Converting Office & Retail to Affordable Housing May Soon Be Easier

Repurposing vacant office and retail properties into affordable housing seems like a two-birds-with-one-stone solution; it provides desperately needed affordable housing as well as a market for struggling office and retail sectors.  These conversions, however, are complex and expensive undertakings with numerous challenges to execution. Fortunately, new laws, along with strategic due diligence, are making successful conversions to affordable housing more attainable.

Legislative Developments

California may be paving the way towards making conversion more viable with recent legislation designed to fast-track affordable housing redevelopment. California Assembly Bill 2011, The Affordable Housing and High Road Jobs Act of 2022, provides streamlined review for qualified affordable housing projects in locations zoned for retail, office or parking use. AB 2011 was effective July 1, 2023. One of the most significant provisions in the law is exemption of qualified projects from the California Environmental Quality Act (CEQA). This exemption should greatly expedite project approval and save considerable time and expense on the part of the project owner who would normally have to submit an environmental impact report and await government and public review before project approval.

Two additional California bills, AB 1532 and AB 529 also aim to remove barriers for affordable housing redevelopment. AB 1532 seeks specifically to streamline approval for office-to-affordable housing conversions, and AB 529 would modernize state building codes to make it easier to convert office and retail buildings into housing.

The affordable housing shortage is not unique to California, nor is the growing number of vacant office properties and underutilized retail space. AB2011 requires the California Department of Housing and Community Development to study the outcomes of the Affordable Housing and High Road Jobs Act and publish its findings.  If this new legislation has the desired effect of alleviating both problems in California, it would be reasonable to expect other states to follow suit with similar legislation.

These legislative solutions could go a long way towards easing some of the main challenges to property conversions, namely zoning compliance/regulatory and building code hurdles; however, plenty of issues remain. Well-scoped due diligence can address some of these, particularly those regarding conversion costs and marketability.

Infrastructure, Utilities, and Design

Commercial properties may not be equipped to handle the increased demand for utilities, such as water, sewage, and electricity, that come with residential use. Upgrading or expanding the infrastructure can add to the conversion costs. Furthermore, retail and office properties may have limitations in terms of space and layout, making it challenging to create comfortable and functional housing units.

A feasibility study can provide critical information on utility services, traffic generation, storm water and slope constraints, construction budgeting, and other land use and engineering factors that can affect the viability of a change-of-use project. Some feasibility scopes may be incorporated into a property condition assessment (PCA), which can be customized to support adaptive reuse by addressing building system capacity and condition for both the existing use and the proposed use. This approach can be beneficial in validating rough order of magnitude (ROM) construction budgeting; highlighting building systems that will require extensive modification or replacement; preparing pro forma documentation; and supporting discussions with investors and bridge/construction lenders.

Cost vs. Project Value

Converting a commercial property into affordable housing can be expensive, often as expensive as new construction. The cost of renovation and retrofitting to meet residential standards can deter developers who are uncertain about the profitability of affordable housing projects. Furthermore, retail and office spaces may not always offer the most suitable locations for residential living. They may lack access to amenities like schools, parks, public transportation, and grocery stores, which is crucial for sustainable, livable communities.

As discussed above, a feasibility study can help estimate project costs. A market study, performed in this case by a valuation consultant with specialized affordable housing expertise, can help support decision-making through supply and demand analysis. Market studies evaluate the characteristics of the surrounding market area including existing supply and whether the proposed project will meet the particular demands of the subject market. They provide information such as area rental rates and occupancy data. A valuation consultant with affordable housing experience can also advise whether the proposed project will meet the rental requirements of various affordable housing subsidies and funding sources.

Once the project pencils, construction risk management services help to ensure the project is executed according to plan, budget, and schedule. Engaging a third-party construction risk management firm to perform contractor evaluations, document and cost reviews, and construction monitoring can pay for itself by preventing overages and delays that can erode profits.

Conclusion

Converting retail and office properties to affordable housing can be a valuable strategy to repurpose underutilized spaces and address the pressing issue of affordable housing shortages in urban areas. Increasing cooperation from state governments and local authorities will reduce some of the expense and obstacles common in these projects. With expert due diligence and risk management support, this two-in-one solution is becoming a viable option for investors, developers, and communities.