Office to Multifamily? (Office Conversion Series – #2)

November 22, 2023

This is week two of our office conversion series and today we discuss office to multifamily conversions.  Right off, we count over 20 prime office sites in Metro Phoenix that have been developed as multifamily in the last decade. This site stealing is not new. The relatively new thing is developers taking existing office buildings and retrofitting them to multifamily complexes.  We have discussed this in previous C2 Voices here and here.

While selling office land to multifamily developers has been proven possible, conversions of existing buildings are a different matter. There is a lot of hype for this conversion scenario but the reality will fall short of the buzz (in our opinion). Conversions are filled with challenges such as construction complexities, time to convert, and rezoning.  While this can be a viable option for some office space, it will require a lot of expertise, time, and money to pull it off. 

Pros:
– We will continue to see opportunities to help with the ongoing housing demand.
– When these conversions sell, the returns have been very lucrative.
– The numbers work, given the declining value of office buildings today.  

Cons
– Rezoning can be time-consuming and expensive.
-It takes a good amount of time to do the actual conversion (taking the building to shell and rebuilding).
– Markets change and time can kill all deals.
– There are not as many office buildings that have quality construction and convertible floorplates as you would think.  

The article below my signature details more examples, but here are a few more links if you are interested in this topic:
— Multifamily Developers Turn Some Dead Office Space into Apartments
 Converting office buildings to apartments 
— Phoenix could soon capitalize on office-to-apartment conversions
 Phoenix midtown tower could transform into ‘urban resort oasis’
— Turning Empty Offices Into Apartments is Getting Even Harder

Here are my takeaways:

1. Challenges of Conversion: The time to convert is a lengthy process, which includes rezoning, re-designing, and re-building. Additionally, these conversions are expensive because you are taking the office and breaking it down to the shell to rebuild. The plumbing alone is pricey. Changing market vacancy rates/rental incomes will vary widely over the 2-3 years it takes to do the conversion making this risky.  Here is a  tale in our own market at Central & Camelback: One Camelback saga: Stakeholders jockey for position as development careens toward auction sale

2. Optimal Prospects in Specific Markets: Older and more obsolete mid & high-rise office buildings, with higher vacancy rates, have the most potential for profitable transformation into rental units.  BUT only if the floorplans work.  Achieving floorplate layouts with natural light, for each apartment can be a huge challenge.

However, despite the challenges, it has been done. Here are a few examples:

1. Cordell Place in Bethesda, Maryland Converted office into permanent supportive housing for the homeless.  This conversion can change the nature of the submarket creating additional stress on the market.

2. WeBuild Res located in our very own Valley of the Sun They have started to convert three older office buildings into a new multi-family apartment complex that will be called Northern Apartments.  These office buildings date back to the 1980s and were obsolete as office. Click the link here to read more.

One real interest of mine is converting offices into workplace housing for service workers so they can live within close proximity of where they work.  I see this as very interesting but very challenging.  The Federal Government just opened $45 million in federal funds for office to home conversions to try to encourage housing in close proximity to public transit.  Read more by clicking the link here.

We will watch with interest to see how many of these multifamily conversions happen over the next market cycle or two.

Craig

602.954.3762

 


Making the Math Work: Office-to-Multifamily Conversions

April 27, 2022

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 conversionsIn 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 incentivesA 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.

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