Even as industrial real estate remains in high demand thanks to the continued growth of e-commerce, not every building in the asset class can be used as a logistics hub. Some developers are finding that certain properties that don’t fit the profile for a modern warehouse are actually well suited for office conversions. This might seem surprising with the current state of the office market but in areas with a lot of creative and media companies a small but increasing number of industrial properties are being transformed to help fill the void in creative office accommodations.
Industrial-to-office conversions may seem an unlikely redevelopment given the ongoing robust fundamentals in the industrial sector and the dismal performance of the office sector. The U.S. office market recorded a record-high overall vacancy rate in the first quarter of 2023. Despite more workers returning to the office in a scaled-down hybrid capacity, companies continue to downsize their office portfolios and the tech industry has retreated from the major expansions that once buoyed the office sector. However, Class A properties across the country are experiencing solid demand in the ongoing flight-to-quality trend and on a smaller scale, the creative office sub-sector is faring well in a limited number of markets. Usually housed in low-rise buildings, creative office projects generally provide features that are coveted among the creative crowd, including dedicated outdoor space, interior amenity space options, large floorplates, direct entrances, and operable windows.
The industrial-to-office conversion concept is not a trend sweeping the country but it is, as the kids say, a thing. Just ask the management of Redcar Fund which recently closed their second fund that focuses on industrial to office redevelopment in markets that are popular with content creation studios, gaming, music, fashion, and media. And Redcar Fund II brought in $418 million in capital commitments, exceeding the $412 million in commitments raised when the inaugural fund closed in pre-pandemic January 2020. “The quality product that tenants are seeking now includes well-designed creative office properties, especially if the building has a commitment to ESG such as rooftop solar panels and EV charging stations,” Christopher Chee, Co-Managing Partner at Redcar Fund Management, said. “While entertainment and gaming companies have long found our space more attractive than traditional office buildings, we are seeing an increasing number of tenants in other industries prefer our type of space.”
Redcar Fund I acquired 15 properties that, upon completion of redevelopment, will total 1.4 million square feet of creative offices space in high-growth neighborhoods across Los Angeles. Certainly, a handful of Los Angeles submarkets account for a bulk of industrial-to-creative office transformations in the U.S. On the edge of West Los Angeles in Culver City, California, the media and entertainment industries have staked their claim to the historic film studio town and continue to eat up creative office offerings in the area.
Samitaur Constructs has long been active in the planned transformation of the Culver City area’s Hayden Tract neighborhood, a former industrial zone, into a hub for creative office space. Samituar began its conversion activities in the area decades ago, working in partnership with Eric Owen Moss Architects, and has been going ever since because the demand for creative office space hasn’t withered as it has for traditional office offerings. Early in 2023, Samitaur delivered Wrapper, a 16-story, 180,000-square-foot project that holds the distinction of being the first creative office high-rise in Los Angeles. One could argue that the Greater Los Angeles area, one of the tightest industrial real estate markets in the country, would be better served by tearing down any obsolete industrial property and replacing it with a state-of-the art logistics facility, but such a process doesn’t always make sense. “[Industrial-to-office conversion] is really location specific. A plumbing supply shop in Culver City is not the highest and best use,” Chee said.
And there are other industrial pockets in Los Angeles that have been identified as prime sites for creative office tenants, like the historic West Adams neighborhood, which is benefitting from the Los Angeles County Metropolitan Transportation Authority’s ongoing transit expansion program. The Luzzatto Co., a real estate firm that acquired a handful of industrial buildings that had been home to Unified Grocers in West Adams, recently completed its second ground-up industrial-to-office transformation at one of the properties, 3609 10th Ave. Luzzatto replaced a former Unified Grocers truck servicing depot with an approximately 100,000-square-foot creative office building. The property, which delivered earlier in 2023, just hit the market for sale this month.
However, more than a few real estate industry experts question whether the demand for creative office space is strong enough to continue to spur industrial-to-creative office conversions. “The trend you are talking about is no longer relevant,” Anthony Tam Thanh Tran, Regional Director of Research with Voit Real Estate Services, told me. “Industrial space in Southern California has been the leading driver of commercial real estate.” He added that conversion projects should focus on office-to-industrial or office-to-multifamily.
Still, in the midst of a frosty economic climate, Redcar Fund II managed to raise capital from the usual suspects, including endowments, asset managers, pensions, family offices, insurance companies, financial institutions, foundations, wealth managers, and high net worth individuals in North America and beyond, including the Middle East and Europe. The New York State Common Retirement Fund pledged up to $15 million to Redcar Fund II. The Missouri Local Government Employees Retirement System committed $40 million.
Despite the heavy conversion activity in Los Angeles, industrial-to-creative office projects are not just for Hollywood. Marwood, a San Jose, Calif.-based real estate investment and development company, is planning to convert two antiquated industrial facilities located in Opportunity Zones in Portland, Oregon, into creative office destinations through its Madison Qualified Opportunity Fund and Kennedy Qualified Opportunity Fund.
Redcar Fund II is expanding its geographic footprint outside of Los Angeles with its co-investment sidecar, Redcar Austin Opportunities Fund L.P., which will focus on submarkets in Austin, Texas, that are conducive to its industrial redevelopment strategy. Redcar Fund II has already acquired 12 properties, two of which are sited in the St. Elmo and South Austin neighborhoods of Austin. The numbers for industrial-to-office appear to add up. “Even with the significant increase in industrial rents, creative office is still the highest and best use for the properties we target,” Redcar’s Chee said. “This can be attributed to the significantly higher rents for creative office in our target submarkets when compared to industrial rents.”
The industrial sector remains the real estate investment community’s sector-of-preference when it comes to property types, but not every old warehouse is a realistic option for transformation into a cutting-edge logistics facility. That is where the industrial-to-creative office plan comes into play. Some industrial properties that are struggling to attract investors and tenants can be turned into successful creative office destinations, if the location is right. In markets like Los Angeles, Austin, Atlanta, and Nashville, where there is growth in such creative industries as content creation, gaming, media and music, industrial-to-office conversions can help bolster the overall office sector.