Flex space: Not fancy, less pricey

Companies find relief from prime rents

Executives at Lonesource were in a pickle last year.

Their software company's headquarters at Cary's MacGregor Park were too tight for the fast-growing family of 35 workers. But office rents in new buildings, inflated in part by rampant demand in recent years, were too rich.

"The rates had gone astronomically up," chief executive Brad King said. "We hadn't planned for that."

So their broker introduced them to a spartan manufacturing plant across the street where the price was just right.

Lonesource's new offices are in what industry types call "flex space," space that can be used as offices, warehouses or for light manufacturing.

Because it straddles the line between office and industrial, flex space carries a price somewhere in between. Increasingly, it is a sector of intrigue for companies searching for relief as Triangle office rents have surged.

Demand for offices has sparked new construction amid rising construction costs: What followed was a spike in rents. New offices are asking $25 to $30 per square foot, which in turn drives rents up in older buildings.

In the past three years, average annual rental rates for Triangle offices have climbed 9 percent to a record $19.98 per square foot, according to Karnes Research, a Raleigh firm that tracks commercial real estate trends.

Flex rents averaged about $10.04 at the end of March. Even after paying for janitorial services and other expenses found in traditional offices, the cost of flex space is about 25 percent less than average office rates, brokers, developers and analysts say.

"If they're cost conscious, office tenants are not going to pay the increased rate the market has seen in recent quarters," said Brian Reece, managing partner at Karnes. "There's caution out there in hiring, there's caution in expanding, and there's caution in spending."

That caution appears to be making a dent in flex. The region's flex vacancy rate fell to a seven-year low of 12.9 percent at the end of March. And forthcoming deals could tighten things further.

Skipper Day, a Commercial Carolina/Cushman & Wakefield broker, last week sent e-mail to landlords, in search of about 10,000 square feet for an undisclosed tenant that would "prefer single story/flex due to cost."

Laura H. Kiley of Kiley and Associates of Chapel Hill dispatched a similar missive, seeking up to 3,500 square feet of flex space for a young tech company that expects to grow to 20 employees from 12 in the next 18 months. She declined to name the company but said the open layout of flex space would allow it to grow more easily and economically than in traditional office space, further reducing costs.

"I've got three [tenants] that I'm working on that could go that route," said Mike Lotterhos, a Jones Lang LaSalle broker in Raleigh. One is a financial services company; another is a natural gas utility. A few years ago, they likely would have landed in more traditional offices, he said.

The demand is awakening a slumbering sector. Less than 250,000 square feet of new flex space has been built since 2002.

BPG Properties recently finished a 40,000-square-foot flex building at Sumner Business Park in northeast Raleigh. Mike Green, a BPG broker, says deals are in the works to lease more than half the space to office-only tenants.

In the first quarter, 30,000 square feet of flex space was finished, and 140,000 square feet was under construction, according to Karnes.

The activity is a blip compared with the tech boom of the late 1990s and early 2000s. Then, it was the norm for 500,000 square feet of space to be under construction at any time. But when the tech sector collapsed, all types of commercial real estate struggled, and flex took a hit.

Would-be flex tenants were enticed by sweet concessions and low, low rents in Class-A offices.

"They can't get those deals anymore," said John LaRocca, a Grubb & Ellis/Thomas Linderman Graham broker.

That could change if the slowing economy continues to sap office demand. At least 2.6 million square feet of offices were being built in the first quarter -- the most in any quarter since 2000.

Many brokers think office bargains could be around the corner, but not in time for Lonesource or others who need space pronto, they say.

Lonesource was on the other side of the equation in 2003 -- the depth of the tech bust -- when it moved into a 6,700-square-foot space in a traditional office building in MacGregor.

When the company's broker, John Powell of Powell Properties, went looking for space in late 2006, landlords were asking at least 25 percent more than Lonesource had been paying at the end of its lease, King said.

Leasing at that price was possible, but not exactly the message Lonesource -- an expense management software company -- wanted to send its customers.

With flex, it got functional space that "doesn't look like we overspent, and therefore [doesn't make customers feel like] they're overpaying," King said. "We feel like we've gotten a lot more for our money."