Innovation Isn’t Just A Buzzword

In today’s rapidly evolving real estate landscape, innovation isn’t just a buzzword — it’s a necessity. Traditional office spaces are experiencing declining demand as a result of hybrid work trends and the shift is creating some disturbance where savvy commercial real estate investors are finding opportunity. Office-to-anything conversions — from residential to mixed-use or tech spaces — are becoming the next smart, forward-thinking strategy. This type of innovation can unlock new value and turn yesterday’s office buildings into tomorrow’s most sought-after spaces.

The key to successful office conversions is found through an understanding of the challenges and potential these projects present. Zoning laws, structural limitations, and cost considerations can be hurdles, but with the right vision and attention to planning, these obstacles can be overcome. Forward-thinking investors are working closely with architects and municipalities to reimagine outdated office buildings as vibrant, multi-functional spaces that meet the evolving needs of cities and communities.

In a challenging real estate market, there is a demand for flexible, community-centered spaces, and office conversions offer a nearly perfect solution.  Maintaining a forward-thinking and innovative position in the market has helped our team create opportunity for investors.  A current example is an exciting asset class that is emerging from office inventory conversions is tough tech-and it’s an asset class worth watching.

Introduction to Tough Tech

From a real estate perspective, tough tech space is characterized by adaptations that support heavy machinery, specialized labs, and flexible layouts.  Tough tech real estate typically requires high-capacity power, water, and tech connectivity, as well as specialized ventilation and environmental controls. 

The tenants seeking this unique space help more clearly define it and include businesses that are engaged in science and engineering work that comes from extensive research and development with a focus on hardware, processes, materials, or systems.  These tenants represent solutions to complex, real-world problems. 

The physical attributes of tough tech are specialized beyond traditional wet labs or prototyping spaces. They are flexible to allow scaling of lab space to support stages of research and development.  The spaces are also characterized by specialized infrastructure that accommodates advanced equipment like quantum computing labs or refrigeration systems capable of reaching absolute zero temperatures.  Tough tech tenants are unique.

Why Tough Tech Should Matter to Real Estate Investors

Tough tech spaces have become a focus of real estate investors because they deliver attractive investment metrics.  Of course there is always risk in real estate investing, but tough tech typically means custom buildouts that encourage longer leases, premium returns, and a resilience to traditional tech cycles that can be short and erratic.  Support for these tenants is coming primarily from the Federal Government in the form of government contracts and funding from venture capital, both of which are attracted to the promise of their work on real-world problems like climate change, infrastructure, and healthcare. Additionally, investors have a unique opportunity with facilities that support these tenants as they are specialized and often require significant capital investment, regardless of a ground up or retrofit scenario. These barriers to entry naturally keep some investors on the sidelines, which is currently keeping supply at a premium.

Food For Thought

Build-to-Suit vs. Retrofitting Older Assets – Build-to-suit developments are easily built to a tenant’s specific layout, design, and infrastructure needs but this approach is rarely financially feasible with tough tech tenants due to upfront costs like land acquisition and construction expenses. In contrast, redeveloping older assets to meet tenant needs can be more cost-effective, as it leverages the existing structure and infrastructure. Redevelopment also presents challenges including the cost of significant upgrades and municipal hurdles like zoning and code restrictions, but currently it’s the most realistic scenario.

Higher Upfront Costs but Stronger Tenant Commitment – Regardless of the development approach, the associated costs represent an investment beyond standard projects. And tenants are increasing their spend on top of that to deliver space that meets their needs.  The result is tenants that are more likely to commit to extended leases for space that is tailored to their specific needs and reduces the need for future relocations and renovations. This long-term commitment is the key to providing landlords with important, stable income streams that offset initial expenditures.

Tenant Viability: Lease Terms & Longevity – The strength of the tenant and longevity of the investment is creating demand. Balancing the investment is largely a reflection of the tenants in the market. When considering tough tech tenants, the structure and length of standard lease agreements is where the details come together. Fortunately for investors, most of these tenants will accept a triple-net lease structure where the tenant is responsible for property taxes, insurance, and maintenance costs in addition to their base rent. In addition, the length of the term is typically extended to help negotiate the costs of customized build outs.  These two factors help create an income stream for landlords that is predictable and eliminates some of their financial responsibility.

Challenges

Long timeframes for tenant success – The extended R&D time required by tough tech companies can impact their timeframes for entry into the market.  Investors will need to be patient on all fronts and understand the runway required. This all means greater scrutiny of tenants, and alignment of lease terms and structure is necessary if investors want to realize full value.

(Re) Development risks – Many tough tech companies require highly customized facilities—wet labs, clean rooms, heavy power, and specialized HVAC systems. Developing or redeveloping properties for these uses can mean significant upfront capital to navigate both construction costs and zoning/ permitting guidelines with the local municipality.  Of course, strong development expertise on the investments team can alleviate much of this risk.

Exit strategy considerations – The exit strategy for investors breaks some of the rules of real estate investing and is worthy of consideration.  Of primary concern is the fluid nature of the industry itself as it relates to funding sources, development cycles, and government regulation. For investors, this means a thoughtful and specific exit strategy that should consider strategies like sale-leasebacks, tenant buyouts, or long-term holds. A focus on those assets located in established innovation hubs and tailored to meet a variety of tenant demand will help provide the clearest picture for investors.

Looking Ahead

Our dedication and optimism in a challenging commercial real estate market has proven to deliver unique opportunities. The emergence of the tough tech asset class is just one example of why thinking outside the box in a deliberate way can be so invaluable to investors.  The results can redefine physical space—and make an asset class worth watching.