Office Vacancy, Discounted Sales Could Boost Residential Conversions

A spike in discounted sales of office buildings and a historically sluggish market for new leases is making office-to-residential conversions an increasingly viable strategy in the country’s largest metropolitan areas, according to a new report by Commercial Edge.

The real estate firm found that the number of office buildings fit for conversion to residential space might have expanded at a faster clip than investors previously anticipated, given the waning demand for new and existing office space over the last several years. The report also found that as much as 15% of the total supply of office space in the country could be ripe for conversion with enough support from financial institutions and local governments.

Commercial Edge warned that the percentage of office space fit for conversion could be as high as 40% in cities like New York and San Francisco. A sluggish growth in office employment over the last year, particularly in Central Business Districts, could also push more landlords to consider residential conversions in the coming years.

“With the continued destruction of office values and as we see an uptick in incentives at different levels of government, we believe the total pool for potential conversions into multifamily is larger than initially expected,” Peter Kolaczynski, a director at Commercial Edge said. “Not a cure-all by any means, but the 1.25 billion square feet identified isn’t insignificant.”

Commercial Edge said that value destruction in the office sector could increase the number of conversions to residential. However, investors will undoubtedly have to look to local initiatives such as New York City’s Office Conversion Accelerator and Washington D.C.’s Office-to-Anything Program, to make these conversions economically feasible.

Location Location Location

The report analyzed office buildings with footprints exceeding 25,000 square feet that are also located in the 25 largest metropolitan areas in the country and found that the average sale price for office space, on a per-square-foot basis, declined by 40% since 2021.

While the national vacancy rate for the asset class in August increased by 100 basis points year-over-year to 18.1%, metros like Philadelphia, Dallas, the Bay area, and Seattle saw increases in vacancies exceeding 250 basis points over the same period.

Commercial Edge found that cities like Austin and Dallas, which weathered the shift from in-office to hybrid and remote work in 2020 and 2021 better than most large cities, have also seen an uptick in vacancy in recent months, partly due to new space being delivered. However, employment in sectors that use office space has been mostly flat over the last year and is expected to remain flat throughout the next 12 months.

Commercial Edge said that more than a fifth of the total supply of the asset class’ space in cities like Los Angeles, Chicago and Miami could be ripe for residential conversion.

“Perhaps unsurprisingly, Manhattan has the largest share of its stock rated as candidates [at 53.1%],” the report said. “No other top market comes close to having as much space rated strongly for conversion, but San Francisco ([25.8%]), Los Angeles ([24.7%]), Chicago ([18.6%]) and Miami ([16.1%]) all have significant amounts of space that could potentially be converted.”