With Conversion Options Limited, Demolition Breaking Through For Underused Offices
With hope for a full-fledged return to office fading, the conversation around underused office buildings in cities nationwide has largely featured the idea of converting them into housing, laboratory space or another in-demand property type. But with high costs and a litany of other challenges, conversions have been largely characterized as a drop in the empty-office bucket.
Cue the wrecking ball.
It may seem like an extreme step, but as expectations for full Class-B and C offices crumble and renovation costs climb, demolishing buildings to free up the land under them for a new use is gaining traction.
Kyle Bass, founder of Dallas-based Hayman Capital Management, told Fortune magazine in April that office is “one asset class that just has to get redone, and redone meaning demolished,” citing the difficulty of converting office to multifamily.
Demolition, despite its explosive nature in practice, is a slow-moving business when it comes to growth or contraction. It takes time for teardowns to become reality. But January Ibis World data showed the industry growing by 1.4% from 2018 to 2023 to $8.7B in the U.S.
Trends toward smaller office leases, a 30-year high for office vacancy and the tendency for office occupiers to seek space in higher-quality buildings have all added up to a significant amount of lower-quality property sitting idle, CBRE Director of U.S. Office Research Jessica Morin said.
Recent reports indicate most of the vacancy in the office sector is concentrated in older properties, which also tend to be shorter, wider and have floor plates that are more conducive to conversions. That is, they’re theoretically ideal candidates for a repurposing project.
But theory doesn’t account for the reality of the costs that come with conversions, which Moody’s pegged at $100-$200 per SF in April 2022. By CBRE’s count, there were 63 office conversion projects underway in 2022 — up from a previous five-year average of 36 — but that represents less than 2% of the U.S. office stock.
Morin said those buildings that can’t be converted — seemingly the majority of outdated offices — will likely be demolished to make way for new and better uses. It’s a conclusion many others in the real estate industry have come to.
Alpine Demolition Services Vice President of Operations Karsten Pawlik said he has seen office demolitions on the rise in the roughly two-hour radius around Chicago that his St. Charles, Illinois-based demolition business serves. There, the properties are most often cleared for warehouses, not residential projects. It's not surprising considering the area was the top industrial market for transactions last year.
“I always tell people, Chicagoland is just going to become one big warehouse,” Pawlik said.
Pawlik said the increase in inquiries has increased steadily over the past two or three years. In the area, he says he generally sees mid-rise suburban office complexes, maybe 500K SF and under, falling to make way for new industrial space, especially those near major highways.
But shredding steel and crushing concrete isn’t as simple as it sounds. It takes time, planning and money to bring a building down.
Demolishing a 500K SF office complex could cost about $3M to $4M and take between three and six months, Pawlik said.
Owners typically prefer demolition over maintaining a vacant office building and the liability that comes along with it, Pawlik said. But, his company has “dozens” of on-hold demolitions, and cost isn’t what is holding them up.
“It’s more along the lines of interest rates for the project as a whole or community resistance,” Pawlik said. “There's a lot of resistance to warehouses going up in communities.”
Then there’s the matter of the few tenants that do remain in underused offices.
Southern California-based Rexford Industrial snapped up a pair of industrial-zoned office complexes in 2021 in Orange County as covered land plays, with the goal of eventually razing the offices and building warehouses for last-mile delivery users on the sites. Rexford, which specializes in building industrial space in infill sites in the region, has also purchased an empty retail space and a 250-room hotel with the same goal in mind.
But Rexford has yet to demolish the offices it bought, as those came with long-term tenants, but demolition has begun on both the hotel in Fullerton in Orange County and the vacant grocery store space in the beach city of Torrance.
Rexford Industrial Chief Investment Officer Patrick Schlehuber said the reason why its nonoffice demolition projects have advanced faster is a question of vacancy.
“The difference is really just occupancy. Both of those projects [Fullerton and Torrance] were purchased vacant,” Schlehuber said.
And while demolition seems like a drastic step, the idea isn’t entirely unwelcome in the real estate community.
Bringing down some Class-B and C office buildings with higher vacancy rates would remove competition from the market and eliminate product that is pushing vacancy numbers up, CBRE’s Morin said.