The U.S. real estate market is anticipating a possible shake-up resulting from a glut in vacant commercial spaces. Following the pandemic, many have lost their jobs and fewer workers are returning to the physical office setting. A large number of businesses are also opting for remote or work-from-home (WFH) arrangements.
As of September 2021, 20.3 million employees are working remotely compared to just 8.9 million in 2019. The biggest losers are metropolitan markets where building owners are bleeding dry with declining office rentals.
The sheer number of office spaces that have sat eerily quiet for nearly three years simply cannot be ignored. By the end of 2022, the number was placed at nearly 100 million square feet, or about 13 percent of the entire market across the country. A significant chunk of these could end up in fire sales as loans mature and commercial real estate owners seeking to make a graceful exit.
Bullish-minded investors, however, have seen an opportunity in the seemingly dreary forecast. They’re thinking of something else that’s imaginative and out of the box, but has been proven to be successful—converting office spaces into multi-family residential units.
Office-to-Residential Conversion: Past and Present
Transforming existing office spaces into housing isn’t an entirely novel idea. In fact, there are real estate firms that have dedicated their efforts to this type of venture for decades now. Just to demonstrate that the strategy may be a viable option for some, commercial real estate group CBRE reported that around 90 office buildings were converted into multi-family housing spaces between 2016 and 2021. The move created more than 13,000 additional apartment units in different states. Post-pandemic figures were significantly higher, with 125 office building conversions currently underway. Forty-two of these were completed in 2022 alone.
Moving further down history, the Lower Manhattan area is the best testament to the viability of commercial-to-residential conversion. Amidst financial difficulties, building owners transformed over 10 million square feet of old office real estate into multiple dwellings between 1995 and 2006 through the state’s 421-g tax incentive program.
At present, local and state jurisdictions with dire housing shortages and a scarcity of developable land are offering incentives to stimulate office-to-apartment conversions among investors. These include New York, Chicago, and major California cities, as well as Pittsburgh, Philadelphia, and Washington, D.C.
The National Association of Realtors (NAR) also conducted an in-depth analysis of 10 office-to-housing conversions, with case studies outlining the success factors of each project. You can view and download the full report here.
Best Properties for Office-to-Residential Conversion
Not all commercial buildings can be converted into multi-family housing complexes. In theory, it may look like the one-size-fits-all solution to office vacancies. However, executing the changes and making a profit from the project is another story.
The sweet spot for office-to-housing conversion lies in older, modestly-sized, mid-rise structures built between the pre-WWII and 1960s. These buildings are often four or five stories high, with at least two sides facing an open space. They also have operable windows that enable light and ventilation to penetrate more easily. As a result, investors are often searching for these properties as they take the least amount of conversion work and costs.
On the other hand, modern, high-rise commercial buildings that are wedged between other equally towering structures aren’t really the best choices for repurposing office spaces into multi-family housing. They don’t afford the luxury of natural lighting or street exposure. Additionally, their floor plates are often too large and missing other architectural factors that make a space suitable for apartment-style living.
Such limitations, however, have not stopped industry geniuses from pursuing conversions on newer and larger structures. For instance, a former 9-story bank operations center located at the tip of lower Manhattan had been successfully transformed into a 19-story apartment complex.
Architects at the CetraRuddy design firm reworked the entire structure by cutting two courtyards at the center to provide the required light and ventilation for each unit. Furthermore, based on the state’s floor area ratio zoning rule, they were able to build an additional 10 floors of living space on top of the existing structure with the unused vertical square footage they gained from the open courtyard space.
Others that have capitalized on rising office vacancies and the growing demand for housing include New York City developers Silverstein Properties and the Vanbarton Group. Silverstein recently acquired a 30-story office tower in the financial district and is partnering with seasoned apartment conversion specialist Metro Loft for the project. Vanbarton, on the other hand, just received $273 million worth of funding to convert a 24-story office tower into a 30-story multi-family project.
The market is hot for office-to-housing conversions. Vacancies are high and with real estate costs expected to drop, many are jumping into the bandwagon, making office-to-housing conversions more feasible than ever.
Jumping Through the Hoops
Converting office spaces into housing can be a challenging process. There are several factors that need to be taken into consideration, as both types of structures have different specifications and requirements.
Zoning and permits
Converting an office space into a residential space will require zoning and permit changes. This can be a time-consuming process, and the approval of local authorities may not always be guaranteed.
With the glut in office spaces, however, policy and real estate movers across the country are working hand in hand to fast-track the rezoning of certain areas and sites to address both the potential collapse of office real estate and the housing shortage.
Zoning work in some states, such as New York, California, Washington, and Chicago, is also evolving to adapt to changing market needs. Oregon is even set to approve a bill that will allow the local government to approve office-to-housing conversion in downtown Portland without a zone change. This is in addition to a waiver of system development charges normally imposed on such building repurposing projects.
Public support to streamline the approval and permitting processes for office-to-residential conversion is on the rise throughout the country. Lawmakers have realized the need to address regulatory uncertainties that may deter developers from conducting these complex redevelopment projects, which could be the best solution to the increasing housing shortage.
Building code compliance
Offices and residential buildings have different building codes and regulations. A new and different set will be applicable when repurposing office spaces into residential units. This is to ensure statutory compliance with regulations that will protect residents against potential hazards relating to thermal and sound insulation, fire protection, means of escape, and accessibility.
Adapting an existing structure to a new use operates under a different series of building codes. Other local requirements will also entail a lot of inter-agency coordination. Thankfully, state and local jurisdictions experiencing a housing shortage have made some modifications, incentives, and even exemptions to address the complexities of this type of redevelopment.
Structural issues
Converting a mid-to-high-rise office building into multi-family housing is not always an easy or straightforward process from a structural perspective. Office buildings are not designed to support the weight and requirements of residential living spaces, such as bedrooms, bathrooms, and kitchens. Additionally, their systems are typically centralized and will require extensive reworks to bring basic utilities into new apartments.
Mechanical, electrical, and plumbing systems have to be modified or even entirely replaced when repurposing office buildings. For instance, the plumbing layout initially intended for just two restrooms per floor will need a major overhaul to accommodate the needs of multiple tenants residing in the building 24/7. Significant architectural intervention will also be required to make HVAC systems operable on a per-unit basis.
Despite all the modifications needed to turn offices into apartment units, major alterations still make sense. Build time is considerably reduced by not having to do significant foundation and structural work.
Natural light and ventilation
Offices are designed for different types of use than residential spaces, so there may be issues with ventilation and natural light in the converted space. Lucky is the investor who finds office buildings with shallower floor plates and an ideal window-to-core distance, which are mostly limited to older structures built in the 1960s or earlier. These are the easiest and most attractive to convert because they require less intense physical alteration and allow for relatively efficient apartment layouts.
The biggest challenge simply lies in the shape of modern office buildings. Their deeper floor plates and sealed facades make it hard for natural light and air to reach most of the space, once it’s divided into residential units. Ensuring that apartment units from converted office buildings have proper airflow and natural light isn’t impossible, however. It just requires extensive (and often expensive) remodeling, such as cutting out courtyards and atriums in strategic areas, so operable windows can be added to each unit.
Cost
Moody’s Analytics pegged the average cost for office-to-residential conversion at a conservative $100 to $300 per square foot, but some developers say this could go up to as much as $400 to $500 depending on location and market demand. Industry experts place this at just 15 to 25 percent less than new ground-up developments. That doesn’t include “surprise” repairs that may crop up once you tear down the walls.
The stark reality is that private lenders are often reluctant about providing funding for these types of repurposing projects. Unless you’re a top-notch real estate firm with a deep pocket and loads of experience in repurposing office space, such a venture can be quite risky for newbie investors.
To make office-to-housing conversions economically sensible, it might be safer to put together a project plan that requires some sort of government subsidy. Keep in mind, however, that this type of development should have an affordable housing component in return.
State and local jurisdictions have explored the use of public financing tools to help boost the feasibility of office-to-residential conversions. Besides tax abatements and fee waivers, these include access to low-cost loans with favorable terms for the acquisition and repurposing of office properties into affordable rental housing.
Ingenuity + More
Office conversions can be profitable, but a number of challenges must be overcome to make these repurposing ventures pencil out. There is no blueprint or cookie-cutter strategy that will guarantee your success.
Office buildings are constructed differently, and every potential conversion should be assessed on a stand-alone basis. It’s a matter of finding the right type of property in the right location. Market conditions must also be favorable. Additionally, you need to ensure that the infrastructure and floor plate configurations are modifiable to align with the requirements of a multi-housing project.
Ingenuity works, no doubt, but converting office spaces into housing takes more than just that—it also entails careful research, compliance, planning, and execution. It may not be feasible or cost-effective in all cases and requires one to work with professionals who have experience with these types of conversions to ensure a worthwhile endeavor.
