As working from home (WFH) becomes more permanent, and fewer workers commute to offices, cities hope to convert unoccupied and excess office space to residences. But we don’t yet know the possible scale and speed of such conversions, and whether they can make a big dent in our housing affordability crisis.
There’s definitely action on conversions. New York developer Bill Rudin says “you feel the energy” on deals, including his firm’s sale of a 30 story office building at 55 Broad Street in the Financial District to a group including Silverstein Properties. The planned conversion would create 571 market rate apartments.
Silverstein laid down a big marker recently, announcing a $1.5 billion fund for office building conversions, with the firm envisioning a market of up to $10 billion. To make conversions happen, Rudin thinks government will need to help, through zoning and building code changes and possible tax breaks or other financial incentives.
Such aid was essential in the Financial District’s last conversion wave, detailed in New York’s Skyscraper Museum’s “Residential Rising” exhibit. In about twenty years, lower Manhattan’s residential population more than doubled, with conversions a key part of expanding housing supply. New York City’s high-level “Office Adaptive Reuse Task Force” is now working on the issue, scheduled to report by years’ end.
The action isn’t confined to New York City. Houston, Pittsburgh, Washington D.C., and other cities are reporting growing interest and conversion deals. If commercial rents keep falling, many older buildings could be conversion candidates. This leads experts like Alan Ehrenhalt to say cities could “be taking one large step in an urban evolution” that would focus them more on housing and residential strength and less on offices.
But conversion enthusiasts now face a downbeat analysis from real estate giant CBRE, which says conversions only represent “2% of the overall office market.” Emphasizing the cost, regulatory, and physical challenges of conversion, CBRE concludes “conversions are a niche trend” that will be confined to specific local markets.
That 2% number seems very different from other estimates. A 2021 National Association of Realtors (NAR) of 27 major metro markets estimated up to 20% of “vacant square footage” could be turned into residences. But a closer look reveals NAR focused primarily on older class B buildings, while CBRE evaluated conversions in light of the total commercial real estate market.
There are lots of constraints on conversions. Real estate people tend to focus on costs, regulations, and technical problems. And cities correctly want to link conversion incentives with inclusion of affordable housing units. But two meta-issues overhang conversions—what form will working from home (WFH) finally take, and what will Federal Reserve interest rate policy do to development?
We still don’t know the scale and permanence of WFH. Many workers and some employers prefer a “hybrid” mode combining home and in-office work—and that will require retaining some high-quality office space. A looming recession driven by the Federal Reserve’s interest rate increases also may shift the balance of power between workers and employers in favor of more in-office work.
And the Fed’s interest rate increases are raising borrowing costs, which will hurt real estate investments. It will be interesting to see how easy it is for the Silverstein and other conversion funds to raise capital in this volatile market.
Probably the best summary so far comes from Dror Poleg, an economic historian with deep expertise on cities and real estate. He thinks many commercial office building owners “are waiting for the old normal to return” and aren’t ready to sell or convert. But continuing pressure on rents, especially for older stock, will lead to “a tipping point” resulting in a “relative avalanche of conversions.”
Poleg knows commercial and residential real estate is a big, complicated world, and there’s not much that can affect all subsectors. He concludes conversions will be a “marginal issue in most markets” while “in some cases, it might have a real impact on the housing supply.”
That seems right. There’s no one answer to our residential real estate shortage, other than creating a lot more supply however we can while incorporating affordable housing in new market-rate development. For cities with empty older office building, residential conversions will be an important tool—but only one— in the overall housing kit.