You would be hard pressed to find another city more excited about transformation than Indianapolis right now. Previously known as “Naptown” by outsiders due to the sleepy feel the city exuded, those days are long gone. Indy has experienced incredible transformative activity in the past decade, and that extends to the commercial real estate office sector.
For the 18th consecutive quarter, this sector has experienced positive net occupancy gains, and 14 of those quarters have fallen below the 10-year average vacancy rate of 18 percent. Average asking rental rates have experienced healthy growth, with five-year rental rate growth at nearly 14.3 percent.
Matt Niehoff, Cushman & Wakefield
Changing ownership
According to colleague Bennett
Williams, director, the office landscape is really about change right now. “Long-term Indianapolis owners, such as Duke Realty, historically have developed and held their assets, but now that they are selling off their product, national and international firms are entering the market,” he says. “These new firms have been pushing all facets of the deal to maximize the return for their investors.”
Within the past five years, Indy has experienced many ownership changes of large office assets both in the suburban markets and the central business district (CBD). Cushman and Wakefield research has tracked 70 transactions of office assets over 100,000 square feet, of which 23 were in the CBD and 47 were in the suburbs.
The CBD has experienced more investment activity in the past five years than in any five-year stretch in recent history. Downtown transaction volume for this time frame is north of $980 million. Most of that transaction volume comes from assets that make up the Indy skyline. Currently,
Cushman & Wakefield’s Class A Downtown Skyline report shows an overall occupancy rate of skyline buildings at 83.8 percent, which leans toward landlord-favorable conditions and encourages investors to get solid returns on their investments.
The same can be said for suburban markets. Transaction volume nearly matched the CBD with just over $933 million in the past five years. Of that transaction volume, the lion’s share of investment was in places within large office parks where landlords can push rents through the addition of amenity centers and other tenant perks.
The story is the same with vacancy in the suburbs. It remains tight (17.4 percent) with rates below 10-year averages. Williams indicated that landlords are able to leverage low vacancy to push rental rates and sign longer-term deals in these highly desirable locations.
Quality space is key
My colleague Spud Dick, associate vice president, points to another trend with occupiers in Indianapolis. “We are seeing tenants care more about quality of space and the work environment that is created for their employees over actual rental rates,” he says. “Tenants want to be in space that provides value to their company and their employees, and they are offsetting the higher rental rates with more efficient office footprints.”
But this trend isn’t just local. Many occupiers are looking toward what their experience per square foot is versus their rent per square foot, according to the sixth edition of Cushman and Wakefield’s Occupiers Edge report.
“Companies want to use their real estate as a human resources tool to aid talent recruitment and retention, especially as unemployment numbers begin to reach pre-recession levels. Employees are a top focus for office occupiers,” says Dick.
Landlords are picking up on this trend, too. One example is Zeller Property Group’s acquisition of Market Tower, located within the CBD. Zeller acquired the asset out of receivership at a low basis and invested $7 million in value-add and tenant-focused improvements, which, in turn, attracted new tenants to the asset and brought occupancy levels from 58 percent to nearly 80 percent. Zeller was able to push asking rates to $28 per square foot prior to its successful disposition of the property in 2017. The company plans to execute that model again with the recent acquisition of the Capital Center, also located in the CBD.
Suburban owners hope they can use similar tactics to attract new tenants to their assets. For instance, a partnership between Strategic Capital Partners and Rubenstein Partners bought one of Indy’s largest suburban office developments, The Precedent office park, for $132.7 million last year.
The companies recently announced plans to change the name to Lakefront at Keystone and invest in four tenant-focused improvement projects, including an outdoor lounge equipped with games; a floating, harbor-like outdoor lounge and entertainment area; an indoor amenity center and lounge; and other lakefront walking paths. They expect the project to set a new standard for Indy office space.
Build-to-suit activity back
Capital investment to attract tenants has worked so well for landlords that large blocks of space are rarely available. As rental rates increase on existing product, the pain threshold is compressing, and we are starting to see tenants take the build-to-suit avenue to meet their demands.
Recent examples include KAR Auction Services’ $80 million investment in a new 250,000-square-foot building in Carmel, and Duke Realty’s $28 million investment in a 78,000-square-foot facility near Keystone. Once both projects are complete, KAR and Duke will vacate their current spaces in existing office parks, helping bolster the shortage of large, contiguous space on the market.
— By Matt Niehoff, Senior Research Analyst, Cushman & Wakefield. This article originally appeared in the November 2018 issue of Heartland Real Estate Business magazine.