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Major retrofits and the repurposing of older buildings have become leading trends as urbanism and millennials drive transformative change.
As 2014 winds down, we find the real estate industry in the throes of transformative change thanks to economic recovery and a fast-evolving workforce that continues to redefine corporate space requirements.
For companies with ambitious recruiting and expansion plans — and for real estate owners, developers and investors faced with the pressing need to upgrade older holdings to meet next-generation demand — this is a pivotal time. All stakeholders must focus on positioning themselves for long-term growth, change and competitiveness. The challenge is accentuated by the fact that much of the existing office inventory is antiquated, with decades-old features designed to accommodate a different generation of users who had different priorities and work habits.

Why the sense of urgency? Economic and related real estate recoveries are on track to accelerate over the next 24 months. Already, the office market is gaining solid traction. In the first three quarters of 2014, central business district (CBD) leasing and absorption reached the pre-recession levels of 2008, and overall vacancy fell to its lowest level in five years. Rents are creeping up in hot markets like New York, Chicago and San Francisco. With projections looking positive as we head toward 2015, the demand divide between older and new buildings is growing as tenants seek space that accommodates new workplace models. The questions on many minds are 1) how will older buildings compete and 2) is a bifurcated market emerging in which new towers will ultimately outperform older Class A stock? Here is a look at some of the trends and issues behind this transformative period.
Demographics and Demand

Two well-documented shifts related to human capital are having profound impacts on the office market. First, the sudden rise of urbanism over the last 10 years has resulted in explosive growth in many central urban markets. The exodus of millennials and empty nesters from suburban to urban markets shows no signs of letting up and, in turn, companies are seeking modern space as close as possible to this concentration of intellectual capital. A shortage of modern office product has ramped up competition for Class A space and is triggering new office development cycles.
Second, the labor pool is shrinking as baby boomers retire. By 2022, millennials — who today represent a much smaller population of workers — will make up more than 40 percent of the workforce.
Such influences are converging and are major reasons why companies are moving quickly to position themselves to compete for talent in central urban markets. Senior managers know that in order to attract and retain a millennial-based workforce they must offer updated workplaces that support collaboration and offer ample lifestyle amenities. Today’s custom-designed environments provide lots of light and fresh air, supporting employee work habits with both open and private work areas. Never before have workplaces played a more important role in reinforcing brand, culture, employee morale, productivity, corporate social responsibility and retention/recruiting objectives.
New efficiencies are also being delivered and, as always, cost control remains a priority. As labor costs rise, companies will work to lower other major line items — including real estate, effectively switching focus from cost per square foot to cost per seat. To that end, and also because of changed work habits that have rendered large offices unnecessary, average square footage per employee continues to decrease.
There are many examples of firms growing with less space, but one major accounting firm comes to mind. It reduced its space at a premier Class A office tower by 22 percent and incorporated a “virtual office” hoteling concept. This enabled it to increase its head count by 36 percent and support its larger staff in just 75 square feet per employee.
Aging Inventory, Modern Environment

The majority — 82 percent — of Class A office buildings in U.S. CBDs were constructed prior to 1990, and 53 percent were built before 1980. Can yesterday’s buildings support today’s workplaces? The answer, in most cases, is no, which raises the question: What can be done with that product? In a growing number of cases, owners are extensively retrofitting buildings and/or converting them to other uses. Others are being taken down altogether and rebuilt to suit the needs of specific tenants.
Within these projects, the traditional layout of cubicle farms surrounded by corner offices is disappearing in favor of open architecture and collaborative work areas. Formal glass and steel finishes are being replaced with exposed brick and timber. Technology and systems are being upgraded to the latest, fastest and most efficient standards.
New office designs are also blurring the lines between work and play. When it comes to lifestyle amenities, companies are incorporating bars, game rooms, rooftop gardens, gyms and more. It all comes down to corporate branding and the fight for talent. Adobe, which focuses on giving employees an “awesome experience,” is a well-known leader in this area. Its major sites incorporate bistro restaurants, locker rooms, basketball courts, fitness classes, dental and other health care facilities, hair stylists, dry cleaning and ATMs.
Some of these more “extreme” lifestyle amenities may stay within the technology industry and creative sectors. However, even law, financial services and insurance firms are being influenced by new workspace trends. While there may never be a pingpong table in the break room at a large law practice, we are seeing more open floor plans and collaborative areas, as well as careful consideration of locations near areas with amenities and urban context. Again, all of these shifts are aimed at attracting and retaining younger professionals.

CBD Renovations on the Rise
As more companies buy into updated workplace models, renovations to older buildings have skyrocketed. In New York City during 2013 and 2014, 24 buildings totaling 8.3 million square feet were or are being renovated. This compares to nine new construction projects totaling 7.5 million square feet that were built during the same period.
The burgeoning Midtown South submarket, which is home to 10 of these property renovations, is a direct beneficiary of this trend. Long considered a residential part of the city, as well as home to smaller and less traditional office space users, Midtown South is now drawing household-name corporate tenants. The famously quirky office of one of its best-known occupants, Google, serves as a prototype for the office-meets-company-culture movement.
Examples of the renovation/con-version trend in Chicago include 1000 West Fulton (now known as 1K Fulton), a former cold storage building that Sterling Bay is converting to creative office space. (See “Edge Markets Go Mainstream” on page 60.) Nearby, Shorenstein is renovating a 64,000-square-foot former meat packing facility at 210 North Green Street. Shorenstein also recently completed the 1.2-million-square-foot River Point North (formerly the windowless Apparel Center), which caters to tech tenants. In 2013, 3.3 million square feet of space was renovated in Chicago and, as of late 2014, an additional 735,000 square feet of space is under renovation/conversion.
In San Francisco in the last two years alone, more than 3.1 million square feet of space has been renovated and upgraded to meet the demands of the region’s robust tech growth. Shorenstein’s 2012 renovation of the former Furniture Mart, which became the home of Twitter, helped gentrify the Mid-Market area and attracted additional tech companies, including Yammer, One King’s Lane, Square and Uber. Another noteworthy renovation involved the transformation of 680 Folsom from a vacant former PacBell building into the home of Macys.com and Riverbed Technologies.
Not Just an Urban Phenomenon
The renovation craze is not confined to central urban markets. In fact, the country’s suburban markets — particularly those outside major urban hubs — are home to some of the most creative property reinventions. These projects are bringing urban lifestyle amenities to non-CBD markets.

In New Jersey, corporate downsizing, aging inventory and the growing popularity of new workplaces have left sprawling suburban campuses vacant or struggling. At the same time, however, many are finding new life as mixed-use, “live, work, play” environments. A great example is the 472-acre, 1.8 million-square-foot former Bell Labs research facility in Holmdel, where Somerset Development is planning an indoor “town center” featuring a pedestrian promenade and a blend of uses. Foremost in the plan is a health and wellness component, including an ambulatory surgery center, doctors’ offices and assisted living and skilled nursing facilities. The balance of the space is being marketed to include retail and dining outlets, office space, a hotel and conference center, educational facilities and an upscale spa.
Across the country in El Segundo, California, Pacific Corporate Towers is a 1.6-million-square-foot, three- building office complex. A recently completed renovation positioned the 1970’s-era property as a lifestyle-rich, multitenant campus. The ownership, an investment management client of BlackRock, converted indoor and outdoor areas into lively communal gathering spaces with a contemporary design aesthetic. This included the addition of breakout rooms with lounge seating, flat screens and high-top tables, as well as outdoor decks with heaters for seasonal comfort and electrical outlets for computer use. New outdoor recreational amenities include bicycles, a pingpong table and an outdoor exercise area adjacent to a full-service gym. Today, the complex is home to a community of 80 tenants ranging from creative start-ups to Fortune 500 companies.
In the Chicago suburb of Northfield, Kraft Foods Group wanted to create an open workspace that would spark innovation and reflect its “startup” spirit following the company’s launch as a new, independent Kraft in October 2012. Renovation of its 715,000-square-foot, 88-acre suburban campus eliminated private offices and incorporated a new collaborative office layout. The company added amenities like shuttle service, massages, retail, health care and pet care. Kraft has proudly exceeded its talent and recruiting objectives.
In Silicon Valley, Google is using innovative ways to retain and attract talent to the suburbs while competing directly with tech companies expanding in San Francisco’s urban hot spots. The company transformed a more traditional 525,000-square-foot, four-building campus into a mini-urban environment known as “the Googleplex,” a 2.3 million-square-foot campus that now spans a large portion of Mountain View. In addition to providing a dense concentration of complimentary amenities, Google is pioneering a “version 2.0” of the live, work, play concept. Cutting-edge flexible internal space is supplemented with outdoor cafeterias that serve food prepared by renowned chefs, organic gardens, sporting venues, sculpture parks, fitness facilities, massage rooms and even sleeping quarters known as “nap pods.”
America’s tallest building, the 104-story, 3 million-square-foot One World Trade Center, offers smaller buildouts to attract smaller creative office tenants as well as space for larger tenants. The building is 62 percent leased to Condé Nast, Vantone China Center and the U.S. General Services Administration.
Google is also tackling one of the broader challenges many suburban areas face: undersupplied mass transit. In addition to providing bikes that workers can use to navigate the sprawling campus, the company offers electric car charging stations and Google buses equipped with Wi-Fi and workstations to foster a working environment while employees commute from San Francisco and Oakland. Google continues to think ahead of the curve, acquiring additional property rumored to be as diverse as corporate housing to offset the lack of affordable housing near the campus. The functionality of real estate at the Googleplex is an essential element in the company’s plan to “captivate” employees, elevating their standard of living by blurring traditional work/life barriers and dwarfing a typical employer’s competitive advantage.
Looking Ahead
Simply put, retrofit activity in both urban centers and suburbs responds directly to demographic and technological change. It is happening in places where the people who make up the evolving labor pool want to live and work. How developers respond will have a direct impact on asset pricing and value. In turn, the investment community will be paying increasingly close attention to these shifts. Investors are already altering allocations for certain markets and property types. In the short term, this will translate into some fairly notable transformations. As for the long-term outlook, it is safe to say that this is not a passing phase and that these trends will continue to redefine the office real estate landscape for the next 10 years or more.
By: Maria Sicola (NAIOP Development Magazine)
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ATLANTA—Women have come a long way in commercial real estate, but Lori Kilberg, a partner at the Hartman Simons & Wood commercial real estate law firm in Atlanta who began her one-year term as president of CREW Network in January, says there’s still a long way to go. Indeed, women are still not on par with me in the industry, according to industry research.
“Work hard, be passionate about what you do and be authentic,” says Lori Kilberg.
GlobeSt.com caught up with Kilberg to get her take on the challenges facing women in commercial real estate and her predictions for 2015 in part two of this exclusive interview. You can still read part one: How One Woman Networks for Success.
GlobeSt.com: Where do you think women in commercial real estate have made the most progress, and what remains their biggest challenge?
Kilberg: Women have unquestionably made great strides in the industry, and many have advanced to positions of influence. CREW’s collaborative approach to doing business and to “developing relationships to develop business” is one that resonates with Millennials and will continue to be an important model for the future.
Unfortunately, although there are many qualified women coming into the industry as well as in mid-level management positions, there is still much too great a discrepancy between the number of men and women in the C-suite. CREW’s research indicates that this is in part because of a lack of sponsors, for example, people who actively advocate for the advancement of women in their companies.
Pay disparities also remain. Our research shows that women in commercial real estate specifically, and in business in general, are less likely to negotiate their salaries or ask for promotions.
GlobeSt.com: If you were to give some advice to a woman just entering the commercial real estate industry, what would it be?
Kilberg: This is advice I give to any young person starting a career, and I believe it applies equally to men and women: Work hard, be passionate about what you do and be authentic. Take interest in your work and the people around you, be curious and ask questions. Find a mentor and a sponsor, and actively nurture those relationships—it’s hard work!
GlobeSt.com: What’s your quick prediction for how the commercial real estate markets in Atlanta and through the Southeast are poised to perform over the next 12 months?
Kilberg: I am optimistic. The multifamily sector of course has been on a record-setting streak over the past few years, and the office, industrial, and retail sectors continue to head in the right direction. Broadly speaking, I think a steadily improving economy and rising consumer and corporate confidence will result in a commercial real estate sector characterized by increasing occupancies and rising rents in 2015.
By: Jennifer LeClaire (GlobeSt.com)
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For most landlords, some security may be better than none.
Landlords want to be assured of the economic strength of their tenants; however, determining what is the right amount of security can be difficult. In a perfect world, the landlord takes a full guaranty from a creditworthy person, especially if there is any question as to the tenant’s ability to pay the rent and meet its other obligations under the lease. However, the creditworthy principals behind the tenant will likely resist a full guaranty. After all, that is part of the reason some company principals choose to organize as corporations and limited liability companies.
In these situations, landlords may still be able to satisfy their need for security with a limited guaranty. The following three limited guaranties are possible options. Though not an exhaustive list, they should be a good starting point for negotiations with tenants and any potential guarantors, providing landlords with acceptable security for tenant obligations under the lease.
Maximum Dollar Cap
The parties may agree to a maximum dollar cap on guarantor’s liability. The liability can be capped at any amount, and something is better than nothing. The cap of liability should be related to the value of the lease and the landlord’s potential loss. The larger the risk of loss from a tenant default, the higher the dollar cap should be.
Obviously, the perceived credit strength of the tenant is a factor, as well as whether it has been in business for several years or is a new company. Negotiating a maximum dollar cap amount for a limited guaranty would allow the lease guarantor to limit its potential liability to an acceptable amount, and it would also allow the landlord to mitigate its risk and reduce potential losses.
Formula-Based Guaranty
Alternatively, a formula can be used to create a cap that will cover a landlord’s foreseeable losses. This approach may allow more flexibility than a simple fixed cap. The following categories are commonly used to create a formula to cover certain out-of-pocket expenses incurred by the landlord at the start of any lease:

• the amount of the unamortized tenant improvement allowance and
• lease brokerage fees.

To the sum of those amounts might be added an allowance for preparing the leased space for a new tenant and an allowance for attorney’s fees expended to recover the premises. Some part of the rent, both past due and pending, might also be added. The following is an example of a formula-based guaranty:
Guarantor’s maximum liability =
delinquent rent + six months’ rent + unamortized tenant improvement
allowance + any allowances for recovering and preparing the leased space
Another variation on this approach is to provide that the number of months of rent that is covered reduces over time. If a tenant defaults in year one of a 10-year lease, the guarantor will owe one year’s rent plus the other guarantied amounts. If no default occurs until year five, then six months of rent might be guaranteed.
Of course, a formula-based guaranty will focus on the business considerations of the parties and will differ from lease to lease. A formula approach can be useful since it is more flexible than a maximum dollar cap approach. When using a formula-based guaranty it is important to define all key terms such as rent, attorney’s fees, maintenance costs, and others used in the formula. If the components of the formula are not specifically defined, then enforcement of the guaranty will be impaired.
Rolling Guaranty
A third option is a rolling guaranty. If the tenant performs and fulfills its monetary obligations under the lease for a certain period of time, then the landlord’s risk of loss declines, and the guarantor’s liability may be reduced. Thus, if a tenant does not default for the first 36 consecutive months of a seven-year lease, then the guaranty could expire at that point in time. Or the cap of the guaranty may decrease in stages over time. Finally, instead of the simple lapse of time, the cap on liability under a guaranty might decline upon reaching certain financial benchmarks, such as an increase in net worth, gross sales, or revenues. As long as the parties agree on the benchmark, any financial target can work.
These three examples of limited guaranties are just some of the ways to address a landlord’s need for security while attending to the desire of a lease guarantor to limit liability to a reasonable level. The keys to a successful lease negotiation when a separate lease guaranty is necessary or desired are for all parties to remain flexible and to understand the legitimate business needs of the other party. By doing so, the parties should be able to arrive at a mutually acceptable limited lease guaranty that facilitates the successful negotiation of the lease itself — and helps secure the landlord.
By: Tamarah R. Feigl and Megan Rose Altman (Commercial Investment Real Estate)
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Low interest rates fuel loan prepayments.
With the real estate market on a significant upswing and lenders across the U.S. loosening their purse strings, defeasance activity has picked up substantially over the past two years. According to industry reports, more than $13.2 billion of commercial mortgage backed securities loans were defeased in 2013, representing a 123 percent increase from the previous year.
With Treasury yields keeping defeasance costs relatively high, defeasance activity has been driven primarily by borrowers looking to capitalize on the current low interest rate environment and the improved lending arena in general, both for purchases and refinances. A major impetus behind defeasance is an increase in property value. The defeasance process allows borrowers to extract equity out of their properties and lock in new, long-term financing. With property values rising and sales activity increasing, the result is that more loans are becoming attractive to defease.
Considering the high volume of loans nearing maturity over the next few years, the already booming defeasance industry is expected to be exceedingly active, with Trepp projecting a significant increase in 2014 defeasance volume over 2013.
The majority of loans defeased in 2013 were retail, office, and multifamily properties, accounting for 82 percent of total activity. Similarly, for the first half of 2014, retail and multifamily properties led the way as the most commonly defeased loans by asset type, followed by office, hospitality, and self-storage properties, according to AST Defeasance consultants. Moreover, the short-term trends of the last few years are changing with 2013 data from Moody’s showing that borrowers are defeasing loans with longer remaining terms than in 2012.
Defeasance Explained
Despite the rebound in defeasance transactions over the past two years, defeasance remains an unfamiliar topic to many professionals in the commercial real estate and finance arenas. Most often used in commercial real estate as the prepayment penalty on conduit/CMBS loans, defeasance is the process of releasing a commercial property from the lien of the mortgage and replacing it with a portfolio of U.S. government securities. Once a loan is defeased, the securities portfolio effectively replaces the borrower’s payment stream and makes the remaining mortgage payments on the loan, allowing the borrower to either refinance or sell the property free and clear.
The process of defeasance is highly coordinated and involves an array of professionals, including accountants, attorneys, brokers, consultants, rating agency personnel, and trustees. Defeasance consulting firms have become a standard component to defeasance transactions, retained by borrowers to help maneuver the process and minimize costs.

While the defeasance process itself is relatively standard, each loan contains unique attributes that consultants maximize to the benefit of their clients. In addition to ensuring the process runs smoothly, the defeasance consultant is also responsible for structuring the defeasance portfolio. This portfolio of optimized securities, typically U.S. Treasurys or Agency securities, will match the debt service payments of the original loan while still adhering to legal and industry standards. Strict guidelines govern how much cash may be included, month-end balances have limits throughout the life of the loan, and a large universe of bonds exists from which to construct the portfolio.
Timing Defeasance
Defeasance can be a preferred option in many different market environments, the most obvious being when interest rates are falling and borrowers can obtain lower interest rate loans on their properties by refinancing. However, defeasance can also make sense in a higher interest rate environment when borrowers have enough equity in their properties to cover the prepayment penalty.
While penalties still range from tens of thousands to tens of millions of dollars, many borrowers can save considerable amounts by defeasing in today’s lending market. Defeasance presents the opportunity to move interest rates from 5.5–7.5 percent to 3.5–4.5 percent, while offering protection against probable interest rate increases over the next few years. In many cases, defeasing today means negating interest rate risk at a minimal cost.
For example, for a borrower with an original principal loan balance of $10,000,000 originated in June 2007 at a 6 percent interest rate with a 10-year term, the potential cost savings from defeasing now will be approximately $562,094.63, based on current interest rate forecasts. As illustrated in the graphic below, while the total cost to defease today is approximately $1,040,000, total interest payment savings from locking in a new 10-year loan at 4 percent interest today rather than 5.5 percent interest in 2017 will be approximately $1,600,000, resulting in a net profit of approximately $560,000. Should interest rates move above 5.5 percent by 2017, these savings will be even more substantial.
Moreover, for borrowers looking to lower their defeasance costs by waiting for yields on Treasurys to rise, it should be noted that this strategy will most often have only a minimal impact on costs. For example, should the borrower choose to delay defeasance until the relevant Treasury rates increase by 10 basis points, the defeasance savings will be only approximately $21,000. Obviously, while these savings are certainly helpful, they pale in comparison to the potentially hundreds of thousands of dollars in increased interest costs that borrowers risk incurring by delaying their refinance.
Indeed, most borrowers view defeasance as a Treasury-rate game, believing that they should delay their defeasance as long as possible to lower their costs. However, as demonstrated by the savings in the graphic below, the rewards associated with defeasing today can often outweigh the rewards of delay.
By: Eitan Weinstock (Commercial Investment Real Estate)
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