GRAND RAPIDS — Ever wonder what it takes to get a new Class A office structure built downtown? Well, obviously, it takes cash — lots of it.
But it also takes pre-leasing at least half the building to at least one large tenant who is willing to pay a pretty premium for the space. That primary element has to be in place long before the groundbreaking ceremony is planned.
That factor is also compounded by a host of other factors, like the amount of available and affordable parking, the work and social environments of downtown, and an economy that allows firms to expand or move their headquarters there.
Developers don’t control those intangibles.
Because contrary to popular belief, a new office building is not a cause of economic development. Rather, it is the result of the economic progress done by others, which creates a market for office-building developers.
The Business Journal spoke with Waters Corp. Vice President of Development Joseph Zainea, who is also president of the Building Owners and Managers Association, and Silveri Company President Glenn Turek to learn what it would take to construct a new 180,000-square-foot office building downtown.
To get a better handle of the building’s size, think of the Campau Square Plaza Building at 99 Monroe Ave. NW, which is a dozen stories tall and has 178,000 square feet of space.
As for the cash, it would take about $35 million to build it. That breaks out to $27 million for the structure, figured at $150 per square foot, and $6.5 million for a decent piece of downtown real estate.
Under this cost scenario, the developers would probably invest about $8.75 million of their own money and get a loan for around $26.25 million. Then the developers would likely have to refinance with an insurance company in order to get a long-term note. But before any money changes hands, something else has to happen: a major tenant has to sign on.
“The prudent investor and the prudent lender are not going to commit to a $35 million project without some assurance that when the building is complete at least half of it is going to be occupied,” said Zainea.
“The tough part is finding a tenant who is willing to commit to 90,000 square feet,” he added. “You don’t do that with a lot of small tenants. You do that with one, two, maybe three large tenants.”
Someone like Boeing, or a large law firm or financial services business would have to sign on for about $28 per square foot. Throw parking into the mix and Turek felt the cost for a tenant would rise by at least another $3 for each square foot. Charging $31 per square foot for downtown office space would set an all-time high-rent record. Both Zainea and Turek estimated that downtown’s top charge now is about $23 per square foot.
Not every tenant would pay the asking rate of $31. The smaller ones likely would, such as those leasing around 5,000 square feet. The major tenants, however, would almost surely get a discount worth about $5 per square foot because they would qualify as volume renters.
But finding a major tenant involves more than money. The developers also have to find one who is willing to wait for up to two years to move in while the building is being built.
For the developers, the bottom line is they need a minimum of $3.5 million in rental revenue each year. Most of that, if not all, should be on the books before the building opens. That’s why developers look for major tenants before construction, and then try to fill the remaining space while the building is being built.
But right now, Zainea said, finding a tenant who could take 90,000 square feet to get the project financed isn’t likely.
“It would take something really unusual, something really dramatic like a corporate change. Or something new in the local economy, some new actor coming into play that would need that much square footage,” he said.
Nor is it likely that many downtown tenants would willingly move from their current building into this hypothetical one.
“Put yourself in the shoes of tenants,” said Zainea. “Conjure up what you think they are paying in rent and then ask them to add another 70 percent, or whatever. Doesn’t make sense, does it?”
No, not really, when the average downtown asking rate was $19.30 per square foot last year, or 61 percent less than our hypothetical $31 price tag.
But one thing makes sense of why a new Class A downtown office building hasn’t gone up in about eight years. It’s because a new building is not a catalyst for economic development. In fact, it’s just the opposite.
“What this kind of building is, if it’s successful, is the result of economic development, not the cause of it. In other words, when Steelcase expands, when a local firm hires more people, when Birgit Klohs brings in a company from Germany, all of those kinds of things create jobs,” said Zainea.
“When you create so many new jobs that builds a need, if you will, for other jobs in legal services, financial services, accounting, advertising, all that. And at some point then, space is needed,” he added. “A new building should be the result of economic development.”
“The economy isn’t robust and expanding. It’s in a watchful mode right now and so the robust type of expansion is not occurring. In fact, there are a lot of firms holding the line and we’re seeing cuts instead of jobs being added,” he said.
“The office sector is a service sector and it’s going to be impacted by our large employers and what they’re doing,” added Turek. “Right now, we’re not in an expanding mode and the undercurrent is sort of against a new project for a little bit.”
If a new office building goes up without the demand generated by the development, a major problem is not only created for the entire office market, but also for the project itself.
“The name of the game is to increase occupancy and lower vacancy. If you’re creating more space than you can occupy, you’re increasing vacancy,” said Zainea. “And if vacancy is too much, then rents weaken. And you just can’t build anything new because you can’t get the rent that it takes to get the required return.”