In KC’s Office Market, the Times They Are a-Changin’

By Bob Fagan

Regional realty market dynamics differ, depending on Downtown or suburbs.

I went to see Bob Dylan live a few years back to cross him off the list of living legends I wanted to see in person. At the end of the show, I realized that not only had he lost most of his voice, he hadn’t picked up a guitar once during his performance. “The times they are a-changin’,” indeed. That’s true for both Dylan and, more relevant to us in Kansas City, for the ever-changing office market in our fair city.

Overall, the market is gaining health based on rising employment numbers and the safety of our greatly diversified local economy, which is one of the city’s greatest attributes. The commercial real estate market is much like a spider web in that the different elements of it are inexorably tied into one another. If office vacancy rises, that means fewer office employees are occupying that space—which means fewer apartments are being rented and fewer disposable goods are being bought at retail locations and summarily stored in warehouses.

Probably the best way to view the continued health of the office market in our metro area is to break it down into two areas of geographic concentration: the Central Business District (Downtown) and the suburbs. Each has its own set of economic dynamics; each can seemingly move up or down independent of the another.

The suburbs are now seeing the shift away from a “tenant’s market” for the first time since early 2008. Class A properties are faring much better than Class B properties, but that is part of the “Flight to Quality” cycle that occurs in every down market.

The real issue now is that our seemingly modern suburban buildings are now showing their age. The vast majority of the suburban office development happened between 1978 and 1992, which means there are gleaming glass or brick buildings on well-placed corridors that may appear modern, but can no longer compete. They are either subject to demolition or a resetting of the base value, whether through a sales price much lower than current construction costs, or a foreclosure and inevitable sale at prices that allow redevelopment.

Take for example the Glenwood Buildings at 95th and Metcalf in Johnson County. These 256,000-square-foot twin towers were forced to suffer foreclosure and then sold to a user for about 10 percent of what it would cost to build them today. Resetting of the value of these assets allowed the new buyer to make the substantial reinvestments needed to bring them up to standards demanded by modern tenants.

In 2010, we saw an unprecedented number of vacancies in the suburbs in excess of 100,000 square feet in buildings with healthy landlords. Today, that number stands at just three,
which illustrates that savvy tenants have treated lease space as the commodity it is and leased when prices were at the bottom. Unlike Downtown, when a building in our suburbs becomes obsolete, there is rarely an opportunity for residential conversion.

Every city’s downtown market goes through multiple periods of reinvention, and ours is no exception—it is changing before our eyes. The expectation that retail entertainment and support elements like a centrally placed grocery store would create a rush of increased office occupancy was premature. What those things did help with is the resurgence of Downtown living, with more than 22,000 residents today and with 2,500-plus units planned or under way.

One way to raise occupancy numbers in any area is to reduce the stock of office vacancy by converting it to other uses. As it stands today, six Downtown office buildings are under contract with plans to convert to residential. Between them, 911 Main, the Mark Twain Tower, Traders on Grand, the Scarritt Building, the Argyle Building, 215 W. Pershing and the Corrigan Building have roughly 1,438,000 square feet of space.

That represents 9 percent of available CBD office space. This will result in an improvement in the vacancy numbers for the area as well as average lease rates. Unfortunately, most of the recent leases executed in the CBD have been tenants moving within that market and from nearby.

The imminent move of the GSA to 147,000 square feet in the CBD will raise occupancy rates by about 1 percent without creating any trackable office vacancy anywhere else in the metro area, which is great news. Although Downtown is improving and the news is encouraging, the pace is slower than anticipated.

I am going to see the Eagles at the Sprint Center this month to check them off my list. They have a number of titles that would apply here, like “On the Border” or “In the City,” but I would imagine the most applicable song for this market is “The Long Run” because, tenant’s market or landlord’s market, the proper view of the office market future here indeed is a long one.