While uncertainty still clouds the outlook for office space in many of the largest cities in the U.S., demand for housing remains significantly higher than supply. Housing shortage estimates range from three to four million units, so empty offices seem like a natural source of space that could be converted to multifamily housing. But office-to-housing conversions are not as simple as they appear.
The feasibility of office-to-rental housing conversions faces several challenges, including construction complexities, rising building costs and the economics of the differential in vacancy rates and rents.
In a recent analysis, Scholastica (Gay) Cororaton, Senior Economist and Director of Housing & Commercial Research with the Research Group of the National Association of Realtors (NAR), found that offices in Chicago offer the best potential for a financially viable conversion of Class B office space to Class A rental units.
“We looked closely at Class B offices because vacancy rates are higher for Class B buildings than Class A and Class C offices,” says Cororaton. “Also, Class B buildings are older than Class A offices and might need to be refurbished anyway to attract new tenants.”
Cororaton looked at six major markets in her study, including Chicago, New York, Boston, San Francisco, Los Angeles and Washington, D.C., because of the continued severe losses in office occupancy rates in those cities since the pandemic began. The net absorption rates of office space in those cities between the third quarter of 2020 and the first quarter of 2022 was -29.2 million square feet in New York, -11.5 million square feet in Los Angeles, -9.4 million square feet in San Francisco, -9.2 million square feet in Chicago, -9 million square feet in Washington and -2.8 million square feet in Boston.
“There’s still some uncertainty about office demand in the future, although it seems clear that many companies will have a hybrid workforce,” says Cororaton. “The objective is to have collaborative space for meetings, but what that means for office space is unknown. I think in two years or so we’ll know more about office needs.”
In San Francisco, Los Angeles and Washington, Class B office rents are still higher than Class A residential rents, which means office-to-residential conversions are less enticing, she says.
Construction challenges for office conversions
In addition to the rent differential, numerous other factors influence the viability of office-to-residential conversions, including zoning regulations that could increase project costs or discourage conversions.
“The configuration of the building matters, too, because if you have an office with big deep floor plates like a big square without windows, you’ll need to figure out a way to add an atrium or something for natural light for apartment units,” says Cororaton. “The location of the elevators, HVACs and other systems in the building also has a big impact on the cost of converting it to residential use.”
Affordable housing conversions feasible with government incentives
A November 2021 report by NAR researchers analyzed office-to-housing transformations in 27 markets and found that based on rent differentials, conversions from Class B and C offices to Class A multifamily units are feasible in 22 markets. The report included case studies of eight conversions at a variety of price points including affordable housing.
One success story is Cordell Place, a former office building in Bethesda, Maryland, a suburb of Washington, D.C., which was converted to homeless permanent supportive housing. The collaboration with a nonprofit organization and an $8 million investment from the county government made the project financially viable and the building’s narrow and wide structure made it more adaptable for residential use.
A $4.1 million investment from Montgomery County, Maryland assisted re-development of Octave 1320, an office building close to Silver Spring, Maryland’s transit station. Octave 1320 was converted to affordable efficiency condos for first-time homebuyers. The developer said construction time was reduced to 12 to 13 months from 18 to 24 months with an office conversion instead of ground-up construction.
“In cities with inclusionary zoning and government incentives, including Low Income Housing Tax Credits, developers can find ways to convert offices to affordable housing,” says Cororaton. “That can be easier when you can find the right Class B office for the project.”