Office-to-Apartment Conversions? Some Say It’s Just a Fad, and a Small One at That
Moody’s Analytics says the talk sounds good, but the realities are expensive and tough.
While the office segment seems to stabilize, record-high vacancies has a growing number of cities considering rethinking single-use downtown. All that empty space and no promises of how companies will operate the continuum from all-in office, flex, hybrid, and working from home.
Turning square footage into another use, like conversions to apartments at a time that housing stock is low and rents skyrocket, sounds good. But probably too good to be real, in the view of Moody’s Analytics, which says the practicalities are difficult to surmount.
“Contrary to hints of a conversion wave, it’s much easier to theorize about office-to-residential conversions than to execute and profit on them,” wrote Moody’s Jeffrey Havsy, Xiaodi Li and Kevin Fagan. “In our analysis, in addition to substantial physical impediments to office-to-apartment conversion, office values and rents would have to drop much further for the trend to become more than anecdotal.”
They took New York City as a metro case study, which has its pluses and minuses as a choice, but it’s more realistic to try modeling one city rather than all. The premises included a risk of “long-term disruption from remote working” and “demand (and prices and rents) for multifamily properties may be likely to exceed that of some offices.” The authors also saw the city as potentially the most at risk of disruption from continued remote working.
Out of 1,100 office buildings they track in the city, only about 35, or 3%, of them “would meet what we consider characteristics of potentially viable apartment conversions, and the vast majority of those are class B or C offices.”
The most basic problem is that building something doesn’t guarantee profitability. Assuming $150 per square foot of hard and soft costs (and inflation may have pushed those up significantly) and a 15% profit margin, developers would need office space at around $262 a square foot. But the median office price in the city was $542 in 2021 and only 20% were at $262 or below.
Then factor in the number of office buildings getting asking rents below the median apartment $55 per square foot, the need for a vacancy rate of 30% or higher, only 0.7% of Class A and 6% of Class B/C office buildings could make the conversion profitable.
There is the further issue of office layouts that don’t need everyone to have natural light exposure. Put everything together and the result is the 3% estimate. At best, this is a minor trend “unless office values and rents see some major, permanent decline after the pandemic.”