Spec Suites: A Powerful Tool in the Battle To Fill Office Space
Lack of clarity about a potential recession, and whether employees should work from the office or elsewhere, continue to confound business owners whose companies typically operate from office buildings.
To manage this uncertainty, some are downsizing their office footprints and moving to higher-quality or better located space, while others are staying put and executing short-term lease renewals.
Another approach involves leasing prebuilt spec suites. While the spec suite market has been growing over the past decade, brokers say that current market conditions are making this option even more attractive.
What is a Spec Suite?
A spec suite — short for speculative suite — is a newly constructed office suite built by a landlord prior to a tenant signing a lease. The suite is considered speculative because the landlord is gambling on the premise that the size, number, layout and design of the office suites they constructed and paid for will fit the needs of a future tenant.
If the space is not leased, a landlord could have potentially misallocated their capital. But this risk can be mitigated by developing a flexible spec suite strategy that allows for suites of varying sizes across full or partial floors.
It is important to note that spec suites are not executive suites or coworking spaces that are shared by multiple companies. Spec suites are dedicated offices leased directly from landlords that give tenants exclusive use of and full control over their suites. They differ from typical office suites because landlords predesigned and constructed them, rather than having tenants design and construct custom build outs .
Origins of Spec Suites
Larry Fitzgerald, executive managing director at Newmark in northern Virginia, explained that the typical tenant for a spec suite tends to be from a smaller company, “and by their nature, those small companies don't have real estate departments,” so there's nobody focused on when the current lease is set to expire.
He said that years ago, he began to get calls from executive assistants supporting CEOs that would say ‘Hey, our lease expires in six weeks and we need a space. Do you have anything that's ready to go?’
“After you have that conversation a number of times and you relay that information to landlords, it starts to resonate with them,” Fitzgerald continued. In response, some of his landlord clients began building out office suites to accommodate those small tenants that waited until the last minute to think about their office space. Fast forward a decade or so, and today its commonplace for office buildings to offer spec suites for lease.
Why Tenants Like Spec Suites
According to Fitzgerald, spec suites are good for tenants because most have trouble visualizing how an existing or unfinished space will look and flow; or more importantly, they don’t have the time, resources or desire to take on a design and construction process, in addition to a move.
Grant Pruitt, president and managing director of Whitebox Real Estate, headquartered in Dallas, agreed saying “when you walk through with a tenant it's easier for them to visualize,” how their office will look and function if the suite is already built out. Bigger corporate users that have real estate departments and multiple offices can imagine closed offices along a window line or a glass enclosed conference room, Pruitt said. “But if it's somebody that just has one office and it's 3,000 square feet, and he's moving from where he has been for 25 years to a new space,” it’s hard for him to visualize.
Asked if certain industries or sectors gravitate toward spec suites, Pruitt noted that “people think open ceilings and concrete floors are cheaper, but [those finishes] are actually more expensive” than carpet and ceiling tiles. With tech and marketing companies seeking those raw industrial-type buildouts, he concluded that professional services firms seem to be the most likely users, based on what he has seen.
But in cases where second-generation space, with raw ceilings and floors, is converted into spec suites, this creates options for creative firms seeking edgy space that can be quickly occupied.
Sizes, Components and Finishes
There's always an exception to the rule, but typically spec suites tend to be small, anywhere from 1,500 to 5,000 square feet and built out somewhat generically, Fitzgerald said. “You don't want to build something that's so specialized that most companies or tenants can't use it.”
He added that the broadly appealing design includes a kitchen or pantry, a conference room or rooms, maybe a small workroom and some mixture of hard walled offices and open spaces for cubicles or desks.
Higher end finishes are also a component of spec suites, Pruitt added. Rather than going with standard building options that are limited to certain grades of carpet, light fixtures or paint, on the spec suite side, you typically see upgrades such as Herculite glass for the conference rooms, or carpet squares instead of rolls.
Determining the layout of individual suites is one puzzle that must be solved, but another is determining the size and number of suites to build out. “If I have a landlord that says, ‘what should I do with this 10,000 square-foot-floor?’ I would say, carve that up into three or four suites of differing sizes so that when that prospective tenant comes in,” something will appeal to them, Fitzgerald said.
“It's like the old Goldilocks theory,” he continued, “that one’s a little too small and that one's a little too big, but this one right here is perfect.”
He emphasized that whether the suite is small or large, it should have all of the things that a company wants: work rooms, conference rooms, a kitchen or galley, a couple of offices and some open areas.
“You're trying to appeal to a wide market,” Fitzgerald said, so sometimes a prospect will say that a space is perfect, but they need two more offices. In that case, the landlord will pop two offices in along an open window line. “I'd say it's probably 50% of the time somebody wants to tweak a spec suite and then 50% of the time they take it as is,” Fitzgerald added.
How Many Suites Per Building?
In terms of determining how much space a landlord should convert into spec suites, Fitzgerald acknowledged that “every building is different.” But he did share a typical suggestion he makes to landlords.
For a building with 50,000 square feet of vacancy over two 25,000-square-foot floorplates, “I would tell that landlord to leave one floor unencumbered. Just leave it like it is, because if we get lucky,” and somebody comes along wanting a full floor so they can control their access, “we will have something for them.”
He added that “those big companies tend to start shopping very early,” so there will be time to go through the design and build-out process.
“But for that other floor that's sitting there vacant, let's carve it up. Again, it’s the Goldilocks thing, let's create three to five suites of varying sizes and slightly different configurations. Maybe you leave one that's 10,000 square feet, again unencumbered, and you don't build it out because that's for a larger tenant,” Fitzgerald said. He added that this strategy has proven very successful because landlords often get a slightly better rate because of the “ready-to-go” factor.
A configuration Pruitt has seen involves creating numerous spec suites on a 25,000-square-foot floorplate with more break rooms in the suites than one might typically feature. These break rooms create places where walls can be easily demised to create larger contiguous suites if a tenant needs a larger block of space. To diversify and add even more flexibility, some landlords will build out full floors that offer a range of build-out conditions including finished suites, whiteboxes and shell space.
Furniture and Cabling
Occasionally spec suites are furnished, and Fitzgerald said “it's typically the aggressive landlord that wants to spend that extra money to furnish their spec suites so they're that much closer to being ready to go. But it's expensive and you're taking the risk that the tenant won't want or won't need that furniture because they're coming in with their own stuff.”
“But I tend to say, if you are willing to furnish it, let's do it, because you're staging, like [you would] a house for sale. You want the space to show well and the prospect to think ‘Johnny could go over here, and Mary could sit there.’”
In Dallas, Pruitt said “we've started to see some landlords, and I don't mean a lot, but some landlords provide cabling, which is a true value; that’s an expense that a tenant of that size may not be aware of.”
Why Landlords Invest in Spec Suites
“I think the way most landlords view it is that by building out a spec suite, it expedites the lease up of that space,” Fitzgerald said. He characterizes it as a cost benefit analysis; it costs a little bit more upfront to get the space ready, but “the delivery timeline is that much quicker.”
This has become “the go-to strategy now with most landlords,” Fitzgerald said. They're building spec suites because they're finding that many tenants don’t want to go through the construction process. He added that this is especially true in a market like the one we are in now, where companies are downsizing and there continues to be uncertainty about whether or not employees need to work from the office.
Asked if rising construction costs are deterring tenants from traditional custom build outs, Fitzgerald said, “I don't think the tenants are that mindful or understanding of the costs.” Instead, he said they focus on the new condition of the space, the ability to be up and operating in 30 to 60 days, and the opportunity to avoid the brain damage of “designing, building and having somebody on staff coordinate with contractors.”
Sunk Costs and Short-Term Leases
Pruitt noted that spec suites are more expensive for a landlord to build than an office suite that is preleased and custom designed by a tenant. This is because in the latter scenario, landlords normally share the buildout costs with the tenants in the form of a tenant improvement allowance. With spec suites, landlords alone bear the design and construction costs.
Most landlords view this as a sunk cost, Fitzgerald said. Since they have already spent money to build out the space, they're willing in many cases to execute shorter term deals of three to five years. And, what they are banking on down the road is a renewal, so they can get an even better return on their investment.
But again, Fitzgerald added, the decision to make this capital expenditure up front depends on the mindset of the owner. If it's a landlord that is hyper focused on occupancy they will spend up front to secure a tenant. If it’s a local entrepreneurial landlord, they are typically more focused on cash flow, so they may choose to opt out of a spec suite.
But a quick lease up is not the only motivator for a landlord. Pruitt noted that many build out spec suites in space that is hard to lease because, for example, it may lack natural light, the views may not be optimal or the configuration may be awkward. In these cases, it makes sense to build out the space because an inviting interior can draw attention away from some of the shortcomings of the space.
Pruitt added that in his view, really savvy landlords will also offer a short-form lease for spec suite tenants to further simplify the process.
Targeting Spec Suites Exclusively
Despite declining overall demand for office space and very high construction costs, landlords continue to build spec suites, Fitzgerald said. “It's almost like you're at a competitive disadvantage if you have an office building and you don't have spec office suites available.”
“I know tenant brokers who look exclusively for spec suites when they're setting up tours because, for whatever reason, their client doesn't have the time, patience or inclination to fool with build outs,” he added. “They want to go to ready-to-go suites.”