Change comes to everyone, whether you’re ready for it or not. The debate about whether offices will continue to be a need in our modern economy rages on, but there is no denying that the basis of demand has changed and there’s no going back.
I still have an office that I go to almost every day. But I work from home (or my car, or Starbucks…) on occasion too, as the flexibility of work thanks to modern paperless tech goes with me everywhere that my laptop goes.
Just like shopping malls have been going through a process of metamorphosis, office buildings are currently beginning to undergo a major shift. Online shopping has forever affected the shopping mall, and the changes that were brought about by COVID will forever mark a turning point in the office market.
As a result, many office buildings will need to be re-adapted for another use.
The Office Vacancy Crisis
The COVID-19 pandemic accelerated the shift towards remote and hybrid working models, significantly reducing the demand for traditional office space. According to a report by CoStar, office vacancy rates in major cities soared to unprecedented levels by 2023, with some cities experiencing vacancy rates as high as 20-30%.
Shrinking demand continues to plague the U.S. office market so far in 2024, shooting nationwide vacancy up to a record 13.8% and bringing cumulative negative absorption to nearly 210 MILLION square feet since April 2020, as seen in the chart below. This figure is over four times the lost occupancy observed during the Great Recession.
It is important to note that not all office buildings are created equal – newly built Class A office space is enjoying growing rents and occupancy, while Class B & C older buildings are where most vacancy is concentrated.
Housing Shortages in Urban Areas
Simultaneously, many cities face a severe housing shortage. Rapid urbanization and population growth have outpaces the development of new residential units, leading to skyrocketing rents and home prices. According to the National Low Income Housing Coalition, the U.S. faces a deficit of over 7 million affordable housing units. This shortage exacerbates homelessness and forces many to live in substandard conditions.
Part 1 – Transforming Vacant Office Buildings into Apartments: Does it really make sense?
Transforming vacant office buildings into apartments seems to offer a natural solution to these dual challenges. The benefits can include:
- Cost Efficiency: Converting office buildings can be (see part 2 below) more economical than constructing new apartments from the ground up. Developers save on foundation and structural costs, as the primary building framework is already in place. According to the Urban Land Institute, adaptive reuse projects can cost 10-20% less than new construction.
- Sustainability: The environmental benefits are significant. Adaptive reuse reduces the need for raw materials and minimizes waste from demolition. Additionally, these projects often involve upgrading building systems to be more energy efficient, contributing to greener urban environments.
- Revitalization of Urban Areas: Converting office space into residential units can breathe new life into downtown areas. Increased residential density supports local businesses and enhances the vibrancy of urban centers, creating more dynamic and livable cities.
Part 2 – Challenges and Considerations
Despite the clear advantages, transforming vacant office buildings into apartments is not without its challenges. Each project requires careful consideration of several factors:
- Zoning and Building Codes: Many office buildings are located in areas zoned for commercial use, necessitating changes to zoning laws and building codes.
- TIP: Look at performance code to help with design, which can be a money saver on construction.
- Ask townships if there are vacant office buildings they would like to see rehabilitated. Having them on your side as an advocate can open doors, and benefits everyone involved.
- Design and Infrastructure: Office buildings are typically designed with large, open floor plans, which may not easily translate into residential layouts. Developers must creatively reconfigure spaces to accommodate residential needs, such as plumbing, kitchens, and private bathrooms. Additionally, ensuring adequate natural light and ventilation can be challenging.
- Consider actually tearing down part of the building in order to gain more interior light and windows for egress.
- Use interior space that may not be suitable as living space for amenities like a gym, movie lounge, co-working space, storage lockers, and common areas.
- Market Demand and Pricing: Developers must assess whether there is sufficient demand for the type of housing being created, whether it be luxury apartments, affordable housing, or something in-between. The setting of office buildings on high-traffic roads or within business parks may or may not be the ideal location to spring up more apartments.
- Look for buildings within Federal Historic Districts. These locations, if rehabilitated according to program standards, can qualify for 20%+ tax credits, which can make the difference on a project’s feasibility. Some states also have a state historic tax credit program that you can consider.
- Suggest creative financing, like having the seller hold equity or debt into the project. Owners who realize their options are limited may be much more willing to engage in creative financing arrangements.
- Generally, office conversions will work best in markets that can command rents for Class A units greater than $2 per square foot.
Successful Case Study
In York, the old Fox Bakery Building on North George Street was built in the 19th century and is currently being converted into 43 one-bedroom apartments with parking. Formerly an office and a warehouse, the downtown location provided an ideal setting for an apartment conversion. Slated to be a $7million project, it’s a joint venture between Kinsley Properties and Royal Square Development & Construction. The units will have rents starting around $1,095 per month.
Where does this make sense?
Many states in the Sun Belt region have more flexible zoning and land use approval structures than in the Northeast. As a result, there have been a large amount of apartment units added to the supply in high growth markets such as the Carolinas, Texas, and Tennessee. Office conversions in areas such as those will happen less frequently.
Meanwhile, in regions like the Northeast where the barrier to new product entry is higher, the conversion process is and will be more common as demand drivers make the financials feasible.
Conclusion
The debate about office use can continue, but no one can deny that the way we use offices has changed, setting the tone for many vacant office buildings to be converted into a new use.
Investors with a careful eye for value can benefit from the trend towards transforming vacant office buildings into apartments, by a selective and creative approach that will have everyone else saying, “I wish I had thought of that!”
Looking for a conversion project? Call our expert advisors to discuss the right strategy and identify opportunities for your consideration.
