REITs are turning their attention to B-grade office space as developers and tenants focus on sustainability credentials, according to Colliers.
B-grade offices tend to be overlooked in the wider world of property development in favour of A-grade and Premium spaces and new builds.
However, this could be changing as investors look more closely at secondary office assets that are suitable for refurbishment and can address demand for high-quality spaces with a focus on sustainability.
Colliers said that REITs were hiring people dedicated to locating secondary office assets and found that average net face rents for B-grade offices recorded year-on-year growth of 6.1 per cent compared to other grades of office by the end of Q3 this year.
Colliers managing director for office leasing Simon Hunt said that the team had noticed a heightened interest in environmental, social and governance concerns (ESG) from occupiers since the pandemic.
“This means that occupiers are willing to pay more for ESG, whereas pre-Covid, the number of people that could fit in an office space largely underpinned its value,” Hunt told The Urban Developer.
“Appetite for refurbishment will continue to increase as industry sustainability benchmarks catch up, with embodied carbon frameworks being introduced by NABERS and the New Buildings tool from Green Star.”
This could mean that demand for B-grade increases in the coming years, especially given the good supply of B-grade office space in prime CBD and metropolitan areas.
Colliers is already leasing successful B-grade refurbishments at 309 Kent Street in Sydney, which was fitted out to A-grade standard and received a rental uplift of $50-$100 a square metre, as well as 6 O’Connell Street and Eagle House at 473 Bourke Street in Melbourne with Cushman & Wakefield.
Hunt suggested that investors and developers were attracted to the quicker turnaround times for refurbishments rather than new builds.
“While the amount of work required to refurbish secondary office spaces varies, new fit-outs are being completed at a rapid pace as landlords commit to achieving premises which compete with new Premium and A-grade assets,” Hunt said.
“For the 14 leasing deals for 309 Kent Street achieved in the last 12 months, an average of 4.5 months’ downtime was experienced from completion of the fit-out, which included a new ground-floor plane and lobby, to a tenant’s lease commencement date.
“While there is a scramble to reposition B-grade office assets to ensure they remain competitive as occupiers lift quality demands, and shift from an ESG tick-box approach to requests for waste diversion, carbon neutrality and other specific indicators post pandemic, landlords are certainly being rewarded with rent and occupancy uplift in return.”
ASX-listed Centuria Capital Group has $20 billion of assets under management, and Centuria Office REIT fund manager Grant Nichols said that although Premium office space remained in demand, B-grade space had a lot of potential to fulfil the increasingly diverse needs of tenants.
“We definitely are still open to acquiring and owning the office assets. But a lot of it comes down to location. At the moment tenants are gravitating towards generally better quality accommodation, which is probably more within the Prime grade,” Nichols told The Urban Developer.
“But in saying that, a well-located B-grade office building always has a place. We’ve got Prime-grade assets in metropolitan areas that are leasing well, and the same applies to B-grade. That location is critical.”
While B-grade might not overtake Premium office space, especially in a period of elevated vacancy such as that which the market is currently experiencing, there is a lot of cost-effective and sustainable potential to improve these sites.
Historically, Nichols said, tenants and investors had wanted higher quality NABERS and Green Star ratings, but a growing awareness of the embodied carbon of new build developments.
“We are noticing a trend for tenants and investors that they are becoming more aware of the embodied energy which goes into construction, which can be huge.
“From an environmental standpoint, it can be better to retrofit or refurbish an existing building because you are not putting as much embodied energy into that retrofit while also improving its environmental performance.”
Nichols also suggested that it could be in the commercial interests of investors and developers to look at a refit or refurbishment.
“Moving into a building with a low rating, the environmental impact of transitioning from a low rated to a high rated has more bang for your buck in terms of the environmental impact, rather than moving to a new building with a high NABERS or Green Star rating,” he said.
It also helps that some metropolitan and CBD areas have a good supply of B-grade offices, older stock and smaller builds which are ready for this trend, he said.
“We’re starting to see tenants be more aware of their fit-out, wanting to use or recycle existing fit-outs, if a tenant was very conscious they will be looking at what they can recycle from a built and internal form.
“There are also mandates by certain tenants that they have to be in a certain rating. So if you can’t hit a certain NABERS rating, you might preclude yourself from being able to attract some government and commercial tenants.”
However, there are challenges with B-grade office space, especially older stock which was not necessarily built with not only ESG considerations in mind, but also the demands for modern tenants.
“Some B-grade buildings, because of the nature of how they’ve been constructed, it can make it difficult for, for argument’s sake, a large user to move in there,” Nichols explained.
“But for a certain tenant and investor set, I can see this making sense, and from an environmental sense, the more the general community understands the impacts of embodied energy and what goes into it in construction, it will make it more appealing to consider situations where you can make an improve and existing built form.
“Even if you have no fundamental environmental standpoint, making the building more efficient reduces your operating costs.
“So regardless of whether you’re doing it for environmental reasons, there is still a cost reason for making these buildings as efficient as possible.”