As office vacancies increase and affordable housing remains in short supply throughout the nation, office-to-residential conversions have risen to unprecedented numbers. According to a recent report by real estate research firm, RentCafe®, the list of conversions more than quadrupled over the past four years – from 12,100 units in 2021 to over 55,300 at the start of 2024.
In this blog, we’ll explore how office-to-residential conversions have become a growing trend, and the opportunities and challenges they bring property owners, investors, developers and community leaders.
THE CURRENT LANDSCAPE
The rise in office-to-residential conversions has been fueled by the merging of several trends. Let’s review the top trends:
• Office vacancies: CoStar™ reports the national office vacancy rate at a record 13.8%, and currently forecasts it will rise to 15.0% by year end.
• Maturing mortgages: Nearly $150 billion in mortgages on U.S. office buildings are maturing by the end of 2024, pressuring owners to pay up or restructure their mortgages at a time when vacancies and interest rates remain high. Owners unable to retain or accommodate existing tenants, particularly buildings ranked at a Class B or C level, may have a difficult time refinancing. This could lead to the surrender of properties by deed-in-lieu of foreclosure or involuntary seizure.
• Lease expirations: Approximately 217 million square feet of office space have leases with expiration dates in 2024 or 2025. Given the lack of demand for office space, it’s likely that many leases will not be renewed, which could leave the space vacant and property owners exposed to near-term rollover risks.
• Demand for housing: Housing inventory remains limited as demand continues to rise. According to a recent statement from the National Association of Home Builders’ Chairman, Carl Harris, there is a nationwide shortage of roughly 1.5 million housing units. The National Low Income Housing Coalition’s annual report on affordable housing finds that low-income renters face a shortage of 7.3 million affordable and available rental homes.
THE CONVERSION PIPELINE
Some developers are jumping at the opportunity to repurpose office buildings, especially aging buildings in dense metropolitan areas. RentCafe® reports that office conversions currently represent a staggering 38% of the 147,000 apartments in future adaptive reuse projects, outpacing any other building type. The top 10 cities leading the conversion trend, by number of projects, are:
- Washington, DC (5,820)
- New York, NY (5,215)
- Dallas, TX (3,163)
- Chicago, IL (2,822)
- Los Angeles, CA (2,442)
- Cleveland, OH (2,012)
- Cincinnati, OH (1,563)
- Kansas City, MO (1,510)
- Atlanta, GA (1,422)
- Phoenix, AZ (1,377)
For a full list of the top 20 cities, the year-over-year increase, total amount of conversions as a percentage and number of planned future conversions for each city, click here.
BENEFITS
Converting office buildings into residential space provides numerous benefits to developers, property owners, future occupants and the community. Some top benefits include:
• Construction cost and time savings: Conversions typically take less time and money compared to new construction. A 2022 report from the National Association of Industrial and Office Parks (NAIOP) found that per-unit construction costs for adaptive reuse projects can be 30% lower than the cost of demolish and rebuild projects.
• Revitalization of central business districts: Office-to-residential conversions can offer benefits beyond residential spaces. In coming years, these conversions could have a favorable downstream effect, leading to the transformation of central business districts into flourishing mixed-use-neighborhoods that offer residents easy pedestrian access to grocery stores, retail space, restaurants and other businesses.
• Sustainability: From an environmental standpoint, research shows that repurposing office space often saves 95% of building materials, significantly reducing carbon emissions in comparison to new construction. Some developers also choose to adopt green building practices, contributing to reduced energy consumption, lower utility costs for future residents and an overall heathy living environment.
• Legislative incentives: Some policymakers at the state and local level are incentivizing office conversions by amending zoning ordinances, revising building codes, and providing property tax abatement and other financial incentives. At the federal level, a guidebook to federal resources is available for conversions that provides information on topics such as federal loans, grants, tax incentives and technical assistance programs.
CHALLENGES
Although office-to-residential conversions seem like the perfect solution to office vacancies and the housing shortage, they are not always practical. There are several factors and challenges that need to be considered. Some of the major ones include:
• Structural constraints: Office space differs significantly from residential space when it comes to floor plates, layouts, facades and mechanical systems, which could impose substantial construction and design limitations. Global architecture, design and planning firm, Gensler, created a methodology to analyze office buildings to determine if they meet criteria for what the firm calls "Goldilocks" buildings. From Gensler’s research, Goldilocks buildings date back to the 1970s, have smaller floor plates, reasonable window-to-core distances and are located in desirable areas.
• Financial and economic concerns: The cost of an office conversion varies greatly from project to project, but generally ranges from $100 to over $500 per square foot, according to a CBRE report. Comparatively, the cost basis for new construction of an office building generally runs, on average, around $320 per square foot. Commercial real estate is known to earn more per square foot than residential real estate. So, even with office vacancies, the higher yield per square foot for commercial property could be comparable to residential space over the long term, depending on the location of the property.
Property owners may also find themselves having to bring in new investors, funds or personnel in order to support the shift in direction. Doing so may be challenging and costly as economic uncertainties continue.
• Legal and regulatory factors: Although some adaptive use ordinances are being amended to allow for less rigid zoning and building code requirements, property owners and developers may still find themselves faced with regulatory barriers, as laws vary among state and local governments. Property owners and developers must carefully examine multiple legal factors long before any construction begins.
CONCLUSION
Over the last four years, we have seen an extraordinary rise in office-to-residential conversions. It has become a popular solution in helping to revive central business districts and ease the housing shortage across the nation. Although office conversions appear to be an easy fix for addressing two problems at once, it is not a one-size-fits-all solution. To move confidently with an office-to-residential conversion, property owners, developers, and community leaders will each need to carefully evaluate the benefits and challenges.
As with any real estate transaction, title and closing services are essential to completing an office conversion. Old Republic Title’s National Commercial Services Team is ready to assist investors with their title and escrow needs. To learn more about Old Republic Title’s title insurance products and closing services, and to find out how we can help your next transaction, visit oldrepublictitle.com/commercial/ncs/.
Old Republic Title, its officers and employees do not provide, and this communication is not intended to be, investment, tax or legal advice. Old Republic Title makes no representations or warranties regarding the accuracy of the information or tax consequences addressed herein. You should consult an investment, tax or legal professional of your choosing to advise you of the benefits and risks of your specific transaction.