The Costly Complexities of Office Conversion Projects

While nearly 20% of office spaces are currently empty across the United States (a devaluation of $423 billion), the vacancy rate for multi-family on the other hand is at a low of 3.1%.

So, at first glance, high demand for housing and simultaneous low office vacancy may seem like an ideal opportunity to capitalize on a booming market while putting premium space to use.

However, a closer examination of the conversion process unravels a multitude of challenges and obstacles, underscoring its complexity and rendering it anything but a simple solution. In this article, we delve into the reasons why transforming offices into housing proves to a complicated feat, requiring careful consideration and strategic planning to navigate the complexities of regulations, infrastructure, and market dynamics.

Empty Office Buildings are Draining the Economy

Office buildings sitting empty represent a major issue- not just for CRE professionals, but for the economy at large.

Because widespread vacancies put a major drain on banks, burdened with approximately $1.2 trillion in unpaid office loans. But beyond that, numerous small businesses reliant on white-collar clientele and foot traffic and cities that rely on office property taxes for revenue are greatly suffering.

And as the vacancy climbs while occupancy rates get lower across the country, the issue is mounting. And the pressure to do something about it is being felt.

All of this occurs of course at the same time as a housing crisis. So why not kill two birds with one stone? The most recent politician to launch this initiative is NYC’s Mayor Adams who announced a plan to turn empty NYC offices into 20,000 new apartments.

“The need for housing is desperate, and the opportunity offered by underused office space is clear, these concrete reforms would clear red tape and create the incentives to create the housing we need for New Yorkers at all income levels.”

Manhattan’s Newest and Biggest Office Conversion

With New York attempting to spearhead a mass-conversion pipeline, it’s no wonder that they’re home to the country’s biggest conversion project.

25 Water Street, once home to  Daily News and JPMorgan Chase, was purchased by two firms (GFP Real Estate and Metro Loft) for about $250 million. And the firms are planning to spend hundreds of millions more on converting the 1960's structure into more than 50 market-rate and luxury apartments.

The new apartments are planned to include a large gym with two swimming pools and ground floor shops.

By ushering in a mixed-use environment, it is a powerful attempt to reclaim lost foot traffic and economic stimulus lost to zombie buildings. At the same time, it mirrors the live-work-play community dynamic, which is wildly growing in popularity among young, working Americans.

So, will these developments become the norm? Probably not right now.

While repurposing an office is usually a quicker solution than building a functioning structure from the ground-up, it is not simple, nor cheap. Let’s discuss.

Office Conversions are Expensive

According to Moody Analytics, the median apartment rent in NYC is $55 per square foot. While it could be likened to comparing apples and oranges, office space in Manhattan is rented for about $90 per square foot. So, the point is there is already a significant price delineation in rent alone.

Then, converting offices to residential living always represents an additional loss because of the common area factor. Apartment tenants don’t pay rent to common areas like hallways, stairwells, elevators, etc. This is of course opposed to office tenants that do cover square footage that is rentable but not usable.

Then, and only then, can the immense cost of construction be considered. Consider the sheer amount of work required to gut office buildings, their plumbing systems, and layouts. Then to build the inside back up again in line with strict residential codes. For example, there are certain laws regarding the number of windows that qualify a space as livable.  

All said and done, “The cost to convert offices to an average apartment building is about $100-$200/SF, although that cost could be significantly inflated now. If we assume $150/SF of hard and soft costs plus a 15% profit margin of $23/SF, a developer will need to seek offices available at $262/SF,” according to a study performed by Moody Analytics. 

The high cost (and massive undertaking) of transforming offices to apartments is not yet worth it to most property owners. It’s predicted that the value of offices will need to further drop before mass conversations are commonplace.

Because of this, luxury buildings usually provide a more appealing ROI. So even though affordable housing is what is really needed, it will not necessarily dominate the conversion pipeline.

Office to Housing Conversions are Complicated

Not only are building conversions expensive, but they are a massive logistical undertaking. Beyond zoning and regulations, office buildings have drastically different footprints than apartments. Hurdles in renovation are widespread, including:

• Complying with housing requirements for lighting and ventilation
• Transforming an office’s large floor plates into individual dwellings
• Accommodating multiple new units and bathrooms with extra sewage
• Trenching into floors to ensure sewage pipes have appropriate room without compromising the building’s structure

One of the key challenges in repurposing the building is ensuring that its windows comply with city rules. There needs to be appropriate light and ventilation deemed for residential dwellings.

And this is an easier task for some buildings than others. Some offices are more conducive to successful conversions. The size and shape of the floor plate are the main determinants.

“Some were designed like doughnuts, some like an L shape or a skinny bar about 60 feet wide. Those shapes allow for lots of exterior surface on the buildings—so lots of opportunities for light and ventilation,” according to architect and Professor, Suzanne Charles.

And developers are taking creative, drastic steps to achieve this ideal angle. Most often this involves scooping out an internal portion of the building to make way for courtyards that accommodate lighting and ventilation demands. Because to accommodate HVAC efficiency in offices, many were largely sealed.

This technique is being utilized by the developers at 25 Water St. as the construction involves carving out two courtyards from the center of the building and wrapping apartments around them. And its success may usher in a new era of conversions in NYC.

Because in order to ease the strain of creating 20,000 new apartments, NYC’s Mayor Adams has included proposals to simplify zoning restrictions and offer tax breaks to property owners. Until this is accepted, zoning will continue to be another hurdle developers are faced with in conversions.

So, while major office conversions into housing may repurpose empty buildings causing strain on communities, it is not a solution to the housing crisis.

What Tenants Should Know About Conversions

While conversions are being suggested more and more to solutions to the office vacancies and affordable housing crises, they will not be more common until the value of office space drops further.

Because developers who feel up to the task are faced with upwards of hundreds of millions in renovation for a property structure that represents a loss from its original state. So right now, many landlords may want to hold on to their offices because the value of housing conversions has yet to be proven on a grand scale.

The key for tenants is to stay on top of evolving trends because they may implicate the leverage your tenancy has. The time for prospective tenants to act is now while there is still a glut of unused office space. You have the power to negotiate for the terms, price, and concessions you want. But this once-in-a-lifetime opportunity to cut your CRE leasing costs won’t last forever. Developers and governments are ready to confront the wasted office space crisis, so make sure you don't miss out on what's latest in the commercial real estate world and subscribe to our blog to deliver CRE tips to your inbox.