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Tuesday, Jul 5, 2022

Fast Turnaround Drives Spec Space Demand

While some office spaces may be presented as a blank canvas, others are being built out into speculative, or spec, suites. These suites are created by the landlord in a way that will be appealing to a variety of tenants.

The cost to develop these spaces comes out of the landlord’s pocket, but property owners agree they can have huge upsides.
Bob Tarnofsky, an executive vice president at El Segundo-based Continental Development Corp., said the company is a big believer in spec suites. He said the company created suites as the South Bay market moved away from just aerospace users to a greater variety of tenants.


“The aerospace product was set up so that we could cut up spaces, retain perimeter offices along the glass line and create spaces that we customized that saved us from the need to be in and redoing tenant improvements every five years when leases rolled, and they were just plug-and-play suites provided for tenants to come in who didn’t undertake a lot of advanced planning,” Tarnofsky said.


Tarnofsky added that despite the pandemic, he was seeing “very good reception to these types of spaces,” talking about spec suites in the 1,000- to 2,500-square-foot range.
He said larger spec suites are generally not created because bigger users tend to have more specific needs.


Chris Rising, chief executive of downtown-based Rising Realty Partners, said the company has spec suites in about 65% of its portfolio and is looking to have them in all of its properties.

 
“It has become extremely popular for owners to be building spec office suites,” said Bill Bloodgood, an executive managing director at Newmark Group Inc. “It has accelerated over the last couple of years based on the success owners have seen by building quality spec space.”


Natalie Bazarevitsch, a senior vice president at CBRE Group Inc., agreed, saying “most of our landlords are in some form or fashion” building spec suites. She said more landlords are creating spec suites than were pre-pandemic, and she is hearing some say they will always have two to four spec suites at their properties.

 
James Malone, an executive vice president at Jones Lang LaSalle Inc., added that some spaces haven’t been renovated in a long time and don’t meet the needs of today’s tenants, which is where spec space comes in.


“We see a number of landlords and other owners take a space and build something new to showcase it so tenants can see what a brand-new built-out space with glass, open space, etc., looks like,” he said. “They want to (create a) showcase. More often than not, that space will lease, and it is something you can replicate somewhere else in the building.”


Quick turnaround

Property owners agree that one of the major benefits of spec suites is that tenants can move in quickly.
Spike Whitney, senior vice president of asset management for downtown-based Coretrust Capital Partners, wrote in an email that “the attraction to developing a batch of private spec suites is that they sell quickly because the concept of plug-and-play, while not always perfect for the occupier, is more efficient for the occupier — both cost and time — than finding a traditional second-generation space and/or building new space.” 
Rising agreed.

“If you can deliver something immediately … you are more likely to get it leased,” he said.
Bazarevitsch added that the cost of developing spec suites usually pays off, especially in today’s market where many tenants delayed making decisions about leases due to the pandemic and are now looking for spaces they can move into quickly.

 
“Many ownerships are evaluating all of their vacancies, and yes, they have to spend a lot of money up front to fix them up … but then they deliver the space, and we’re finding a high percentage of the time, they are leasing a lot more quickly than they would if they were just in open condition or white box,” she said. “It shortens the downtime for a space.”


She added that permitting a space to be built out can take time, so tenants like having a space that “gets them close enough” to what they need.
Bloodgood added that traditionally, it can take six months from when a tenant signs to when they actually occupy the space. Spec suites, he said, “dramatically cut” down the time.


Owners and brokers also agree that lease terms are generally more flexible with spec suites, which appeals to tenants in today’s market.
“They are typically of shorter-term duration,” Tarnofsky said. “Because they are of shorter-term duration, we don’t want to commit tenant improvement dollars to customize the space. We prebuild the space to what we believe will be attractive to these users and we endeavor to minimize any improvements for customization to the space.”


“If these things roll, we’re okay because we haven’t had to invest a significant amount of tenant improvement dollars,” he said.


Bloodgood added that landlords may be more willing to spend $80 a foot for a spec space but not on tenant improvement allowances for short-term tenants because the improvements the company makes to create a spec suite will make the site desirable for future tenants as well and help the site get leased faster since the landlord will have to do very little to re-lease the property.


Good ROI

Tarnofsky said spec offices usually command rents 10% to 15% higher than the rest of the company’s portfolio, which is another benefit of the spaces. He said the flexibility they offer tenants is part of why they are able to earn higher rents.

Bloodgood said tenants looking at longer leases are paying market rents, but in cases where tenants are looking for shorter leases, the landlord can “often get a premium.”
Rising said that during the pandemic, rental rates and rates for spec suites have remained relatively consistent, but incentives like free rent and more tenant improvement allowances have increased.


He added that doing spec suites themselves rather than decking out suites as tenant improvements has had some cost savings.
“We get more for our buck because we control the cost, then put a price on it that’s market rate and hasn’t dropped,” Rising said.


Malone agreed that landlords have an easier time controlling costs when it comes to spec suites. Often, he said, they are done at a high speed, and landlords are able to get someone in quickly, and there are no concerns about labor and material costs increasing during that time. 


Sublease competition

During the pandemic, the amount of sublease space in L.A. has risen from pre-pandemic levels.
These spaces are attractive because of their potential rent discounts and because companies can move into the offices quickly.


“Spec suites are competing with sublease space and coworking space,” Malone said. “Landlords see the ability to offer a tenant something that’s their own and compete with sublease and coworking space.”


Bloodgood said an added bonus is that spec suites allow tenants to negotiate directly with a landlord rather than having to follow a lease that is already in place.
“If everything works for you — the space, the term, the existing layout, the fact that you aren’t going to have an extension to renew and you feel comfortable with that — they can be very competitive, but when you are dealing with a spec suite, you have a lot more flexibility,” he said.


Tarnofsky called the amount of sublease space on the market now “a bit deceptive,” adding that a lot of it was not contemporary space.
Experts expect to see landlords continue to create more spec suites. Bazarevitsch said that the ability to lease spaces faster and to lease them again quickly with just a minor facelift after a tenant vacates makes them desirable.


“It’s easier to lease a spec suite that has been occupied by a tenant for three years. … You still have a return on investment with the next tenant that goes in since you already spent the money up front,” she said.


Rising added that the company would fully build out smaller spaces and do basics in larger spaces.
“You see this in a lot of downturns, you want to build out space to have it ready,” he said.

Hannah Madans Welk
Hannah Madans Welk
Hannah Madans covers real estate for the Los Angeles Business Journal. A USC grad, Madans has done work with publications including The Orange County Register, The Real Deal and doityourself.com.

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