Could Luxury Homes One Day Fill America’s Languishing Office Buildings?

As American manufacturing declined over the decades, major cities inherited vast stretches of disused factories and warehouses. Eventually, savvy owners and developers redesigned and renovated that manufacturing space to create desirable downtown condominiums and loft apartments, often with stylish industrial accouterments.

Now, in metropolitan business environments forever altered by the Covid-19 pandemic, an abandoned office space is today’s empty factory. With many major urban areas still facing housing shortages for working professionals, the minds behind a new trend explore the possibility of transforming offices into residential real estate opportunities.

According to a recent report, cities across the U.S. are seeing office vacancy rates averaging higher than 20%. The areas with the highest reported number of open office space include Fairfield County, Connecticut (32.6%), Westchester County, New York (25.6%), Houston,(25.4%) and Brooklyn, New York. (25.2%).

With a growing sense that viral pandemics might become a seasonal phenomena, and with remote-work technology proliferating the cultural landscape, there remain questions if those empty offices will ever fill again. Residential transformation could prove a solution for real estate companies possessing ample empty buildings.

While developers have the urban space to transform quiet offices into new condominiums or luxury apartments, the question remains if they want to take on the considerable cost. Like disused factories and warehouses, orphaned offices require reparceling and utility servicing to create living spaces.

Government incentives are percolating

David Downey, president and CEO of the Washington, D.C.-based International Downtown Association, or IDA, says his organization is supporting the effort to reduce disused office space. He cites the Revitalizing Downtowns Act now before Congress as a key to pushing this metropolitan repurposing effort forward.

Sponsored by U.S. Senator Debbie Stabenow, a Michigan Democrat, the bill “expands the investment tax credit to add a qualified office conversion credit.” The 20% credit must apply to qualified converted buildings. The bill defines such a pre-conversion property as a nonresidential property available for lease to office tenants; a property substantially converted from an office use to a residential, retail or other commercial use; a building initially placed in service at least 25 years prior to the beginning of the conversion; and a building with an allowable straight line depreciation.

“IDA is supporting (the Revitalizing Downtowns Act) to incentivize conversion of underutilized office space into other uses, including residential,” Mr. Downey said.“The rehabilitation concept is similar to urban warehouse conversion from recent past decades. However, downtown office asset values are significantly more expensive than vacant industrial warehousing, which is why a conversion tax credit incentive is so important.”

Acknowledging a housing shortage in many city environments, Mr. Downey considers such governmental involvement essential to pushing repurposed office use forward in many cities.

“Greater housing levels in downtowns is imperative for building inclusive and resilient cities,” he added. “Throughout the pandemic, city centers with more residents were able to sustain small businesses and remain more vibrant even when the daytime office worker traffic was diminished.”

Plus, the benefits of new housing emerging from abandoned offices are practical, enabling more residents to live and work while dramatically reducing commute time and congestion, Mr. Downey said.

Redevelopment could take some time

David Bitner, global head of capital markets insights for global real estate serving firm Cushman & Wakefield, said the concept of making abandoned urban offices into condos or rental properties remains in its infancy as the industry comes to terms with the transformational necessities.

“The reality is that it is typically difficult and expensive to convert urban office space into residential use,” Mr. Bitner said. “For many of these to pencil, you would need to have buildings that are substantially vacant and have undergone dramatic write-downs. There are certainly cases where this will transpire, but it will only ever be a marginal influence on the office and multifamily markets, respectively.”

Mr. Bitner said conversions of older warehouses to offices was a niche or opportunistic development trend driven by demand for adaptive re-use offices from top-tier tenants. The pre-divided office layouts may not lend themselves as easily into homes.

“The often unfavorable floor plates of office buildings make them potentially less attractive to tenants,” Mr. Bitner added. “An exception would be older office buildings with attractive exteriors and small floor plates, which could make them more amenable to laying out residential units, though the interior work necessary would still be substantial.”

Developers could find themselves stuck between two worlds when it comes time to market any new spaces they create, he added.

“Conversion is expensive, which suggests that a luxury price point would be necessary,” he explained. “However, the compromises on unit layout may make them less competitive in the luxury set.”

Regardless of the practical challenges, Mr. Bitner acknowledged the appeal of new urban housing in many cities.

“I think that the pandemic has brought home the importance of submarkets having a mixed composition of office, retail and residential for maintaining vibrancy,” he says. “I think that cities should encourage this development. If they really want a lot of this to happen, then they will have to offer a range of inducements.”

Office to condo is Challenging, but not impossible

Matthew Gardner, chief economist for the Seattle-based Windermere Services Company, considers it unlikely that the offices-to-homes trend will take off significantly because of very real world problems such as plumbing.

“The core depths of traditional office buildings are not suited for conversion,” Mr. Gardner said. “There are significant issues with plumbing penetration. Warehouses are far better suited to conversion and have been successful in conversion to residential spaces for decades—such as in the Meatpacking District in Manhattan.”

If a trend for office space transformation does take off, Mr. Gardner echoed others that the resulting residences need to go upscale.

“I can’t imagine that they would be an affordable option, given conversion costs would be significant,” he says.

Despite clear challenges, Mr. Downey, of IDA, said metropolitan areas should encourage more productive use of building assets.

“Pre-pandemic, employers were already relocating to the city center where the knowledge workforce preferred to live,” Mr. Downey said. “Additionally, aging populations continue to seek walkable, amenity-rich neighborhoods with easy access to services without the use of an automobile. The Revitalizing Downtowns Act works to help finance these costly conversions as an alternative to continuing to build further out in the rural landscape.”

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