Q&A … With Nick Suarez

Q: Four years after the pandemic, has the office market in this region fully digested the impact of those sudden changes?
A: I don’t think the market has fully processed the impact of COVID yet, because there are still hundreds of thousands of square feet of sublease space available and a large number of leases that were signed pre-COVID that haven’t expired yet. When those leases expire, it’s safe to assume that all those sublease opportunities won’t be absorbed and many tenants won’t sign a new lease with the same amount of square footage. We have plenty of recent examples of tenants expanding, but on average, new deals are being signed for less space than pre-pandemic. From a vacancy-rate standpoint, for the foreseeable future, I think we’ll continue to see the overall vacancy rate increase. 

Q: Those pre-COVID leases go back at least five years; how has the experience since then altered tenant preferences on duration of leases?
A: Every company is different, but I would say that, with the exception of existing spaces in really good shape with higher-end finishes that a tenant can plug right into, companies that are relocating an office today are typically looking to make long-term lease commitments, in excess of five years.  It’s a big endeavor to relocate an office and particularly expensive to build out a new office today, so it doesn’t really make sense to go through that whole process and make that type the investment to relocate for a short period of time. I also believe that many companies are starting to figure out how they want to use space for the long term, so they are comfortable taking that leap of signing a longer-term lease. 

Q: Tell us a bit about how you see the flight to quality unfolding in the Kansas City area in terms of new facilities coming on line, demand and rent-rate trends.
A: We’re absolutely experiencing a flight to quality in Kansas City, just like they’re seeing in other major markets across the country. Flight to quality is a real thing. If you look at the buildings in Kansas City that have had the most success attracting new tenants coming out of COVID, they are the newest, the nicest, best-located, and most-amenitized buildings. The vacancy rate in Kansas City is hovering between 18 and 20 percent. However, for buildings built in Kansas City since 2012, the vacancy rate is 7.3 percent. That’s a fraction of the rate of other older properties. If employers are requiring staff to be in the office, they generally want to provide a higher level of experience for those workers and create an environment that they want to work in. 

Q: What does the new Class A market look like?
A: We’ve got really good examples of new Class A buildings outpacing lesser-quality buildings coming out of COVID. Buildings like 46Penn on the Plaza and City Place at College Boulevard and U.S. 69 have had a tremendous amount of success attracting new tenants. These represent some of the most expensive office buildings in Kansas City and tenants are willing to pay the freight. 

Q: What’s defining those high-end amenities today?
A: Conference centers, fitness centers, food options, walkable amenities—those kinds of things. Those have always been important, but they’re critically important today. With amenities, you can’t just check the box and say we have a conference room down the hall with four chairs and a table. It has to be well-done, easily utilized by tenants, with full AV/IT setup, etc. Tenants really need to see the value in the amenities that are being offered because it’s important to create an environment that employees are happy with.

Q: Does that trend extend down to mid-size and smaller companies?
A: Absolutely. Employers want to offer an environment or building that pulls people in, as opposed to pushing them into a building. It’s interesting: I believe tenants’ attitudes toward certain projects have changed coming out of COVID. Crown Center and the Aspiria Campus are good examples; both always had all the amenities that companies were looking for today with fitness centers, food options, all these different experiences for tenants. But I feel like those experiences are so much more important to employers today than pre-COVID, and as a result has increased demand for those projects.

Q: What’s your take on the overall quality of existing office space here, doing the triage between percentages of trophy, functional and obsolete structures?
A: I would say we do lack true Class A, high-end product that you might find in larger metros across the country. If you look at most of the nicer buildings built around the city, aside from newer properties the last 10 years, a lot of these were built in ’80s and ’90s. Certainly, there are buildings that offer really nice space all throughout the city and are available. But if you’re looking for big chunks of really high-end space, we don’t have a large supply here in town.

Q: Is that level of demand pushing up lease rates?
A: Coming out of COVID, we really haven’t seen rental rates go down; in fact, they’ve increased slightly. Part of that is because it’s so expensive for landlords and tenants to do new deals. If a landlord is offering a significant improvement package to a tenant, it’s hard for them to also offer a super-reduced rental rate. The math doesn’t work. Additionally, operating expenses and real-estate taxes have gone up, which have contributed to the raising rates.  That’s not to say that there aren’t buildings out there where you can’t find a deal, you absolutely can, but it will be in a less-desirable property.

Q: Aside from the existing Class A, can the merely functional buildings out there be modified to achieve trophy status, or something closer to it, that will justify higher rents?
A: I don’t think that will work for every building. If there’s a building in a fantastic location with good bones, and really functional floor plates, there’s certainly a case to be made for an owner to invest a significant amount into the building, and they’d be able to achieve much higher rental rates. But the cost to do that in today’s world is extremely high. Getting a lender to play ball with investors to redevelop a building is also a challenge today. That said, there is evidence of that repositioning working successfully here in Kansas City.  There is a perfect example of a building out on College Boulevard, where the owner had a long-term tenant in the building, but it lacked windows, was old and generally not appealing to tenants in today’s world. That tenant moved out and the owner decided to make a huge investment, completely overhauled the building, refaced it, made it feel brand new and it quickly filled up. They’re now leasing that building for rates that are as high as most buildings in Kansas City. That’s evidence that if you can deliver a really nice product that’s well-located, tenants are willing to pay. There just aren’t many buildings like that available right now and the cost to do that is an impediment.

Q: Do certain submarkets of the region have disproportionately large percentages of those older, less-functional sites?
A: You can go into every submarket and find some buildings that aren’t appealing to office tenants today. If you take a building that’s obsolete, it’s nearly impossible to invest enough money to go from Class C to Class A. It would really have to be in a perfect location. A lot of things would have to fall into place for that to work. Certainly, there are some smaller, older buildings Downtown that probably don’t make sense for office space anymore, but a lot of those have already been converted to other uses, whether it’s residential or hotels.

Q: Where’s the momentum for repurposing those, and what formats might those projects be taking? Residential? Retail? Medical? Or is demolition the more likely solution?
A: Again, a lot of the buildings Downtown that seemed to have made the most sense for some type of residential conversion have already been converted or are in the process of being converted.  That’s not to say there won’t be additional repurposing of buildings but it sure seems like the low hanging fruit has been converted. We’ve also seen examples of suburban buildings being considered for residential conversions, but I’m not aware of any of those that are full-steam-ahead quite yet. In other markets around the country, we’ve seen office buildings scraped for industrial development, but we haven’t seen that in Kansas City yet.

Q: Does the decline in the value proposition of obsolete structures portend downstream issues for municipalities, such as property-tax assessments/collections?
A: There is certainly a snowball effect of people not working in offices. If you’ve got a building Downtown or in a submarket where, pre-COVID, that building was 100 percent occupied, and it’s now 50 percent, almost half the people are no longer there to get coffee at the shop down the street, a sandwich for lunch or a beer around the corner after work. That means less business for those shops, less sales tax being paid, and so on and so forth. So it’s not just the office building owner that is impacted, it’s felt by other parties as well.

Q: How much of the underlying economics of office demand are grounded in asset quality, and how much is attributable to other factors, such as higher interest rates?
A: In my opinion, the demand for office space is mostly influenced by the change in how people are using office space today. Again, we have plenty of examples of companies acquiring more space; HNTB great example. Nationally, since the pandemic the average deal size for new leases has decreased by over 20 percent. People are typically taking less space, and when less space is being absorbed, it impacts a lot of things.

Q: So the market will, for the near term, anyway, continue to be unsettled?
A: I don’t believe the hybrid workplace model is going away anytime soon, but I do believe that more companies are settling in on how they intend to use space for the long term. What many companies are trying to figure out now is how to accommodate the same number of people they previously had but in a more efficient way.