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Office Values Have Further To Fall Before Residential Conversions Start Picking Up Speed

The office building at 1425 New York Ave. NW in Washington, D.C.

As office vacancy remains historically elevated more than two years after the pandemic hit the U.S., converting empty commercial buildings to residential is often offered up as the answer to both the housing crisis and the remote work movement. But the buildings that would be candidates are still too expensive for the practice to become widespread.

About 50 office blocks have been converted or are in the process of being redeveloped into multifamily since the pandemic set in, The Wall Street Journal reported, citing CBRE data.

The number of conversions in the pipeline in 2022 stands at 17 — fewer than the 18 planned or completed in 2018, according to CBRE. That is in contrast to the United Kingdom, where an average of 12,000 new residential units have come from old offices each year since 2015.

For conversions to ramp up significantly, the value of office buildings needs to come down further than it already has. The value of the residential property needs to be around 50% more than an office for it to be worthwhile, Olivier Elamine, the CEO of Alstria, a European office real estate investment trust, told the WSJ.

In a conversion, about 20% of rentable area has to go into common areas that residential tenants don't pay for, and that still doesn't factor in that in many cities, office rents per SF are still higher than residential rents.

Manhattan offices rent for 17% more than multifamily per SF, per the WSJ, citing Colliers data. That is down from a 44% gap before the pandemic, and office values are expected to keep dropping in the coming years, opening up more conversion opportunities in the future.

“I think the value destruction of an office is going to be really severe,” PGIM Real Estate Global Chief Operating Officer and Head of U.S. Equity Cathy Marcus said at Bisnow’s National Finance Summit late last month. “I think that will ultimately lead to interesting opportunities. I don't know that we're there at present.”

While it hasn't taken off yet, these office-to-residential conversions are beginning to take place. The epicenter appears to be Washington, D.C., where close to a half-dozen projects have kicked off in the last two years.

Developer Foulger-Pratt acquired a 14-story office building at 1425 New York Ave. NW in December and announced plans to turn it into 255 apartments. Willco is planning its own conversion at 1111 20th St. NW, and a partnership of Lincoln Property Co. and Cadillac Fairview is moving forward with plans to convert two downtown office buildings to apartments at 1125 15th St. NW and 1313 L St. NW.

In New York City, Silverstein Properties and Metro Loft are turning 55 Broad St. in the Financial District, a largely vacant office building, into more than 500 apartments.

City officials in Chicago have released a plan to provide incentives to developers revitalizing the city’s iconic LaSalle Street, which is dealing with 5M SF of vacant commercial space. The city will offer tax increment financing dollars and other incentives to turn vacant office buildings there into new apartments and condos.