The Office Conversion Dilemma

The Office Conversion Dilemma

Monday, December 18, 2023, from Floor Covering Weekly

By Kermit Baker
The U.S. has a serious housing shortage, particularly for affordable homes. Years of underbuilding have caused both house prices and rents to increase dramatically. As a result, recent government data indicates that over half of renters in the country are considered to be rent burdened, meaning that they devote 30 percent or more of their income to monthly rent payments. Even more significantly, over half of these rent burdened households are considered to be severely rent burdened, meaning that over half of their income goes toward rent.

Meanwhile, there is an oversupply of commercial facilities. The increase in e-commerce has limited the need for traditional retail facilities. Even more so, remote work still accounts for about 30 percent of paid workdays which means that there is less need for office space. Office vacancy rates have soared to over 18 percent nationally and currently are above 25 percent in historically vibrant metro areas like San Francisco, Dallas, and Chicago.

So, what if we were to convert underutilized office space to affordable housing? That would help to address both problems. However, while sensible, this strategy is much more complicated than it appears. Between 2010 and 2020, rental units created by conversions from office buildings and hotels/ motels averaged about 5,500 per year. Since then, a period where rental affordability worsened and office vacancies soared, these conversions increased only modestly to an average of 6,200 a year. In fairness, there is more attention and more governmental incentives to undertake these conversions now, so these numbers should pick up considerably in the coming years. Still, since 2015, we’ve averaged about 425,000 multifamily housing starts a year, so even doubling or tripling the current level of commercial conversions wouldn’t move the needle much to increase the rental housing stock.

Why haven’t we seen more in the way of office to rental housing conversions? There are several reasons, including zoning, building footprints and building systems. Office buildings are generally in areas zoned for commercial uses, so that would need to chance to accommodate residential uses.

Most office buildings have larger floorplans that don’t accommodate the layout of individual rental units. Rental units in the interior of a larger office building would have few if any windows.

Older buildings are generally better candidates for conversion because they typically are smaller and rely on windows for ventilation. However, older buildings present other challenges for conversion. Older office buildings typically have older plumbing, electrical and HVAC systems that would need costly upgrading to accommodate apartments. Cooking and bath facilities would need to be added. Acoustical standards would need to be upgraded for an apartment or condo from that of a typical office building.

So, the feasibility of office conversion mostly comes down to simple economics. In some areas of the country, there appears to be significant opportunities for office conversion. CBRE, a real estate services and investment company, recently reported that office conversion was either underway or planned for almost 11 percent of the total office space in Cleveland and almost seven percent in Cincinnati. These high shares are due to the generally older office stock in these metros coupled with a generally weak office market. However, other markets currently have a much lower share of activity.

Typically, the economics of office conversion don’t work for affordable rental housing. The costs are such that they only make sense for upper-end units. It was recently reported that the iconic Flatiron Building in Manhattan would be converted to 40 luxury condos or rental units. If that occurs, it will help to reduce commercial vacancies in the city and generate badly needed property tax revenue. However, it will do little to provide affordable housing. opportunities.