The most noteworthy event in the world of Louisville commercial real estate during the first quarter of 2017 was the news in February that Humana and Aetna had called off their merger.
Whatever shoes had yet to drop as a result of the $37 billion deal drifted softly down to earth. Of particular importance to Louisville, Humana would not leave town and vacate the approximate 2 million square feet of office space it occupies in downtown Louisville.
Of course, there was another shoe in the air: that Aetna may be convinced to relocate its headquarters from Hartford, Conn.
“There was always the hope that Louisville, being such a great community for executives to live and work, could woo Aetna,” says Doug Owen, senior vice president, brokerage, for the real estate firm JLL, which has just released its Louisville Office Outlook for the first quarter. Within the past few months, Bristol-Myer Squibb and GE had quit Connecticut because of unfavorable tax treatments, and Duracell was rumored to be next.
“That was the dream if the merger had gone through,” Owen says. “The current state administration in Frankfort has been pretty aggressive in terms of restructuring some of its taxes.”
But mostly, says Owen, there was “a sigh of relief.”
“Losing Humana would have had a tremendous impact,” he adds, “especially just as downtown Louisville was making such tremendous progress in the last few years with its commercial real estate profile.”
Running just under the radar of the Humana-Aetna breakup was the announcement, also in February, that international business services giant Ernst & Young would open a 125-person office in downtown Louisville.
According to the EY press release: “The office will house members of the firm’s expanding National Executive Assistance Team, which supports EY partners across the country, as well as creative and digital services employees. The firm hasn’t yet signed a lease but intends to locate in Louisville’s Central Business District, hiring its full complement by mid-2018.”
At the time of the announcement, Brent Summers, EY’s Americas enterprise support services leader, said: “We were very impressed with the level of talent in Louisville and commend efforts by the city, state and local learning institutions to grow the talent base even more aggressively and in new areas. That, along with Louisville’s affordability and quality of life, were important factors in our location decision. We are also excited to be locating our new center in the downtown area. There is so much new development and energy. We think it will be a great environment for our new team.”
“EY was looking at about five different cities – or a suburban location here – and ended up picking downtown Louisville,” says Owen. “That’s where they see their employees wanting to be.”
Owen also believes there were some incentives on the city and state levels “that really drove the thing. That’s what I like to see. Any time you get a big national firm, that’s great publicity and very positive for Louisville. It encourages other big national and multinational firms to take a look.”
Within the Louisville community, the ad agency Scoppechio announced it would be moving out of its long-time Jefferson Street location and into two floors of 400 West Market (a building that will probably always be known as the Aegon Center to Louisvillians).
“I think the new Scoppechio offices will be a space unique to Louisville,” Owen says. “Nothing like it in Louisville, or in the region.”
But what about Scoppechio’s old home? While all the new activity has been filling up downtown Louisville’s Class A office space – JLL pegged the vacancy rate at around 12 percent – it also has cast a new spotlight on the city’s Class B commercial real estate.
“As we see these older, obsolete Class B office buildings being converted to other uses, those tenants want to stay downtown, and so they’re trading up to Class A,” Owen says. “It’s helping backfill towers like Meidinger and Brown &Williamson, both beneficiaries of tenants coming out of the Starks and other older office buildings.”
What is the future of commercial Class B real estate? Scoppechio was the dominant tenant of the old Kentucky Home Life Building at Fifth and Jefferson for 23 years.
“Plans for the building seem to be swinging back and forth between keeping it as office space or converting it to residential,” says Owen. “I think, from what we’re seeing as the demand, they’d be smart to convert it to residential.”
There’s a lot of Class B commercial real estate downtown — 5.5 million square feet, according to the JLL report, with a vacancy rate of about 7 percent — but Owen feels the future is not in office space.
“Downtown, Class B buildings run a gamut in terms of size, style and age,” Owen points out. “In the suburban market, there’s just about 600,000 square feet of Class B space, and most of it was constructed in the last 40 years. We don’t have historical buildings out there that have reached the point of obsolescence.
“But downtown, Riverfront Plaza is not comparable to the Kentucky Home Life Building or the Starks Building or to one of the smaller Class B office buildings closer to Broadway.”
As evidence of that, Owen points out that Class B space in the suburbs will reliably rent for between $15 and $17 a square foot. But downtown, that range could be anywhere from $9-$10 a foot to $17 or $18.
And at the lower end of that rental range, Owen points out, it becomes impractical to update the buildings to LEED or Energy Star requirements that today’s commercial tenants demand because the cost of that investment isn’t warranted by the return.
But where downtown Louisville’s Class B commercial buildings do have a viable future, he believes, is in the renovating and repurposing to residence, hotel and entertainment space. Much of that has already happened and continues to happen.
Owen notes that the Landmark Building at Third and Liberty is being converted to a boutique hotel by its new owners, an affiliate of a Cleveland-based investment capital firm; the Wilder Building on Sixth and Main has been acquired by Vision Hospitality Group out of Chattanooga, for the purposes of turning it into a hotel; and then there’s the Starks Building, at Fourth and Muhammad Ali, “a mixed-use conversion right in the heart of our urban core.”
Owens dismisses the delays and lawsuits that have held up work on the Starks Building. “I think, whatever happens, the building will not convert back to office space, nor will it be torn down,” he says. “I think it’s a prime building for conversion, it’s well-situated, and it will happen, whether by the existing owner or a new owner.”
The real lesson, he insists, is that out-of-town developers are seeing historic Louisville property like the Starks Building not as discarded assets but as property that can be turned into profitable conversion projects.
“It says to me that there’s a trend going on in downtown Louisville, creating that urban hub that we see in other larger cities. All the urban revitalization gives more reason for employers to want to move into downtown Class A towers. Their employees are increasingly millennials, and that age group wants to be in the urban core – working, living, eating, hanging out.”
Owen says Louisville is getting so many looks from residential developers because they can buy the property cheaper than in other established cities, convert it and have a nice return. “Developers who convert historic buildings are giving Louisville a hard look, which says there’s value there,” he concludes. “Converting commercial space is not inexpensive, but these guys have figured out how to do it. They know the markets, they’ve researched the customers, they recognize the good signs and the bad signs.”
“We’re clearly sending out the good signs, that it’s a good place to place your money,” he adds. “Companies won’t place their money without doing their research.”