In the last few years, the greater Des Moines metro area has been a title holder, reigning as a “Top Place to Live,” “Top City for Young Professionals” and even “Best Place to Retire.” Meanwhile the economy, business environment and commercial real estate sector hold titles like steady, stable and reliable. However, over the past 24 months, the commercial office market could add thriving, prosperous and robust to that list of adjectives.
As office lease rates continue to rise 1.5 to 2.5 percent annually in quality buildings, most landlords are implementing capital improvement plans that “refresh” their assets and have begun to offer amenity packages that the tenant marketplace demands. With the unemployment rate near a historical low — an estimated 2.4 percent — it has become ever more critical and competitive to recruit and retain new workforce talent.
Korey Birkenholtz, CBRE | Hubbell Commercial
Lease concession offerings from landlords, such as rent abatement and above-standard tenant improvement packages, have decreased since post-recession levels. Despite these positive fundamentals, headwinds are facing the marketplace. A tremendous amount of block space, some from formerly non-competitive or single-tenant buildings, has come available and concession levels could once again increase as landlords compete for tenants looking for a larger footprint.
Vacancy shifts
As large office users move from leased space to build-to-suit or owned campuses, an increased number of office vacancies is imminent. Companies such as Nationwide Insurance, Principal Financial Group, Wells Fargo and Wellmark Blue Cross started this trend several years ago.
Now our market is experiencing another round of these corporate campus developments as IMT Insurance (vacating 52,209 square feet), Sammons Financial (138,000 square feet in late 2021), Holmes Murphy (67,275 square feet), and Kum & Go (80,800 square feet) have or will have vacated leased space for new, single-tenant corporate campuses. Additionally, Wells Fargo recently announced that it will vacate approximately 127,000 square feet of leased space at the Financial Center in downtown Des Moines at the end of this year and relocate into an owned building.
While this is a long-term testament of the confidence these companies have in Des Moines, the result is that the vacancy rate has tilted upwards to approximately 8.1 percent, which doesn’t yet account for the Wells Fargo and Sammons Financial future vacancies. The vacancy is still roughly 4.4 percent lower than the national average and will remain stable until these larger 50,000 to 100,000-square-foot spaces are backfilled.
One of the most centralized locations exploring alternative users and tenant-suggested upgrades is Capital Square in downtown Des Moines. The Class A building, which was built in the 1980s, is under new ownership that is re-evaluating all options for the 130,000+ vacant square feet, 53,000 of which is contiguous on a single floor, and up to 80,000 contiguous between two floors. Although the building is not new construction, it has all the amenities — downtown location, access to multiple parking options, food options, skywalk connectivity, patio connection to Cowles Commons and onsite 24-hour security — that prospective tenants are searching for in a new-construction building.
Landlords are now faced with the major challenge of converting these large empty spaces into offices suited for tenants requiring less than 10,000 square feet. This demising generally becomes “forced,” resulting in costly and inefficient renovations. Despite the increase in available large floorplates across the market, it remains difficult to find suitable Class A office space for small-to-mid-sized users, which make up a bulk of our tenant marketplace.
The increasing costs of construction are also having a major impact. As many projects are underway or just finishing completion, the lack of available work force, contractors and raw materials has caused an increase in tenant-improvement costs. Construction pricing can often easily approach $50 to $60 per square foot or more for simple open-office and exterior-private layouts. As costs continue to rise, smaller project development, which has been the backbone of our local Des Moines economy, could be priced out of the market.
Quality is key
While tenants are attracted to value and quality, ergonomics have recently taken precedence over economics. High-quality office spaces with modern workplace amenities and efficient layouts are more apt to be leased than their competition due to value created for the employer and its employees. Rental rates and expense costs will continue to be a factor, but tenants are focusing on other value components, including location and building amenities. This need for value, outside of lease rate alone, is similar across all office classes, and buildings with a lesser value are difficult to lease.
The prime example of tenants seeking higher-quality amenity spaces is R&R Realty Group’s development of the Westfield Building, a 180,000-square-foot Class A building at Country Club Office Plaza in West Des Moines. The building provides a high amenity package, including underground parking, a conference center, fitness center, rooftop patio, coffee bar and outdoor seating areas. This building also brings a first to the competitive market, with the asking net rental rate above the teens beginning at $22.95 per square foot.
Once fully assessed building operating expenses are applied and any tenant improvement overages are amortized into the rent structure, the full-service rent could approach the low $40s per square foot, but tenants seem to be willing to make the investment.
The first tenant to the building, Centene, is occupying 80,000 square feet and the building is now approximately 75 percent leased. Also, in the fourth quarter of 2018, R&R delivered Phase I (45,000 square feet) of its 90,000-square-foot, two-story Class A project in Urbandale, called the Paradigm Building. Phase II is currently slated to deliver in late 2019.
In addition to R&R’s impressive new building deliveries, a great example of this higher amenity trend can be found in the new owner-occupied Kum & Go headquarters in downtown Des Moines. This 160,000-square-foot building is contemporary and an architectural masterpiece, sporting an entirely glass exterior. The building’s interior is complete with an art gallery, first-floor café, outdoor plaza, food truck court, fitness center and rooftop and fifth-floor patios. These top-of-market amenities will undoubtedly aid Kum & Go in attracting new employees.
We anticipate there will continue to be similar opportunities for new office construction throughout 2019 as the market embraces the higher rents associated with these projects. Landlords and developers will continue to carefully pursue opportunities with a focus on pre-leasing when possible in order to eliminate potential risks of a future economic downturn. As history reminds us, we’ll likely soon be reaching the proverbial backend of the peak on our economic bell curve.
However, here in Des Moines, we plan to stay steady, stable and reliable.
— By Korey Birkenholtz, Vice President, CBRE | Hubbell Commercial. This article originally appeared in the June 2019 issue of Heartland Real Estate Business magazine.