Office to industrial conversion likely to be minimal
What to do with vacant and underutilised office buildings has been a question that the commercial property industry has pondered since the pandemic.
At the MIPIM global property conference in Cannes, France, which I attended this week, the question of vacant offices was hot on the agenda. While everyone agreed that the office sector would change, the world's most influential players in the property industry were looking for innovative ways to repurpose the growing number of redundant office blocks.
Many unnerved investors in the sector asked whether converting urban offices to logistics real estate was a viable option. One of the UK’s largest asset managers explained that industrial land prices were becoming more valuable in certain parts of London than office land prices. In many leading cities, rental rates for logistics spaces were now beating office rates.
The largest industrial property owner in the world, Prologis, announced that it had acquired an 11,000 square metre office block and had plans to develop it into an 18,000 square metre logistics facility. This ability to scale this model was discussed at length at the well-attended conference.
It is critical to understand that the Prologis example is unique because the office property they plan to convert is unique. Their newly acquired complex sits on a giant piece of land, a critical requirement for logistics real estate that relies on vehicle delivery and dispatch. The site is adjacent to highways, twenty minutes from a Port and an International Airport, and was right near several dense population centres.
The same questions that floated around MIPIM are being asked back in South Africa. Owners of emptying office blocks have been asking us whether Inospace can convert them into logistics real estate assets.
Yes, there is growing interest in logistics conversion opportunities as South Africa follows global trends. Logistics and warehouse spaces have been one of the big winners of the Covid-19 pandemic. We are not unique.
Expanding demand has pushed the supply of logistics and industrial real estate availability to new lows. Before the onset of the pandemic, the global supply chain was already fragile, but the disruption from the lockdowns caused it to snap. A domino effect ensued as businesses tried desperately to keep up with the sudden surge of online orders. The system couldn't keep up with demand, causing every transportation and logistics operation to boom.
We live in the delivery and digital economy because technology has taken us to the point where physical offices are not required for administrative functions, and shopping malls are not needed to distribute products. Yet, warehouses are necessary to assemble, store and deliver goods and products.
Most investors never believed that we would ever live in a world where industrial space is worth more than office space. The London example is not unique. There seems to be a global trend of sharply rising industrial rentals.
We have already reached the point in Cape Town where a warehouse in Paarden Eiland is getting the same rental rate as a B-Grade office in the city centre.
Growing demand and limited supply of new mini-industrial units (which are used to house last-mile logistics spaces) have collided to create an extreme scarcity of logistics space where it's most needed.
Unfortunately, our view is that office blocks in South Africa will not be easily converted into last-mile logistics spaces. There is significant availability of office blocks. The reason is that there's not a lot of need for big-floor-plate, white-elephant suburban office buildings in and around South Africa's cities.
So what happens to these ageing edifices across the country —whether they are converted to other uses, demolished or upgraded to suit modern needs—will shape what work the contemporary city and surrounding suburbs will look like in the decades ahead.
Our view is that the differences in building requirements and tough zoning regulations would lead to minimal conversions of office space to logistics space. Although we believe that over ten million square metres of office space could be converted into other uses over the next three years, most will be residential conversion. Residential conversions, like the ones that developers Blackbrick are doing, have been particularly successful.
There are several reasons why most office spaces will not or cannot be converted to logistics spaces.
Offices have limited reuse potential as logistics facilities. Using existing buildings is determining; they would need to be demolished, adding to an already complex process, lengthening development timelines and boosting the rents required to justify the conversion financially.
The undertaking would be too costly. A demo and rebuild extend carrying costs, brings rezoning risks and often requires the removal of many different tenants. However, office sites with large parking, narrow floor plates and =double story configurations with basement parking could be a more attractive target.
Only locations that can achieve premium rental rates would justify the high cost to convert. Despite potential opportunities, the office-to-logistics conversion trend is likely to be minimal.
In city centres and better suburban areas, conversions of office blocks into apartments and hotels will grow. Before the pandemic, developers in most CBDs, including Durban, Pretoria, Johannesburg and Cape Town, transformed early 20th-century office buildings into successful apartment blocks. Although these conversions can be tricky, this is the best use for superfluous office blocks, and the trend of more empty office blocks converting into bustling residential buildings will continue.