Can Adaptive Reuse Solve the Real Estate Imbalance of Too Many Empty Offices; Too Few Housing Units?

The latest reports tell the tale of twin problems for the U.S. real estate industry. Office vacancy rates were about 20% at the end of the second quarter of 2023, and in some cities, such as San Francisco, nearly 32% of offices are empty, according to Jones Lang LaSalle (JLL). At the same time, an estimated 4.3 million more housing units are needed to meet demand for rental and purchase housing across the U.S., according to analysis by Zillow.

It seems like an obvious solution to convert offices to apartments and condominiums. Yet the physical complexity of conversion, the financial calculations, and zoning and permitting processes raise challenges that are not necessarily apparent to optimists who see a simple solution.

“The glass-half-full viewpoint is that even if only one percent of office buildings can be converted into housing, that can create tens of thousands of units,” says Adam Ducker, CEO of RCLCO Real Estate Consulting, based in Bethesda, Md. “The benefit of adaptive reuse of offices is that this is an energy-efficient and time-efficient way of creating more housing. It may not be cheaper, but you can get apartments built in 12 to 18 months depending on the project.”

Despite the potential complications of converting an office to an apartment, it is generally faster than ground-up development, he says.

While 10,090 apartments were converted across the U.S. in 2022, the pace of office conversions slowed during the first half of 2023, according to a recent report by YardiMatrix, a commercial real estate research firm. However, the report projects a 63% increase in upcoming projects compared to the first half of 2023, including 45,000 apartments anticipated from office conversions, primarily in cities.

“Adaptive reuse of offices for housing is primarily a downtown story [across the country] because of the density and lack of land to build more housing,” says Hugh Frater. In addition to being a founding partner of Black Rock Inc., Frater is New York City-based chairman of Vessel Technologies, which designs and manufactures apartments, and former CEO of Fannie Mae and Berkadia Commercial Mortgage. “Suburban offices are more likely to be torn down if they’re obsolete or vacant so the land can be used for new development.”

Architectural Reality

Urban-density housing presents a challenge to the process of reconfiguring an office building to housing, since there is typically little space to store supplies and the equipment that conversion would demand. A bigger problem is that many offices aren’t designed in a way that makes conversion easy. Plumbing, mechanical, and electrical systems need to be adapted and upgraded for different uses, with kitchens and bathrooms posing the greatest challenges.

“Offices built in the 1980s and 1990s typically have huge floor plates because companies wanted everyone on the same floor for productivity,” says Suzanne Lanyi Charles, an associate professor of city and regional planning at Cornell University in Ithaca, N.Y. “A floor with 30,000 square feet works fine for an office, but not for residential because most of the floor space is too far from natural light.”

She points out that many office buildings have sealed windows and lower ceilings than residential spaces. “Living rooms and bedrooms must be next to the outside of the building for natural light and ventilation,” she says. “You can design closets and bathrooms into spaces without windows, but in many buildings, there will be too much unhabitable space. No one wants an expensive 2,000-square-foot apartment with enormous closets and just one bedroom.”

Smaller, older office buildings from the 19th and early 20th century tend to offer better opportunities for conversion, Charles says, along with buildings that have a courtyard in the center or a U-shape design, because they offer more light.

“Office buildings that work well to convert into housing are old skyscrapers that were built before air conditioning because workers needed to be cooled by open windows,” Ducker says. “You’re never more than 20 or 25 feet from a window.”

But Ducker says architects are coming up with creative solutions, such as converting the center of a building into storage or hollowing out part of the middle of a building.

“So far, adaptive reuse isn’t usually cheaper than ground-up development because not that many companies have done them,” Ducker says. “You need experienced architects and engineers. But when it becomes 5% cheaper and 5% more efficient to convert an office [than it is now], it becomes a more compelling strategy.”

Market-Driven Considerations

Financing an office conversion can be complicated, according to Ducker, because of uncertainty around costs and rent. “That uncertainty makes it harder to raise money, because investors want to know what it will cost and what the rent will be before they invest,” Ducker says. “Capital markets are challenging right now.”

Investing in office-to-residential conversions takes vision and faith in a complex process, so it’s less straightforward of a decision, he says.

One important element of the office-to-housing dynamic is whether demand exists for downtown housing, particularly as so many cities are experiencing less-active neighborhoods because of the absence of workers. Frater believes it will take creative efforts by community leaders and municipal governments to revitalize downtowns.

“Ultimately, renters care about getting to work, to school, and to public transportation,” Frater says. “But above all else, the amount of the rent matters. For an office to housing conversion to work, it has to be the right property in the right place with the right price.”

The housing shortage is most acute for affordable units, which changes the dynamics for developers and investors, according to Frater. If landlords must charge a lower rent, then their purchase price needs to be below market, or they need government subsidies or both for the deal to be profitable.

“Cities can encourage affordable developments with ‘carrots’ like allowing more density if they include affordable units in a building, and with ‘sticks’ such as requirements for a certain percentage of units to be affordable for different income levels,” Charles says.

Incentives for Conversion Projects

While Frater says developers are usually happy to accept subsidies if offered, what matters more to them is the certainty that their project can be delivered. Officials can introduce regulations that allow developers to build without requiring special zoning hearings for project approvals, he says. City officials can tackle zoning reform, reduce regulations, help expedite sales, offer incentives, and speed up the permit and inspection process to facilitate multifamily development.

Some examples of actions cities are taking to encourage adaptive reuse of office buildings include:

·         Washington, D.C.: City officials offered a 20-year property tax break to developers who convert offices to apartments.

·         Boston: A pilot program reduces property taxes by up to 75% for office conversions.

·         San Francisco: City leaders are working with property owners to identify potential candidates for adaptive reuse and evaluate city and federal support such as tax abatements and zoning changes.

·         New York City: A task force recommended several incentives including rezoning and eliminating some parking regulations to spur conversions.

Many cities have zoning laws that prevent residential use in downtown areas, Charles says.

“Originally, this was for health reasons to prevent exposure to noxious uses,” Charles says. "But now people recognize the value in 24-hour locations with a mix of uses. Zoning laws can be changed to accommodate that and eliminate those downtown pockets that are empty on weekends.”

In addition, several federal government agencies are looking into federal funding of some projects, converting federal buildings to housing, and researching ways to lower costs of adaptive reuse.

For those looking for inspiration, there are numerous examples of creative and successful adaptive reuse projects.

For example, an office building in Northern Virginia was recently partially converted to residential use with a separate lobby, elevators, and amenity spaces, while retaining functional office space for business tenants.

In downtown Dallas, two 1960s office towers will be reconfigured into apartments that offer unique layouts with substantial daylight and an appealing mid-century modern vibe that quickly attracted renters, Ducker says.

Adaptive reuse may not be a panacea, but it’s an option and an opportunity that property owners and investors continue to explore.