Rising Office Fit-Out Costs Are Leaving Some Projects on 'Shaky Ground'

Supply chain challenges might be easing, but they are still among expense nuisances when it comes to office fit-out budgets, according to a report this week from Cushman & Wakefield.

Average fit-out costs in the Americas now total $136 per square foot, up 11% from 2022. Adaptive reuse of existing space costs is typically priced at a 10-15% discount.

It found that supply chain constraints, inflationary pressures, and increased labor costs are continuing to apply upward pressure.

“Many office users are suffering from sticker shock as project pricing comes into focus, leaving some planned construction projects on shaky ground,” Brian Ungles, Project & Development Services Americas Lead at Cushman & Wakefield, said in prepared remarks.

Nowhere is it more expensive to do fit-outs than in coastal gateway U.S. markets. San Jose is the priciest at approximately 76% higher than the Americas average. The top six markets’ costs increased an average of 12% from the previous year, with the largest jump being New York at 14%.

Hikes are Remnants of Past Two Years’ Escalations

Tom Murphy, director, project services, Hiffman National, tells GlobeSt.com that, working on second-gen office space improvements, 7% to 10% escalations were consistent in Houston, Chicago, and San Diego.

“While we are beginning to see some stabilization of construction materials over the past four months, we believe overall pricing will continue to reflect the pressures from transportation and labor constraints,” Murphy said.

“Many of the increases we have been experiencing are remnants of escalations from the prior two years. During that time, customers filled warehouses to alleviate supply chain interruptions. The result is manufacturers are now reporting a decline in sales by as much as 40% in Q1-23 compared to Q1-22.”

Deciding Only When ‘Forced To’

Roger McCarron, president & CEO, Project Management Advisors, tells GlobeSt.com that many companies have been standing still on their real estate footprint since before 2019, only making decisions when their leases force them to do so.

“Prices feel astronomical to them because they are significantly higher than they were 7 to 10 years ago when those leases were signed,” McCarron said.

He said he had one client build out the exact same space as they did before the pandemic and their costs were nearly 35% higher for furniture and 25% higher for construction this time around.

Sticker shock is forcing companies on two common paths, McCarron said. “Either decrease their overall square footage and upgrade their space to be more efficient or keep the current square footage and hope people come back to the office in large numbers,” he said.

“The latter group has expressed fears that moving to shared workspaces and hoteling will only decrease attendance.”

“Both approaches must be combined with real leadership and a willingness to make difficult decisions about increased in-office requirements. There are many companies that publicly endorse hybrid work while privately complaining about it. Refusing to make the hard choices is only going to prolong the in-between state of the office and keep companies paying more for their real estate.

“Now, there is a move to Class A space because it gives companies the most bang for their buck. And if you’re bringing employees back, why not invest in high-quality space with bonus amenities? But will that be the case in a few years when the market swings from an employee-driven to an employer-driven one and employers have more control over how often employees are in office?”

Tenants Want Shorter Lease Terms

The report said that comparing office inventory in the U.S. by tier, “at least 60% of total space has the potential to be considered for a fit out by landlords and occupiers as they aim to continue to attract workers back to the office.”

David VenHorst, managing broker & partner, Tenant Advisors/CORFAC International, tells GlobeSt.com that this increased cost of tenant improvements is creating a “tale of two office spaces.”

He said if a landlord has vacant space with good, modern existing conditions and finishes, he’s in a good position to capture tenants in the market because he can keep his construction cost down by reusing much of the existing conditions.

That landlord can also offer a shorter lease term, which tenants today seem to want, VenHorst said.

“On the other hand, if a landlord has raw space, or badly outdated space, that is becoming increasingly difficult to lease because when you factor in the high cost of improvements, the returns just aren’t there for landlords,” he said.

“The high cost of construction also dictates a longer lease term, which is a negative in today’s tenant’s market.”

Electrical Panel Hoarding

Tonya Gottesman, senior advisor, MDL Group/CORFAC International, tells GlobeSt.com that the office market is seeing continual pressure with supply chain constraints and costs associated with its erratic nature.

The latest one is electrical panels, she said.

“Developers and contractors are preordering so much with the unknown of what is really needed,” according to Gottesman.

“With the tenant improvement cost from shell delivery, we are seeing office tenants and buyers directing their efforts to 2nd generation office where mechanical systems are already in place and only a refresh of the space is needed.

“Even with uncertainties in cost, there continues to be one bright light in office, and it is medical office. The demand for medical offices continues from the large healthcare corporations to the single practitioner.”

Office Must Provide ‘Peak Experience’

Sanjay Rishi, Americas CEO, Work Dynamics, JLL on the importance of quality spaces, tells GlobeSt.com that investing in quality spaces is paramount for leading organizations to create peak experiences for their employees coming into the office.

“Our clients are seeking our advice to create differentiating experiences by creating high-quality spaces that attract current and future talent, reinforce culture, drive collaboration and innovation, enable professional growth, and bring the best brand experience to clients and employees,” Rishi said.

Kul Wadhwa, CEO of BeyondView, tells GlobeSt.com that the rising costs of office fit-outs are just another hurdle facing the commercial sector.

“Different results are expected, yet digital options are not being embraced across the board,” he said. “Property managers need to leverage technology to reimage spaces quicker than traditional means and at a fraction of current costs. With empty offices across the country, property owners must get creative when trying to fill vacant spaces.”