Pandemic-related changes in commuting patterns and office use have led to widespread office vacancies, but turning excess office space into housing is a commercially risky venture that could require government help with zoning reforms and financial assistance, developers say.

Adaptive reuse of office space is not new, although attention to it has grown as office space vacancies increase. A report from rentcafe.com found that nationwide, 11,090 new office-to-apartment units were added between 2020 and 2021, a 43% increase from the 2018-2019 period and an all-time high. Nearly half of them (5,500) were in 10 markets: Washington, D.C.; Chicago; Philadelphia; Los Angeles; Alexandria, Virginia; Nashville, Tennessee; Union, New Jersey; Baltimore; Hyattsville, Maryland; and Dallas.

As work patterns stabilize and big companies reevaluate their real estate needs, more conversions seem likely. New York City is seeing a post-pandemic office vacancy rate of 18% — twice the previous rate. The city, which in 1997 successfully rezoned its Financial District to allow additional residential use, recently carried out a study that recommended doing the same with three more central business districts: Midtown Manhattan; downtown Flushing, Queens; and the Bronx Hub. It hopes to convert offices into as many as 20,000 new apartments over the next decade, according to a spokesman for New York City Mayor Eric Adams.

But conversions can be complicated, both financially and politically. There are big questions about whether the surplus of office space will continue over the long term and if office building owners can weather high vacancy rates until the market rebounds — if it ever does.

“It does not seem likely that office occupancy will return to pre-COVID levels,” said the city spokesman. “That said, the recommendations … are specifically designed to facilitate conversions while letting the market point to which kinds of office buildings … should remain offices and which … could become housing.”

“There’s really a whole question being asked about the future of office demand,” said Andrew Akers, senior advisor to the UIP Cos., a developer based in Washington, D.C. “How and where we work is a big issue. I think it has put uncertainty around the value of an office asset. Over the last couple of years, valuations and economic pressure on office owners have increased, which may make a [conversion] project more viable.”

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Uncertainty over zoning and other government regulation is a major obstacle. “Spending time with government officials who may not be as experienced with the nuances of the development or [with] other constituent groups can take a lot of time, cost a lot of money and cause a lot of delays,” said Brian Steinwurtzel, co-CEO of GFP Real Estate in New York. With other investors, GFP is converting the 1.1 million-square-foot 25 Water Street in Manhattan’s Financial District into 1,300 apartments, which it hopes to open over the next three to five years. “Time is one of the most valuable things we have, so having a path to start the project as quickly as possible is the most beneficial thing that [governments] can do for a developer.”

Not all offices are good candidates for conversion, developers say. Steinwurtzel says he won’t consider an office building that isn’t totally vacant due to the amount of disruptive construction required. And although vacancies may be up, he says, fully empty buildings are still fairly uncommon. “Thus far, it seems that there are some opportunities, but it’s not an overwhelming amount of opportunities.”

In addition, residential conversion for many buildings won’t pencil out economically. Construction and financing costs may not work if the goal of a project is market-price or affordable housing, even with tax credits and other governmental assistance. Modern office floor plates are often deeper than those in residential buildings, which require windows (in many cities, windows that open) in every bedroom. At 25 Water Street, that requires two new cores to be cut through the entirety of the building’s 22 floors.

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“If you talk to a lot of developers that are experienced in ground-up construction, they consider adaptive reuse to be more complex and more difficult than just building out of the ground,” Steinwurtzel said. “Investors are going to expect a higher return because of the risk and complexity to the projects.”

To make a conversion to affordable housing possible, Steinwurtzel said, a local government may need to sweeten the deal with tax abatements or zoning bonuses. “There’s a tremendous need for housing, especially affordable housing, and yet the economics to develop affordable housing are not there,” he said. “There are clearly investors that are willing to invest in real estate projects, but they need incentives in order to have those projects be all or partially affordable.”

In New York City’s case, the development process is made more complex because the task force recommendations require approval at the city and state levels.

Development can be controversial, which can slow projects and drive conversion projects away. “We don’t go into a place where a project is going to be adversarial,” Akers said. “That’s it. I’ll just go find another project where people are happy that I’m coming with my money.”

And building conversions do not happen in a vacuum. An area like Midtown Manhattan may be dense with offices but does not have much in the way of supermarkets or schools — the things that make a neighborhood.

“What we found is that successful projects are actually mixed-use neighborhoods, and creating a mixed-use neighborhood is a good idea,” Steinwurzel said, pointing to changes in the Financial District over the past 30 years. Some of those [central business district] neighborhoods really are not mixed use, and I think the addition of residential to those neighborhoods will make not only the residential market better but will also make the commercial market better. I think it will go a long way to creating some of the housing that is desperately needed.”

By Leslie Shaver • Jan. 31, 2023