Office Buildings: a Strategy for the Future

How do occupier expectations and market fundamentals affect the quality of office space? Bolesław Kołodziejczyk, Head of Research & Advisory at Cresa Poland, presents four strategy options for property owners: maintain, transform, defend or repurpose, depending the building’s quality, location, tenant-mix and expected rates of return.

Age structure of Poland’s office buildings

The Polish office market is growing at a rapid pace. Poland’s total office stock rose from 4.9 million sq m in early 2010 to approximately 10 million sq m today, and is expected to expand by 30% within the next few years.

Despite this, Poland’s office stock is relatively young compared to other more developed markets. Over the last eight years, the average age of a square metre of office space in Poland has risen by nearly two and a half years and now stands at approximately nine years. Warsaw has the oldest and largest stock in the country - the average age of its office space is approximately 11 years. By comparison, Hong Kong’s Class A office buildings are aged 20 on average, while office buildings in Western Europe are about 40–50 years old. US buildings, including recently-refurbished office schemes, are aged about 30.

In Poland’s six largest regional cities, including Krakow, Wrocław, Poznań, Tricity, Katowice and Łódź, the average age of office buildings is just above six and only about 115 modern buildings are aged more than ten.

In the current conditions many property owners are not very keen to upgrade their buildings. This is expected to change gradually going forward. Healthy supply, rising tenant expectations and reduced availability of plots in prime locations will force property owners to intensify efforts to improve the standard of office buildings or to repurpose them.

Careful consideration is required to decide whether or not to engage in a refurbishment project and to identify the scope of works to be carried out. Four strategy options are available: maintain, transform, defend or repurpose, depending the building’s quality, location, tenant-mix and expected rates of return.

Potential strategy options:

1. Maintain

This strategy centres on partial refurbishment in order to preserve the competitive edge of an office building on the rapidly expanding office market. Refurbishment* spending is classified as normal building maintenance costs and does not constitute any significant operational or financial expenditure.

This strategy aims to retain tenants and to minimise potential income losses due to refurbishment works underway.

* Minor refurbishment aims to prolong the lifecycle of a building in order to retain tenants. This usually involves improving the standard of entrance areas, reception lobbies, toilets and other common areas, including lifts, installing new lighting fixtures on the building’s façade and landscaping. These works typically do not require any administrative permits and may be carried out during normal occupancy of the building, usually within six months.

Case study: Warsaw Financial Center, completed in 1998, 49,800 sq m, (Tristan Capital Partners)

The building’s lobby area and access control system were upgraded in 2014. The building received a new visual identity and environment-friendly solutions were implemented. Warsaw Financial Center was awarded a LEED Gold certificate for “Existing Buildings”.

2. Transform

This strategy involves full refurbishment of a building and requires major capital expenditure to achieve the expected rates of return. The building must be usually vacant in order to carry out major redevelopment works without disruption to tenants.

Such refurbishment will greatly improve the quality of the building and frequently add new office space for lease to enhance the asset’s revenue potential and value, and to secure strong long-term tenants.

* Major refurbishment aims to add another 15 to 20 years to a building’s lifecycle and to improve the quality of its office space. It typically involves a transformation of the building’s fabric, upgrading all spaces, adding a new exterior finish and replacing the building’s core mechanical and electrical systems, including its fire system. Full refurbishment combined with increasing the amount of office space for lease through space rearrangement or expanding the cubic volume can greatly enhance an asset’s value. This will normally require 12 to 24 months to complete and a vacant building.

Case study: Spektrum Tower, completed in 2001, 27,300 sq m, former headquarters of TP S.A., (Europa Capital LLP)

It was fully refurbished in 2014–H2 2015 and got a new façade on the podium, a new entrance lobby and open terraces. The refurbishment included replacement of most of the building’s systems and design of new green areas.

  • The building had been tailored to one company’s needs
  • Following its refurbishment, it was 95% let
  • Average-sized tenants. Office leases rarely exceed 1,000 sq m due to the typical floorplate size
  • BREEAM certificate

In some revitalisation projects, buildings may be put to different uses, depending on zoning conditions, technical specifications and market conditions.

3. Defend

This strategy focuses on partial refurbishment of an aging building with a view to its repositioning on an office market offering a large supply of premium grade office space.

It aims to safeguard revenue through improved occupancy levels and tenant retention. This is frequently warranted when newly-created business hubs begin to attract both newcomers and tenants from other office buildings on a market.

High rates of return can be achieved through this strategy on markets seeing low or falling yields.

Case study: Adgar Park West, completed in 1999, 44,600 sq m, (Adgar)

In mid-2013, T-Mobile (formerly Era) vacated 20,000 sq m in the complex and moved to a new building.

Growing competition from lower grade office buildings and high supply of Class A office buildings forced the investor to enhance the quality of the scheme and to add new amenities.

Refurbishment was carried out both inside and outside the building, and in its immediate surroundings. It comprised renovation of the building’s common areas, sanitary and electrical systems, and redesign of its ventilation and air-conditioning. The building got a new façade thanks to a glass atrium. It also saw its internal road system and green areas fully redesigned and redeveloped.

In addition to technical improvements, the building was repositioned as friendly to those keeping physically active. The complex now offers a range of amenities such as a bicycle rental service, carpooling, a fitness centre, a climbing wall, free fitness training sessions, etc.

Adgar Park West attracts strong occupier interest and is now nearly fully let. Its anchor tenants include the Polish Office for Registration of Medicinal Products, Medical Devices and Biocidal Products, and the Energy Regulatory Office.

4. Re-purpose

This strategy appears worthwhile when office buildings can no longer successfully compete on the market despite maintaining capital expenditure. Such schemes are often considered obsolete due to location, office space layout and technical specifications. The best option is then to sell a building or to develop a brand new project to maximize perceived asset value.

Case study (1): Aurum, Completed in 2000, nearly 12,000 sq m, including more than 5,000 sq m of office space (Mennica Polska S.A.)

It was developed in part for owner-occupation by Mennica Polska S.A. The building boasted a prime downtown location with limited exposure to Warsaw’s major thoroughfares.

Aurum was gradually losing its appeal to tenants on Warsaw’s highly competitive modern office market due to inefficient space use resulting from large common areas and obsolete technical infrastructure. Its anchor tenant also downsized its presence in the building. In addition, the local zoning plan permitted increasing the site’s development ratio well beyond the then floor-area ratio and adding new uses, including residential.

The property owner shelved refurbishment plans and decided to develop another phase of its flagship residential project Mennica Residence. Following a review of sales figures and market prices the investor preferred to achieve high rates of return within a relatively short timeframe, rather than develop a commercial project that could generate sustainable profits in the longer term.

Case study (2): Ilmet, completed in 1995-1997, over 20 000 sq. m (earlier UBS, now Skanska)

An 83-metre-tall office building providing more than 20,000 sq m of office space. It was developed in the very heart of the city in 1995–1997.

Ilmet had been steadily losing tenants since 2008 due to its outdated design and heavy wear and tear. In mid-2011, it saw its vacancy rate soar to nearly 10,000 sq m. The building was vacated by its last tenant in 2015, which put an end to its commercial use. Meanwhile, work on a local zoning plan for the plot’s area was underway.

Ilmet, now owned by Skanska, is going to be knocked down to make room for a new 60,000 sq m office development. 

Summary

Four different strategies are available to real estate investors. Each will involve varied levels of capital expenditure, depending on the option chosen. In Poland, the average cost of partial refurbishment stands at EUR 150–200 per square metre of gross leasable area compared to more than EUR 750 per square metre on mature global markets such as New York or Paris. By contrast, costs of major structural changes comprising full refurbishment of an office building range between EUR 600–1,000 per square metre of gross leasable area, which is close the average construction cost of one square metre in new office projects.

From the occupier’s perspective

An ideal office must be aligned with a tenant’s strategic objectives and corporate policy. A large BPO company, a small-scale creative industry tenant and a mid-sized law firm are likely to report different office requirements. Most modern buildings are designed to allow flexible office space fit-outs tailored to individual requirements and financial capacity. The size of a typical floorplate is a common limitation for larger tenants - if too small, it will impede efficient employee deployment and communication. Businesses frequently commission analyses of workplace solutions to identify current and future employee requirements, taking account of their growth potential. An office is an important part of a corporate image and may impact on business performance. By choosing the right location and office fit-out you attract the right talent.

Outlook

Given the rapid growth of the Polish office market and the changing structure of its modern office stock, investors seeking to maximise rates of return on office buildings will be increasingly faced with the need to choose the right investment strategy.

Factors driving the right choice of strategy include, to name a few, an increase in the average age of office stock, the falling availability of lands for new projects in city centres and changing occupier needs.

Owners of both aging and recently-delivered office buildings should closely monitor the market situation to be able to choose a strategy best-suited to occupier needs at the right time.

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