• The drivers of stranding risk vary substantially across asset classes and geographies. Within the three dimensions of obsolescence – functional, locational and regulatory – six thematic drivers emerge: building adaptability, building systems, urban experience and connectivity, property market dynamics, land use policy and sustainability requirements.
• There is no “one size fits all” approach to investment. The scale, risks and returns of potential interventions sit on a gradient ranging from incremental refurbishments and light retrofitting to deep retrofits and partial or whole change of use. While deep retrofits and conversions often lead to substantial value uplift, they have higher risk profiles and market sensitivity.
• Strategic retrofitting, most notably comprehensive energy upgrades that are aligned with the characteristics of the building’s superstructure, is key to future-proofing real estate assets. This approach unlocks additional financial opportunities, especially in sectors undergoing widespread automation and adoption of AI or with exposure to volatile energy prices.

A number of significant issues continue to weigh on owners of aging commercial real estate across asset classes and geographies, including operational efficiency, a preference for high-quality properties, misalignment between the built environment and demand for investment-grade buildings and the growing importance of sustainability and climate risk mitigation in asset valuation. With roughly 80% of the built environment to remain in use through to 2050, comprehensive and holistic assessments of how to best sustain and create value will be more critical than ever.

Despite the initial cost, capital-intensive repositioning strategies can unlock greater returns on investment and help to reshape portfolios with outsized exposure to potential obsolescence. Depending on the balance between market dynamics, macroeconomic forces and locational factors, retrofits or conversions can become integral core, value-add or even opportunistic income-generating assets with greater resilience to shifting structural forces. As dry powder remains at near-record highs and currently stands at nearly $600 billion globally, there is a meaningful first-mover advantage to be gained through proactive investment in bringing assets up to newer standards.

Successful building- and portfolio-level strategies are grounded in an understanding of the multifaceted nature of obsolescence drivers and their relative importance in different asset classes and geographies. Obsolescence exists across three dimensions for both spaces and places: functional needs, locational parameters and regulatory requirements. Each of these dimensions contains two principal drivers that refine the decision tree for owners looking to create value in their assets. Although not all dimensions or drivers are equally present or important for a given asset, the balance between them is critical in creating capital retention strategies. Additionally, these drivers are cross-cutting: energy policy, for instance, is a regulatory driver but also affects building systems and adaptability, just as land use policy influences how the urban experience exists and can be improved. 

• Functional drivers outline if the building structure and building systems can accommodate any engineering or technological updates necessary to meet current occupier requirements.
• Locational drivers focus on the interaction between the asset and the broader built environment, in particular user experience and changing urban development patterns.
• Regulatory drivers shape the contours of potential repositioning and development with respect to sustainability, energy and land use policies.

Under these parameters, a number of different combinations can yield core, core-plus, value-add and opportunistic possibilities, such as:

• Opportunistic and value-add plays to avoid obsolescence are often based on “beating” the repricing cycle, such as a deep retrofit of historic buildings in creative, urban fringe submarkets to go from Class C to Class A+, meeting the majority of core tenant needs at a discount compared to prime space. Such strategies are predicated on high-paying, often boutique, occupiers and creating highly differentiated space, but risk a rapid rate of saturation and chasing a relatively small amount of the demand pool.
• Core-plus plays to avoid obsolescence have less of a “beating-the-cycle” focus and can be realized through a medium retrofit of more recent buildings with deeper and corporate-oriented designs to go from Class A- to Class A+, also achieving meeting most tenant requirements at a relative discount to prime space. Such strategies are based on a faster delivery of quality space for value-conscious users as well as spillover product for companies that may have too aggressively rightsized during the COVID-19 pandemic.
• Core plays can take advantage of space that is relatively straightforward to upgrade or convert in asset classes with lower levels of volatility and need for differentiation. Light-to-medium retrofits of moderately older industrial and logistics product, for instance, can continue to generate consistent cash flow as fundamentals are broadly in check, land prices are more amenable and projects tend to be less technically complex with a focus on quick-turnaround take-up rather than providing a distinct experience.

The return on investment from these varying approaches is highly dependent on the asset and market at hand, but the savings and cost re-basing can be substantial, even in the face of high capital expenditures. A medium retrofit can range from $300 per square meter for logistics with a 25% reduction in energy consumption to well over $3,500 per square meter for a deep retrofit of CBD office product, which can save upwards of 60% on energy costs. This is in comparison to the 5%-8% cost of capital expenditures as a share of total asset value for medium retrofits to around 12% seen in deep retrofits. By retaining much of the existing structure, owners can save anywhere from 30% to 40% compared to demolition and rebuilding, critical for ensuring viability where engineering realities and market forces have the potential for an upswing.

Where retrofitting and/or repositioning is not a viable option, replacing existing structure(s) and repurposing asset(s) for an alternative use can help sustain and enhance value​ and maximize ROI

Understanding the dimensions of obsolescence and their related drivers is crucial in creating a strategy that sustains the value of an at-risk asset or makes a portfolio with exposure to stranding more resilient. This is of particular importance as the requirements to remain competitive in the commercial real estate market shift at an ever-faster pace as well as during a period of increasing economic uncertainty. Deciding on a revitalization strategy should focus on ensuring financial performance, compliance with current and future regulations, tenant requirements, market positioning, and branding to maximize visibility.

Investors will need to place more attention than ever before on creating resilient and distinct assets that address sustainability issues and get ahead of not only regulatory changes but also longer-term trends in local and regional urban growth. This will involve using AI-powered technologies, entailing smart building systems and data analytics, to enhance asset performance, improve tenant experience and advance sustainability goals. In doing so, owners can view retrofitting, repurposing and conversion not as impediments to success but rather a concerted method of boosting resilience and gaining an upper hand in an ever-changing real estate landscape.