If demand shifts after the pandemic, can properties be repurposed?
As attention turns to what real estate markets may be like once the COVID-19 pandemic has wound down, the outlook for office properties is particularly hazy. More than a year of home-based work left office spaces idle, and it remains unknown how many people will resume their daily commutes once health conditions and local regulations permit.
Office vacancies in the United States rose to 17.1 percent by the end of 2020, according to a report by commercial real estate services company JLL. That is nearly 6 percentage points higher than a year earlier, when vacancies were 11.4 percent, as measured by investment management company Colliers International.
The possibility of a surplus of underused office space, combined with an ongoing undersupply of affordable housing in many markets, has some real estate professionals wondering whether a wave of office-to-residential conversions will happen. In certain cases, existing buildings can represent an easier path to residential development than traditional ground-up construction. That could be a boon for hot-market cities with high demand for housing, but which have political and regulatory barriers that stand in the way of getting it built.
However, conversions often face unique challenges with both design and regulation and do not necessarily pencil out cheaper than building from scratch. Whether office-to-residential conversions make sense will ultimately be determined market by market and even building by building. But some analysts argue that there is no question that the pandemic has created the right conditions for adaptive use.
Are Conversions Coming?
Jason Ward, an associate economist at the RAND Center for Housing and Homelessness in Los Angeles, is bullish on the prospects for office-to-residential conversions.
“Whether people can work permanently remote or limited remote, that is going to translate into lower demand for office space,” he says. “If that softens up the whole office space market, people will probably want to get out of certain leases they have. Or they might want to trade up for higher-quality space, but less of it. One way or another, it seems quite likely that at least a modest amount of office space is going to be shaken off [given] the current level of demand.”
If underused commercial space such as strip malls and other retail is combined with underused office space, Ward imagines that there could be enough viable spaces around Los Angeles to make an impact on the city’s need for housing. “Even if it’s a couple hundred properties that were suddenly available for a reuse and the process was streamlined, that would be a huge boost to housing production,” he says.
There is precedent in Los Angeles. The 1999 downtown Adaptive Reuse Ordinance has led to the creation of more than 14,000 apartment and condo units converted from underused office space, according to a 2017 report by the Washington, D.C.–based National Trust for Historic Preservation.
D.C.-based architect Michael Wiencek, president of Wiencek + Associates, has done several large office-to-residential conversion projects over the years as well as some other commercial-to-residential conversions. He, too, expects the pandemic to lead to some office conversions in the coming years, although he thinks that it will be more limited than some might guess.
“If you drive through D.C. and see 40 buildings that look ripe for conversion, I’d say it’s really just five buildings that are ripe,” Wiencek says.
He says that although many offices have few occupants right now, plenty of those tenants are locked into long-term leases and will be returning in some capacity when it is safe to do so. He points to his own firm, which leases one floor of a downtown office building. His employees have been working remotely since March 2020, but he is only partway through a 10-year lease and the penalty for breaking it early is steep.
“It comes down to whether or not a building is in dire-enough straits,” Wiencek says. One condition might be that the building has lost its tenants and is struggling to replace them. Another might be that it is an older structure without the sort of amenities necessary to attract new tenants. If it costs too much to renovate, the owners might think about selling at a price that makes conversion feasible.
The building itself also requires certain characteristics to be viable for conversion. Architect Matthew Stephenson, associate principal with Woods Bagot in New York City, has designed several office-to-residential projects and one hospital-to-residential conversion. He says that a typical Manhattan high-rise or even mid-rise building is likely too expensive and challenging to convert. “They’re just too big. They’re too deep. There are laws in New York about what the total depth of the unit is, how far can you get away from the light and air.”
Still, he expects that conversions of smaller buildings in built-out urban cores will occur where a financial and sustainability case can be made for reusing existing space instead of starting fresh.
Not everyone sees the writing on the wall for offices, however.
“I think the demise of the office environment has been overstated,” says Matthew Gardner, chief economist for Windermere Real Estate in Seattle.
He thinks that plenty of people, including himself and many of his colleagues, cannot wait to get back into the office after a year of working in suboptimal home office setups, so there may not be a glut of empty office space on the market.
Also, Gardner points to some of the challenges associated with an office-to-residential conversion that can cause a project to just not make sense. He notes, for example, that a standard office building is often two to three times wider and deeper than a standard apartment building, creating significant challenges with plumbing and natural lighting. Zoning is another hurdle, since many offices are in nonresidential areas and far from amenities like schools and grocery stores.
Benefits of Conversion
Adaptive use might come with some headaches not found in a ground-up project, but there are advantages as well. Wiencek’s first office-to-residential conversion was in downtown Bethesda, Maryland. His firm worked in partnership with the Montgomery County Coalition for the Homeless to turn a vacant five-story office building into 32 units of transitional housing with ground-floor retail space.
The Montgomery County Council had passed a bill allowing disused office space to be converted into affordable housing without any further zoning process. Because there were no zoning hurdles, Wiencek’s conversion project garnered little attention and avoided the NIMBY blowback that can accompany any development, but especially one designed for formerly homeless and low-income residents.
Wiencek says at the same time, just six blocks away, an affordable-housing developer was trying to build new permanently supportive housing and had to fight through seven years of resistance and bad press.
For Stephenson at Woods Bagot, one advantage of adaptive use is the ability to incorporate design elements from old buildings that few contemporary clients would be willing to pay for.
“One project we’re working on now has beautiful mushroom columns,” he says. “The craftsmanship on it is gorgeous and you get this amazing board form concrete ceiling. You won’t see that in a new building because it’s too labor intensive for a modern market.”
Similarly, Stephenson says older buildings often have much higher floor-to-floor heights than new construction. He says that most cost-conscious clients want minimum heights. But with an industrial or office conversion, you can get “really big spaces that you wouldn’t otherwise get.”
Dallas-based developer Ojala Holdings partnered with the city of Fort Worth and the local housing authority last year to convert an extended-stay motel to 119 units of permanently supportive housing for people exiting homelessness. The project was funded with money from the Coronavirus Aid, Relief, and Economic Security (CARES) Act of 2020, which required a tight turnaround to meet federal deadlines.
An extended-stay motel obviously lends itself well to apartment conversions. But still, Ojala associate G. Hunt Neurohr says that the project was completed significantly faster than a similar ground-up project could have been. Because of support from the city, the developer was able to find and close on the property and get all the zoning changes and permitting done in about 45 days. After that, they blitzed through the conversion of the distressed motel in just three months, including adding new paint, appliances, fixtures, and a security system and demolishing several units to create an open club room and offices for management and caseworkers.
“We created 119 homes in 90 days when a ground-up construction project alone can be a 12- to 36-month period,” Neurohr says. “Essentially, we saved an entire year by converting this existing structure.”
There were big financial savings as well. Neurohr estimates that a similar ground-up project would have cost at least four times more than the motel conversion did.
Downsides to Adaptive Use
Offices are often erected on a much larger footprint than apartments with less consideration of plumbing, natural light, and other essential comforts for a living space. And some office buildings are just too big for residential conversion. But, assuming a building is not too massive to begin with, the size issues can be overcome. For example, Wiencek’s firm designed the conversion of two former U.S. Environmental Protection Agency office buildings in D.C. into 560 apartments.
The 12-story structures are 110 feet (34 m) wide, significantly larger than a typical 60- to 65-foot-wide (18 to 20 m) apartment building footprint. To overcome the depth issue, half of the units are what Wiencek calls “boxcar” apartments—long, skinny 16-foot-wide (5 m) units that are up to 55 feet (17 m) deep. The front of the unit has floor-to-ceiling glass, drawing light into the kitchen, dining room, and living room. The main bedroom has a rolling barn door with a glass transom that allows light inside. The second bedroom has a translucent glass rolling door.
Although existing building elements can enhance the converted product, some elements can pose challenges. For instance, when Woods Bagot designed 49 Chambers, a 17-story office building-to-condo conversion across from City Hall in Manhattan, they discovered that the basement bank vault, which they had planned to remove, was far too heavy to move. So, the building’s below-ground amenities including a pool, a spa, a workout room, film screening areas, and more had to be moved to a sub-basement one level down from the 100-year-old vault. On the plus side, the vault can be incorporated into plans for a future occupant of the ground-floor retail space. Stephenson says that he can imagine it being a downstairs VIP lounge for a restaurant, for example.
Beyond Office Conversions
Office spaces are not the only commercial real estate suffering from the pandemic’s economic fallout. A report by Yelp released in September 2020 found that 97,966 small businesses in the United States had permanently closed since the start of the pandemic. The impact has not been evenly felt. An August 2020 report by the New York Federal Reserve found that across the United States between February and April 2020, the number of Black-owned businesses had declined 41 percent, Latino-owned businesses 32 percent, Asian-owned businesses 25 percent, and White-owned businesses 17 percent.
In February 2021, Bloomberg News reported that only about half of the 1,100 U.S. indoor malls have a good chance of survival after the pandemic. Hotels and motels have been hit hard by the lack of travel. Those spaces all have potential as conversions from commercial to residential or other uses.
For example, like the motel conversion project in Fort Worth, Texas, California’s Project Homekey has been purchasing motels for conversion into permanent supportive housing for the homeless. In Eden Prairie, Minnesota, a big-box grocery store was converted into a library. McAllen, Texas, built a library out of a former Walmart. In Charlotte, North Carolina, a former Kmart was converted into a charter school. And in Providence, Rhode Island, the upper two stories of a small mall built in 1828 were converted into 48 micro apartments while the lower floor was left open for dining and retail.
While it remains to be seen what office and commercial real estate markets will look like in the wake of the pandemic, local governments can do some things now to encourage reuse rather than vacancies.
The Center for Community Progress is a national nonprofit organization focused on policy solutions addressing vacant and deteriorated properties. Danielle Lewinski, the center’s vice president of technical assistance, says that local governments should be “trying to get a handle on where vacancies may occur prior to them occurring” by surveying individual landlords and building owners to get a sense of where vacancies are occurring and who is dealing with nonpayment of rent from tenants. The second step is to start thinking about their community’s land use needs, whether market-rate housing, affordable housing, or senior housing, and what zoning changes would be needed to allow those uses in existing commercial zones.