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Record volume of office-to-apartment conversions is in the pipeline. How many will become reality?

Municipalities across the country are motivated to find alternative uses for the obsolete office buildings sitting vacant in their downtowns, particularly because of the hit those reduced building valuations — and taxes — will have on local government revenue.
 

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The number of residential units being converted from office buildings across the country has hit a record, as cities and developers look for new ways to reimagine an abundance of office space sitting vacant in U.S. downtowns.

 

Between 2021 and 2024, the number of apartments scheduled for conversion from office space has grown from 12,100 to 55,339, according to RentCafe, part of Yardi Systems Inc. That means office conversions represent 38% of the estimated 147,000 apartments in adaptive-reuse projects.

 

But among the 55,000-plus units included in the findings, only 23%, or 12,842, of the residential units being added in former offices are expected to be under construction this year. The rest remain in either the “planned” stage — where permitting and development work has been submitted — or the “prospective” stage, where no formal documentation or design has begun yet.

 

Office conversions to other property types, especially residential, are being looked at in cities across the U.S. as a way to help bring people and revenue back to city centers. But office conversions are notorious for being difficult and expensive to pull off.

 

Some obsolete office buildings aren’t good candidates for residential conversion simply because of their floorplate size. For others, it’s because of where plumbing and electrical services are or can be located within the structure, or placement of windows.

Also, since the onset of the pandemic and the subsequent rise in interest rates, there’ve been few sales of the types of office towers that could be potential candidates for conversion.

 

But office building trades are starting to occur again now — some at deep discounts from their most-recent sales — potentially paving the way for more conversion activity.

Doug Ressler, manager of business intelligence at Yardi Matrix, said sellers are starting to recognize reality when it comes to whether to hold or sell certain buildings, including ones that might make sense for a conversion.

 

“Whether you convert (a building) or not, it’s really built on a set of assumptions,” he said. “If the assumptions change, you have to rethink your strategy. Right now, it should be environmentally better to recycle than demolish.”

 

How many planned projects will become reality?

 

Office-to-residential conversions, whether actively underway or in an earlier stage of development, are happening in the usual lineup of cities that have an abundance of older office towers. But cities with a younger office supply, including some places in the Sun Belt, also are starting to see an uptick in conversion activity.

 

Washington, D.C., has the most office-to-residential units underway, with 5,820 in the pipeline for 2024, according to RentCafe. That’s followed by New York, with 5,215; Dallas, with 3,163; Chicago, with 2,822; and Los Angeles, with 2,442.

 

Whether the 42,497 units nationally in the planned or prospective stages turn into projects under construction likely will hinge on broader economic forces, including what happens with interest rates and the cost of capital, as well as what local and state governments may offer in the way of incentives to make those projects feasible.

 

“Interest rates going down is certainly going to free up a lot of investment, but you’ve also got zoning and permitting and the cost associated with moving that forward,” Ressler said. “The longer-term issue seems to be, three to five years out, do I have the (net operating income) to support what I want to do?”

 

The national apartment market is expected to have a record number of unit deliveries this year after a significant amount of rental-housing supply finished construction in 2023. That volume is softening apartment markets where supply currently is outpacing demand. Some of those metro areas are starting to see rental rates flatten or decline.

 

As a result, apartment construction starts are slowing considerably, Ressler said. That also prompts questions about whether rental housing will hit a cliff once the current pipeline finishes delivering in 2024 and 2025.

 

“It takes 18 to 30 months to get a high-rise or midrise or garden-style type of apartment (built), functioning and leased up,” Ressler said.

 

Municipalities are motivated to figure out a solution for the obsolete office buildings sitting vacant in their downtowns, particularly because of the hit those reduced building valuations — and taxes — will have on local government revenue. That’s prompting cities, states and even the federal government to introduce both financial subsidies to reduce the overall cost of conversions as well as reforms to land-use and other policies to reduce regulatory barriers.

 

 

Ashley Fahey
By Ashley Fahey – Editor, The National Observer: Real Estate Edition, The Business Journals