

Last July, DaVita, a kidney care services company, announced plans to build its new headquarters adjacent to Denver’s Millennium Bridge, at the west end of the 16th Street Mall. The 15-story, $100 million project — counting the cost of both land and office building — will sit across from Union Station, a railroad station with roots that date back 130 years, now targeted for a major redevelopment as a multi-modal transit hub for Amtrak, commuter trains, light rail, buses and shuttles, as well as a public promenade and gardens and private development. 

When DaVita decided to leave California for Colorado in 2009, chief executive officer Kent Thiry cited Denver’s good business atmosphere and “an environment where our people could live great lives.” Propp said the downtown’s revitalization, its emphasis on parks, transit, bike and car-sharing programs, and its LEED (Leadership in Energy and Environmental Design) certified housing have made the central city inviting to companies like DaVita and their employees. “Our city has really, really embraced that piece,” he said.

DaVita is not alone in considering smart growth policies a “plus” in potential locations. “There are certain elements of sustainability and overall environmental consciousness that contribute to the return to downtown office space,” but it is hard to quantify how much they play into those decisions compared to other factors, said Heather Payson, a portfolio manager for Ecological LLC, of New York.

Many companies now include “green issues” among the items they consider, she said. “They put more weight on what will enable them to attract and retain young and forward-looking employees. For this generation, the ability to “live a green life” is a factor that is increasing in importance,” Payson said.

In some cities, companies are moving into urban boundaries from the suburbs, but they are not necessarily aiming for downtown digs. Atlanta, for instance, has three urban markets: downtown, midtown and Buckhead, said John Ferguson, president of the Atlanta Commercial Board of REALTORS®. He said while there has been somewhat of an influx back to the city from the Central Perimeter — the ring around Atlanta that comprises the area’s largest office market — the downtown area has not been the biggest beneficiary.

“We’ve seen this trend for about 18 months — accounting, advertising and professional firms that have relocated back into urban centers to take advantage of the market conditions. But what we haven’t seen is a total fight back. Most of the absorption is really in midtown and Buckhead,” said Ferguson, who also serves as executive managing director of CB Richard Ellis for the Southeast.

For the Washington, D.C. area, the trend toward urban environments has been apparent since the mid-2000s, driven largely by traffic congestion and the high cost of gasoline, said Susan Pepper, senior vice president of Grubb & Ellis’ Washington, D.C. office. But there, too, companies have not all chosen downtown sites.

“Certainly downtowns have benefited, but in the greater Washington area, we’ve seen equal growth in northern Virginia and in the Bethesda, Md., area,” Pepper said. “What tenants are really seeking is proximity to public transportation, getting out of their cars and availing themselves to Metro access, rather than the almighty car.” 

As the Metro system expands, development — including offices — is expected to follow, Pepper said. “This region really doesn’t have a discernible trend of businesses leaving the District of Columbia nor a wave of businesses leaving the suburbs for the city. There’s a healthy ebb and flow throughout the region of businesses moving to urbanized environments with direct Metro access, inside the Beltway,” she said. 

With gas prices quickly rising toward $4 a gallon, that’s likely to be the case elsewhere, as well, said NAR economist Ratiu. “If the trend in gas prices continues, it will become simply more expensive to have an hour’s worth of commute to your work versus being able to take public transit,” he said. Suburbs can also be on transit lines. “In some areas, the layout of the metro area is centered a lot more on suburban than central business districts,” Ratiu said.

It will probably be three or four years before the large inventory of office space is absorbed enough to see construction of new buildings ramp up, he said. But when it does, more buildings will incorporate “green” architecture principles, which already have proven their value, Ratiu said. “That, I believe, will become a lot more prevalent. Landlords recognize they are able to attract better tenants and extract higher rents.”

Reis economist Calanog said the nationwide office vacancy rate —which has been the highest in 17 years — is finally starting to inch down slowly, at 17.5 percent for the first quarter of 2011, down from 17.6 percent the previous quarter, and the first decline since the third quarter of 2008. He expects vacancies to be at 14.3 percent in 2015, dropping to12.5 percent by 2019. “So we’re not projecting massive improvements in the office sector given recent trends towards the more efficient use of office space, etc.,” he said. 

As for where the demand for office space will go over the next decade, Calanog offers this reminder: “Trends tend to move in cycles. If central business district office space becomes so attractive that rents start spiking to high levels, suburban office space may once again become an attractive option for businesses that are priced out of ritzy downtown locations.”

Judy Newman is a newspaper reporter in Madison, Wis.

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