Houston Office Conversions Are Picking Up, But Not As Much As They Could Be

Despite having one of the highest office vacancy rates in the nation, Houston has a stubborn history of building new rather than repurposing aging buildings. Since 2017, CBRE has  tracked just 11 projects converting Houston office buildings to other uses, and the city led the nation in new real estate construction over the past decade.

Eight of those 11 projects were announced or started in the last four years, more than double the number started in the four years prior, per CBRE. But for building owners to jump on the adaptive reuse train in earnest, they will need incentives. And those have been slow in coming.

Nationally, conversions of older, unmarketable offices to residential, hotel and other uses is gaining momentum due to pandemic-influenced remote work and a long-term flight-to-quality trend.

They are relatively new to Houston, though, where land is still plentiful. It’s also hard to make such projects profitable, which is why incentives must be on the table for the number of office conversion projects to increase substantially going forward, industry analysts told Bisnow.

“At the end of the day, most of the [conversion] projects need some kind of subsidy to work,” said Brooks Howell, residential leader and principal at Gensler. 

Central Houston, the organization that helps ensure the center city and Houston’s urban core remain vital and progressive, hopes to be part of the solution. It  commissioned AECOM to perform a downtown office-to-residential conversion feasibility study late last year. The results are expected this fall, Central Houston Chief Operating Officer Allen Douglas said.

"The kernel of information that we're really driving for here is, 'In the question of a conversion, what's the capital stack gap that a building that’s currently an office building needs to address when it moves from office to residential, or office to hospitality, or office to institutional?'" Douglas said.

The study is examining three specific office buildings downtown, which he declined to name. The aim is to understand the costs to convert a building, which differ depending on the building size, the floor plate and the aspirations of the lender and the building owner, he said.

"Any kind of program that helps to incentivize that has to take into account all of those different aspects in a way that is equitable and pays fidelity to the fact that public dollars are being used," Douglas said.

The study will also attempt to answer the question of which buildings can be converted in a way that would retain the viability, livability and excitement of downtown, Douglas said.

Houston has an office vacancy rate of 23.6%, according to a Q1 2023 CBRE report, well above the national average of about 17.8%. There are 183 big blocks of space (50K SF or more) throughout the city, according to a Partners Edge report.

Most of those blocks are concentrated in 1970s and 1980s-era and vintage properties, representing 19% and 35%, respectively, according to the report. Only 1% is in new construction.

Vacancy rates are more than double (28.7% versus 13.4%) in older product than newer construction, according to JLL. 

Not all older buildings are good candidates for conversion. There are multiple older, Class-B or lower office properties downtown so unmarketable that some say they just need to “go away,” even if they become parking lots. 

But for those that are good candidates, financing is the next hurdle.

“Houston has its share of buildings downtown that are in trouble right now,” Howell said. “Some of them will convert, but I think it will be more contingent upon when Central Houston gets their program in place, hopefully by the end of the year.” 

Conversions have “definitely become a more significant topic,” said Jock Naponic, senior vice president of CBRE’s capital markets multifamily group in Houston. “But it’s more prevalent in other markets than Houston where there’s still a lot of land and you kind of go to ground-up development.” 

Four of the conversion projects CBRE has tracked are downtown and four are in suburban markets. Four are multifamily conversions, one is a hotel, two are mixed-use and one is healthcare, according to the data. 

The list of projects includes the 45-story, 1.2M SF former Exxon headquarters at 800 Bell St. downtown, which will be converted to multifamily, according to Realty News Report. The tower was completed in 1962 and had been empty since Exxon vacated it eight years ago.

A similar conversion is nearing completion at 1801 Smith St., a 20-story building to be known as Elev8 Downtown, with 372 luxury units starting at $1,505 for a studio, according to Apartments.com.

The latter project is part of the 4M SF throughout five aging office towers that JLL tracked in April as potential conversions to new residences. Others include the 599K SF 808 Travis St. downtown and a 419K SF building at 550 Westlake Park Blvd. in the Katy area. 

One property not included in CBRE’s current conversion projects data is 5555 San Felipe, a 1.2M SF building in the Galleria area that was foreclosed on last year. Starwood Properties has since taken ownership and expressed interest in finding a buyer to convert the building to residences. A potential sale agreement was mentioned in Starwood’s last earnings call. 

At least one downtown office tower-to-residential conversion has seen success: The Star, the century-old former Texaco headquarters that became a 286-unit luxury high-rise community in 2013. Provident Realty Advisors bought the property at 1111 Rusk St. in 2012, after it stood vacant since Texaco moved out in 1989. One-bedroom units now start at around $1,940 a month, according to Apartments.com. 

That project utilized historic tax credits, something Houston Public Media reported was also important to the Le Méridien Houston Downtown hotel, and could incentivize more developers to restore historic buildings. For the hotel project, Development Services Group reimagined Houston’s historic Melrose Building at 1121 Walker St., which had sat vacant for about 25 years.

Despite a bump in activity, Naponic said Houston lacks a deep enough pool of conversion projects to identify significant trends. And whether projects are feasible comes down to location and physical elements like the floor plate.

“It's all case-by-case specific,” Naponic said. “Everyone we've talked to, it sounds intriguing, but we're not going to be able to create some program to go hit each building, because every building is unique.”

Hotel conversions are ideal for buildings in the 200K SF range and the ideal size to convert to residential is about 400K SF, Howell said. 

“That gets to about 350 units, which is what institutional investors like,” he said.

After finding the perfect-sized building, the two largest line item expenses are the skin of the building and the mechanical systems, he said. Bedrooms have to have windows, which sometimes requires altering the exterior of the building, and older mechanical systems often need to be replaced, he said. 

Coy Davidson, senior vice president for Colliers, said it is important to consider that Houston’s office market has some vacancy built in, so a rash of conversions is not needed anytime soon. Houston has about 10% of vacancy built into the market, which is proven by office rents spiking when Houston gets to about 86% occupancy, he said. 

“We had a lot of unmarketable space in Houston even before the pandemic hit,” Davidson said. “Everybody has this idea that ‘We need housing, there’s a housing shortage, just turn it into residential.’ That’s great in theory but … it’s very difficult to do, it’s very expensive to do and a lot of buildings just don’t suit themselves for conversion.” 

Conversions are more doable in relatively dense downtowns than in buildings scattered across the suburban sprawl, which is where much of the older, Class-B office product is, he said. People likely don’t want to live in old converted office buildings in the suburbs, he said. 

“There has to be enough economic incentive for the owner of the building to make a change,” Davidson said.

Even if older, Class-B buildings are just 60% leased, they could still be profitable, he added. The economics would have to get “bad enough” for the owner to consider something drastic.

It's not even clear that the three buildings in the Central Houston feasibility study would be good candidates for conversion, Douglas said. 

"These may not be the buildings that convert. These are prototypes," he said. "We tried to classify the buildings by floor plate, age and location in a way that if [owners of] a building that we're studying says 'No, we're not interested' ... We still have data, we still have information that can help us understand the gap for buildings like that one." 

The study is the first step to later determining an incentive program that could include tax credits and private funding, Douglas said.

“I think incentives will allow people to make the economics work,” Naponic said. “And that's both for the seller side, and the potential buyer and redevelopment side.” 

Howell hopes an incentive program will encourage more conversions, since reuse is less carbon-intensive than building new, and fewer vacant buildings throughout the city would increase vitality.

“It's much more sustainable to reuse a building,” he said. “Ultimately, these buildings are here. If you're looking at carbon footprint and body carbon on projects, it's a much more sustainable deal. The more you can reuse, the more you can save, the better off you're going to be.”