Investors are increasingly looking to redevelop unproductive office properties for industrial uses as ever-increasing demand has left many would-be industrial tenants out in the cold.
Industrial vacancy hit 4.6% as of Q3, according to data from Newmark, an all-time low. And as tenants race to secure space (with rents at staggering highs), the firm says that since 2018, at least 45 office properties totaling more than 11 million square feet have been redeveloped—or are in the process of redevelopment—for industrial use.
“The US office market is contending with uncertainty in the post-COVID-19 world, and the pandemic has only accelerated obsolescence of some older, less-amenitized product,” the report notes. “This divergence among asset classes is increasingly driving investors and developers to consider industrial redevelopment opportunities for some unproductive office properties.”
Most of the office redevelopment Newmark is tracking is in markets where density and a lack of developable land are contributing to historically tight vacancy levels.
“While office space generally costs significantly more to build than industrial and yields higher rents when occupied, the economics supporting industrial redevelopment in these regions are buoyed by exceptionally strong market fundamentals, particularly when compared to each metro’s office market, where office vacancies are roughly 10 to 18 percentage points higher as of third-quarter 2021,” the report states.
Chicago leads the nation in office to industrial conversions since 2018, with 3 million square feet either converted or proposed for conversion. The Windy City is followed by Los Angeles (2.1 million square feet), Boston (1.7 million square feet), Northern New Jersey (1.5 million square feet) and Orange County (also 1.5 million square feet).
However, converting offices into industrial projects isn’t necessarily straightforward, according to Newmark analysts. The firm’s proprietary modelling and analysis says the best office candidates for industrial conversion tend to be older suburban assets with an average land area of roughly 15 to 25 acres and located within four miles of a major highway.
“Layering in zoning considerations, existing land availability, industrial and office submarket fundamentals and other geographic attributes will also inform strategy, as not all obsolete office buildings present opportunity,” the report notes. “Sites may face challenges including community opposition and zoning restrictions, increasing development costs, as well as challenges from competing uses; in particular, multi-family, healthcare and life science reuse.”
Research from Cushman & Wakefield predicts that by the end of 2021, the North American industrial market will hit more than 507 msf of net absorption—the first time ever the market has surpassed 500 msf.