Office to industrial trend likely to be “minimal”: Prologis

As demand for suburban office space has dwindled over the past two years, some industrial developers and investors have touted conversions to industrial space.

That doesn’t necessarily make it a major trend, according to Prologis, the biggest industrial REIT in the world, with nearly 1 billion square feet of logistics space.

The conversion of office to industrial is “likely to be minimal,” Prologis said in a report, city regulatory, zoning and cost issues associated with such redevelopment.

Prologis estimated office to industrial conversions could total between 40 and 80 million square feet over the next 10 years — less than 1 percent of existing logistics real estate and 3 percent of average annual new completions of industrial space.

Most conversions will be located in cities and regions with “high barriers to development and high land prices,” including Southern California, New York and Washington, D.C.

Office properties often have to be demolished to make space for new industrial development. Developers also want properties located near prime transportation routes and large plots of land. Office space with multiple tenants also pose challenges for industrial developers, given all tenants have to leave before redevelopment can start.

“It’s absolutely case-by-case,” Prologis’ global head of research, Melinda McLaughlin, said. “These are unique properties with a lot of complexity.”

In Los Angeles, where demand for Class A industrial space is at an all-time high, developers are taking advantage of older office properties. Rexford Industrial Realty bought a two-building office campus in Santa Ana for $175 million. Though the properties are leased through 2032, the site is zoned for industrial uses, making it easier for Rexford to demolish the office properties once the leases are up.

“We need to be able to do industrial by right,” Schlehuber told TRD earlier this year, adding the firm will only acquire office properties that already have the zoning rights that allow for conversions to industrial sites.

“There’s not enough logistics space in these areas and simply not enough space in irreplaceable locations” McLaughlin said, referring to Los Angeles, Orange County and the Inland Empire, where vacancy rates are approaching zero percent. “Developers have to get creative and this is one avenue for that.”

In other markets, where land for industrial development is still available, it’s faster and more straightforward for developers to build on empty land, rather than going through regulatory hurdles of converting an office property, according to Prologis’ report.

Retail to industrial conversions are more feasible, McLaughlin added, given big-box sites may not have to be demolished. This trend — also an avenue for developers to get creative — could result in up to 100 million square feet of new logistics space over the next ten years.