Will Finished Offices
Lure More Tenants?

With double-digit vacancy rates putting a drag on commercial real estate, owners of office buildings across the U.S. increasingly are turning their unleased space into ready-to-occupy suites to lure tenants.

Stealing a move from anxious home sellers who spiff up their properties, office landlords from Boston to Los Angeles are painting the walls, installing carpet, building private offices and conference rooms and even tossing in kitchenettes -- including the kitchen sink. In some cases, landlords are going even further: furnishing the finished space with conference tables, chairs, desks, kitchen appliances, window coverings and phone and data wiring.

That's good news for prospective tenants -- and also represents a huge change in the way office space usually is leased to corporate customers. Typically, landlords rent space in the condition that previous tenants left it; or, if new, in a raw condition. Customarily, owners allot what the industry calls tenant improvement dollars to cover all or a portion of building out the space.

But awash in unleased, and therefore unprofitable, space, landlords are spending the money upfront -- sometimes shelling out even more than they would in tenant improvement dollars -- to redesign or furnish their vacant property even before a tenant comes along. Building owners typically are slicing up their vast unleased spaces into offices that can hold as many as 50 employees. They're marketing them as "prebuilt offices" or "speculative suites" to smaller tenants, which have been leasing more space these days.

Often, these landlords are saving money over what an individual tenant would spend by building out several offices at once. And the move has an added bonus: By controlling the colors and look of the suites before they are rented, owners can ensure they have more marketable office suites at the end of the leases, if new tenants must be found.

It's all about standing out in a cluttered market. "With so much space in the market and few potential tenants, it becomes more important to differentiate your space," says Michael Belka, a senior vice president of management and leasing at Unico Properties Inc.

The Seattle-based landlord just finished building a few speculative suites in its office building in San Francisco. One of the softest markets in the U.S., the city has nearly 14 million square feet of empty office space gathering dust, or roughly 17% of its total office market. The suites offer a reception area with a mustard-color accent wall, private offices, a conference room and a kitchenette.

Equity Office Properties Trust Inc., the nation's biggest office owner, began installing suites in its office properties across the U.S. this year. So far, the Chicago-based real-estate investment trust has built out about 200 such suites, ranging in size from 2,500 to 10,000 square feet. Building several at a time costs 10% to 20% less than building out a single suite "because we get the economies of scale," says Chief Operating Officer Peyton "Chip" Owen.

The upfront investment appears to be paying off for Equity Office. The company completed about 37,000 square feet of suites last month in San Francisco. About half of that space is leased. "We've had incredible response," says Mr. Owen. "Small businesses are leading us out of the recession."

Not only does the space lease quickly, but "in some situations the space becomes an incubator" because many of these small tenants eventually will need to expand, says Joseph Brancato, a managing principal in New York at Gensler Architecture, Design & Planning Worldwide. The architecture firm has been designing prebuilt space for landlords, such as Boston Properties Inc. and Tishman Speyer Properties Inc., says Mr. Brancato.

When Charles Smithson began looking for bigger digs for his small, New York-based risk-management advisory firm, Rutter Associates LLC, he initially was enthusiastic about creating an office custom-designed to meet the firm's needs. But as he looked at space after space, most of which was gutted or would need to be gutted, he began to have second thoughts about the hassle of overseeing the design and construction of a new office.

"On the one hand, I thought it would be nice to design an office just the way I wanted," says Mr. Smithson, a partner at the five-person operation. "But I soon realized that I didn't have the time to devote to getting it right."

Mr. Smithson is about to sign a lease for a prebuilt office suite at the Lincoln Building in New York. The space doesn't have as many private offices as he would have liked. But he says other amenities made up for that, such as nice window coverings, the ability to control the air conditioning in the space, and a small conference room and reception area that were the perfect size for Rutter. Because the space "was completely finished when I saw it," he says, "I didn't have to imagine what it would look like."

Giving tenants a taste of what a space could look like was the idea behind Brookfield Properties Corp.'s decision to build at its Denver buildings speculative suites outfitted with phones, furniture and even a dishwasher in the kitchenette. Local furniture sellers interested in showcasing their merchandise loaned their goods to Brookfield to display.

The speculative suites are leasing three times as fast as other vacant space, says David Morrison, Brookfield's vice president of leasing in Denver, a market that has nearly five million square feet of vacant office space, or roughly 16% of the total market. In some cases, Brookfield leased the suites even before construction was completed, Mr. Morrison adds.

These suites offer a fast solution for tenants needing space right away. In August, Rich Caschette had less than two months to find an office for the new law firm that he and two partners were starting in Denver. After looking at about a dozen offerings, he chose a prebuilt suite in one of Brookfield's office buildings in part because "we could pretty much walk into it and be open for business the next day."

Even after expanding the suite to 5,000 square feet from 3,500 square feet and declining the furniture that had been on display in favor of ordering its own, Starrs Mihm & Caschette LLP opened for business on time.

But despite a glut of choices, even those tenants in a rush for offices may not find what they're looking for in prebuilt space.

Last month, Jacque Ducharme of real-estate brokerage firm Julien J. Studley Inc. began looking for space for a financial-services company that needs to open an office in San Francisco next month. Without having the luxury of waiting three months or longer to design a space, get construction permits, find a contractor to do the work and build it out, the company was considering a prebuilt suite. But in the end, the company decided to lease a traditional office space because fewer walls needed to be knocked down than in a prebuilt office.

"That's the risk for landlords," says Mr. Ducharme. Prebuilt space "doesn't always exactly fit."

But Taconic Investment Partners LLC has had success building speculative office suites in its building in Chicago for larger tenants needing 12,000 to 15,000 square feet. The New York-based landlord retained the exposed brick walls and ceilings and offers pantries with stone countertops, refrigerators and microwave ovens.

Taconic, which is also building speculative suites in one of its office properties in New York, is spending a little more to build out the suites than it otherwise would give to tenants to improve the space themselves. But the additional upfront investment is worth it, says Andrew Nick, a Taconic principal. "The faster tenants get in," he says, "the faster we collect rent on the space."

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