Converting office space to apartment buildings is hard. States like California are trying to change that.
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Converting office space to apartment buildings is hard. States like California are trying to change that.
As more Americans work from home, some developers and lawmakers are seeing that unused office space as an opportunity to create more housing.
In 2022, the national office vacancy rate reached an almost three-decade high of about 17%, according to a report from the real estate company CBRE released late last year. Meanwhile, as those office buildings sit idle, rents have climbed up on a year-over-year basis.
One California assemblymember has introduced a bill, known as the Office to Housing Conversion Act, that would make it easier to convert these spaces in a state that suffers from a well documented housing shortage. The proposal would ensure that the permitting process and local zoning laws don’t get in the way of any conversions, among other requirements.
There are about 2,300 commercial properties that could be used to produce between 72,000 and 113,000 housing units in Los Angeles County alone, according to a 2022 report from the RAND Corporation’s Jason Ward and Daniel Schwam.
While some see conversions as a promising solution to vacant space and one part of the solution to our housing shortage, the ability to convert office space into residential buildings can depend on the type of building you’re talking about, the types of housing units you’re going to convert it into, and the policies in place in a particular region.
“While office conversions to other uses have become increasingly attractive options for older, less competitive buildings, completed projects haven’t significantly increased since the pandemic,” according to the CBRE.
CBRE said that 42 office conversions had been completed as of December 2022, with 217 on the way or planned.
The challenges in converting older buildings into housing
Jason Ward, the associate director of the RAND Center on Housing and Homelessness in Los Angeles, pointed out that some regions have ordinances and programs that encourage the conversion of commercial properties to residential ones.
Los Angeles’ 1999 Adaptive Reuse Ordinance, for example, led to the creation of nearly 20,000 new housing units in downtown LA within about 15 years. This ordinance made conversions easier by not requiring the same kinds of zoning and code requirements as new construction projects.
And over in New York City, Ward noted that the region had a program called 421-g, which provided real estate tax exemptions and abatements for commercial-to-residential conversions from 1995-2006. (However, ProPublica reported that a majority of these units were not rent stabilized.)
Other areas are starting to encourage these projects, like Washington, D.C., which recently established a program that would provide tax abatements for conversions.
Incentives like these can be helpful for an undertaking that can be costly. Ward’s report for the RAND Center found that hotel and motel properties are the easiest to convert, while office properties can be more variable. There are financial difficulties in converting offices into one- and two-bedroom apartments, although studio apartments show “more promise.”
“If you buy a hotel and convert it to studio apartments, that’s pretty easy, because every room already has plumbing. But when you buy a commercial building, your plumbing is in the middle of the building,” said Linda Mandolini, the president of Eden Housing, a nonprofit that develops affordable housing in California.
Ward said that newer office buildings can be harder to convert compared to older ones because they have very large floors with a lot of space that doesn’t have access to natural light, and may not even have windows that are operable.
However, older buildings come with their challenges, too. In a state like California, Ward said you have to take into account the costs of modifications like seismic retrofitting, which involves strengthening a building to protect it from earthquakes.
Ward and Schwam’s report pointed out other factors that can lead to increased costs, which include utility upgrades, environmental efficiency upgrades (such as rooftop solar requirements), and structural fixes for issues such as water damage.
When offices are converted to housing, Ward said he’s observed that it tends “to be market rate” because “adaptive reuse usually isn’t cheap.” But over the pandemic, he said there’s been a trend toward converting buildings into affordable housing.
California has provided financial support for affordable housing conversions through Gov. Gavin Newsom’s multi-billion dollar Homekey initiative, which launched in 2020 and provides grants to local governments.
How some developers are able to do conversions
Eden Housing is currently working on two conversion projects in the state. One, in Richmond, will convert an unused health center into housing, while the other will involve converting an office building into more than 40 supportive housing units in San Rafael. San Rafael is located in Marin County, which is not just one of the most expensive counties in the state, but the entire country.
The project is part of the state’s Homekey initiative. “We’re doing that with two grants from the state of California,” explained Linda Mandolini of Eden Housing.
When doing affordable housing conversions, the first factor Eden Housing looks at is the location, Mandolini said.
“Where is it? Does it make sense? So in this instance, it’s in a good location,” Mandolini said, pointing out that it’s in proximity to transit and amenities that are needed to support the area’s residents.
Then you need to evaluate the actual building.
“The first decision you make is: Is it something you would demolish? Or is it something you could actually convert?” Mandolini said.
She explained you need to do a structural analysis of the building and determine if there are dangers in there that need to be mitigated, like asbestos.
As for the cost? “For these projects — hold on to your hat, because California is expensive — it’s $500,000 or $600,000 a unit to do this,” she said.
However, she said that Eden Housing uses a financing program known as the Low Income Housing Tax Credit Program, which gives them an advantage. The LIHTC provides tax credits to developers to help “subsidize the construction and rehabilitation of housing developments,” according to the Tax Foundation.
Mandolini said she thinks these projects are “a big win” for these communities, which are in a state that’s in desperate need of affordable housing.
Why an “office apocalypse” could make the process easier
Despite the challenges associated with office conversions, Ward does think that we will see more of them.
“At the time I was doing that report, which was roughly two years into the pandemic, office prices had not adjusted a lot to reflect what seemed like a large decline in demand for office space,” Ward said.
He said this may have been due to the long length of office and commercial leases, coupled with the financial support employers received during the pandemic that allowed them to continue paying for office space — even if no one was using it.
But Ward said “if office demand collapses,” those underutilized buildings will lead to a large decrease in tax revenues.
The effects of remote work have led some researchers to predict the possibility of an “office real estate apocalypse.” Researchers from New York University and Columbia University expect New York City office values to decline 39% or almost $49 billion in the long run. And they estimate the value of commercial offices across the U.S. to decline about $413 billion in the long run.
“This is a huge issue for policymakers,” Ward said. “If the office sector collapses, that’s going to really negatively impact local finance, it’s going to negatively impact local infrastructure.”
But at the same time, Ward explained, we need more housing. So he said the drop in office values could make the conversion process “a more attractive proposition,” since housing could help compensate for lost tax revenues. And those declining office values could make the conversion process easier and cheaper.
Mandolini also said she sees more conversions happening in the future.
“I’m optimistic because I don’t know how else we’re going to reuse some of these office buildings,” she said.
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