The Push to Convert Empty Offices Into Housing: Will it Work?

Since the beginning of the pandemic, about 50 city blocks of office space throughout America have been already converted or are currently being transformed into multifamily properties, according to Bisnow.  

In theory, the process should allow property owners to kill two birds with one stone. They can capitalize on the sustained growth of housing demand while making the most of vacant office space. Doing so would also lessen their stake in the highly concentrated (and unsure) office market. Still, the process is a complicated one.  

Execution is slow and expensive. In reality, the current number of buildings suitable for conversions is likely too few to become widespread. However, and as always, this represents an opportunity for corporate tenants.  

Learn about:  

• The push for office conversions  
• Why property owners are reluctant to start conversions  
• The power corporate tenants have right now
  
  

The Push for Office Conversions  

In the hunt for a solution to the post-pandemic Office Space Apocalypse, the suggested solution is now converting vacant offices into affordable housing in metropolitan areas.  

There’s a precedent of success with this undertaking internationally. For example, in the United Kingdom an average 12,000 new residential units are converted from old buildings each year- and they’ve been doing it since 2015.  

In New York, millions of commercial square footage has been turned into apartments.

Most of this has occurred in lower Manhattan. More recently, 55 Broad Street, a mostly empty office building in the Financial District is set to be turned into over 500 apartments. 

Still, don’t get ahead of yourself yet. While this all sounds very impressive, the tide is not completely turning yet. Office conversions are more of a complicated and rare solution than idealists would suggest.  

While there has been much talk about conversions being the wave of the future, the actual number of such developments is less than one may expect. 

Six of those major projects have taken place in Washington D.C. Currently the nation’s capital is leading the trend. Still, projects are appearing in other popular cityscapes including Chicago, Los Angeles, and of course, New York City (plus more).

If you're looking for office spaces in these cities (or anywhere else), there's things you'll want to get right. Hear from the True Tenant Reps™ at iOptimize Realty® how you can get the best office space in the free course below. 

To Convert or Not to Convert  

Office conversions are yet another attempt of Corporate America to adapt to the disruption of flexible work models.  

Consider where public demand has shifted in recent years. Correlating directly with the WFH movement, people want more housing options and less time at the office. As a result, multifamily and residential rents have climbed while on the inverse, office rents are generally declining because so many sit underutilized  

Office demand has tanked. As such, the value of a CRE investment is not what it used to be. Currently, Manhattan offices are leased for 17% per square foot more than multifamily properties. However, this profit margin is rapidly getting slimmer, already plummeting from a pre-pandemic profit gap of 44%.  

While the office vacancy rate lies around 16.9% (a devaluation of $423 billion), vacancy rate for multi-family is at a low of 3.1%. High demand for housing and low vacancy rates represents an opportunity to capitalize on a booming market with promise to grow even further.  

Still, the high cost (and massive undertaking) of transforming offices to apartments is not yet worth it to most property owners. It’s predicted that the value of offices will need to further drop before mass conversations are commonplace. According to Bisnow, “The value of the residential property needs to be around 50% more than an office for it to be worthwhile.” 

Construction is a Massive Undertaking  

Developers are dragging their feet to convert right now. If anything, that should prove just how expensive an undertaking it is to shift old offices to be livable residences.  

For example, let’s look at New York City for an example. According to Moody Analytics, the median apartment rent in NYC is $55 per square foot. While it could be likened to comparing apples and oranges, office space in Manhattan is rented for about $90 per square foot. So, the point is there is already a significant price delineation in rent alone.  

Then, converting offices to residential living always represents an additional loss because of the common area factor. Apartment tenants don’t pay rent to common areas like hallways, stairwells, elevators, etc. This is of course opposed to office tenants that do cover square footage that is rentable but not usable. So, we are now talking a significant reduction in revenue already.  

Then, and only then, can the immense cost of construction be considered. Consider the sheer amount of work required to gut office buildings, their plumbing systems, and layouts. Then to build the inside back up again in line with strict residential codes. For example, there are certain laws regarding the number of windows that qualify a space as livable.  

All said and done, “The cost to convert offices to an average apartment building is about $100-$200/SF, although that cost could be significantly inflated now. If we assume $150/SF of hard and soft costs plus a 15% profit margin of $23/SF, a developer will need to seek offices available at $262/SF”, according to a study performed by Moody Analytics. 

Corporate Tenants Have Power to Negotiate  

For tenants, the time to strike is now while there’s still a glut of office space. While developers are still slow to fund conversions, they may have no other option soon. The market is soon to reach its mass threshold of vacant office buildings. Since office devaluation will likely need to continue before housing conversions are funded, this means office price drops may have an end in sight. The tipping point has still not been reached that forces a significant reorientation of city layouts. For now, the costs aren’t worth it.  

Apartment conversions are still plotted to be a last-ditch effort. In the meantime, landlords are scrambling to make their office leases more attractive.  

Not as expensive, albeit still pricy, options include a more generous TI allowance. Landlords are giving increasingly higher TI allowances, even funding soft costs. TI allowances can also be leveraged to encourage your landlord to fund the cost of updating the building. Traditional offices are now being considered the “gas guzzlers” of CRE. The push is now for modern, environmentally conscious facilities. 

According to the Wall Street Journal “For now, big listed office landlords like Empire State Realty Trust and SL Green may opt to give tired offices a “green” refurbishment rather than turn them into homes. Demand for sustainable offices is currently strong among corporate tenants.” 

So, rather than convert offices into housing, there seems to be a happy medium (an area of demand, yet reasonable cost relative to apartment construction). If you’re willing to extend your stay or take on more space, your landlord may fund improvements to the space. This is becoming more common. The likelihood of success is also higher since there is such a glut of commercial space.  

But with conversions on the horizon, the time to act is now. Corporate tenants can get the most value out of their tenancy, but only if you are prepared to negotiate. So, whether that means a new and improved TI allowance, better terms, or resetting your rent to market value (which has been steadily declining for years), you have room for massive savings. But, to make the most out of this opportunity it is best you protect your interests by working with a True Tenant Rep.™

The True Tenant Rep™ experts at iOptimize Realty^® have weathered 30+ years in the CRE world. This means, we’ve seen it all when it comes to trend. This latest opportunity for tenants represents a tangible method to take millions off their CRE spending. This is not the time to use the landlord’s broker. You want the representatives that actually have your back. Get the best deal by working with a True Tenant Rep™ at iOptimize Realty^®.  

Talk to an expert True Tenant Rep™ to learn how you can save today.