Apartment demand is soaring at a decade-high level, while office vacancy rates have spiked, and hybrid working-from-home situations are emerging to be the new normal. This has prompted the question of converting vacant office buildings into housing, particularly multifamily rental housing or owner-occupied condominiums. NAR's latest study―Analysis and Case Studies on Office-to-Housing Conversions― shows a strong potential for conversion of Class B office units in New York, Chicago, Los Angeles, and Boston, but little potential in Washington DC and San Francisco. In 22 markets that have been hit hardest by the pandemic, about 45,000 housing units can be created, or 6% of housing starts.
Office vacancy rates and rent growth in multifamily buildings compared to office buildings indicate a potential for office-to-housing conversions
The table below compares the net absorption (demand), vacancy rates, rent growth in the office and multifamily market, and the year-over-year percent change in the median single-family existing-home sales price in the 27 metro areas or submarkets sorted by net absorption in the office market.
In all 27 markets, there was positive net absorption of apartment units, while there was negative net absorption of office space in the past 12 months as of 2021 Q3, according to CoStar® market data that NAR used in this study. The largest declines in office occupancy are in the metro areas of New York (- 21.8 million sq. ft. or MSF), Washington DC (-8.5 MSF), Chicago (-6.4 MSF), Los Angeles (-6.1 MSF), Boston (-4.96 MSF), and San Francisco (-4.95 MSF). In all 27 markets, apartment vacancy rates were lower than office vacancy rates. Table 1 also shows that apartment rent growth is outpacing office rent growth. These indicators show that apartment demand is rising faster than office demand which indicates the potential for office-to-housing conversions.
Potential for office-to-housing conversions is in Class A and B buildings
The chart below compares the vacancy rates by Office Class A, B, and C to the vacancy rate of Apartment Class A properties. The table shows low vacancy rates for in Office Class C properties and higher vacancy rates in Office Class A and B. For example, in Boston, the average vacancy rate in Class A and Class B buildings is 11% each while the average vacancy rate in Class C is only 4%. In Seattle, the vacancy rate in Class C is just 3%. Office Class C Apartment owners could have little incentive to convert with such low vacancy rates and be satisfied if the office building continue to be used as such. This indicates that most conversions will likely be of Class B offices which account for a larger share of the vacancies (along with Class A) compared to Office Class C.
Lower rent in Class B offices indicates strong potential for conversions in Class B buildings
Now, even if vacancy rates are high in Office Class A and B buildings, will those be converted to apartment buildings? Not necessarily. There will be an incentive to convert only if the rents on the newly converted building (Class A apartment rents) are higher than the rents on Office Class A and B buildings.
The chart below shows the rent in Office Class A and B buildings compared to Apartment Class A buildings. The chart shows that rents in Apartment Class A buildings are, on average, higher than rents in Class B office buildings, so there will be an incentive to convert these buildings into to Class A apartment buildings. However, office rents in Class A office buildings are still higher than the rents in Class A apartment buildings, indicating little incentive to convert Class A office buildings into Class A apartment buildings.
However, in some metro areas, the conversion of Class B office buildings is not typically economically feasible because of the office rent premium in these areas, such as in San Francisco (apartment rent of $52/sf vs. office rent of $57/sf), San Jose (apartment rent of $42/sf vs. office rent of $59/sf), Dallas-Fort Worth (apartment rent of $22/sf and office rent of $25/sf), Charlotte (apartment rent of $21/sf vs. office rent of $26/sf), and Houston (apartment rent of $20/sf and office rent of $25/sf).
44,000 housing units can be potentially created with office-to-housing conversions in markets with largest declines in office absorption
The table below shows that approximately 44,500 units of housing can be potentially created if 20% of the vacant square footage is converted into housing at an average size of 1,000 square feet per unit and with 20% common area. Of the total units, 77% are conversions of Office Class B buildings. The new housing units account for 6% of housing permits that totaled 683,134 in the past 12 months as of September 2021.
The top 10 metros that account for the largest office-to-housing conversions are New York (7,484 housing units), Chicago (5,688), Los Angeles (4,200), Orange County (3,065), Boston (2,808), Atlanta (2,799), Philadelphia (2,733), Minneapolis (2,081), Denver (2,009), and Seattle (1,709).
There is little potential conversion in the Washington DC area, San Jose, Dallas, Houston, and Charlotte because office rents are still on average higher than apartment rents in these metro areas so there is little incentive for conversion.
Eight case studies on office-to-housing conversions highlight success factors for office-to-housing conversions
The report also presents case studies on eight office-to-housing conversions in Maryland, Washington DC, New York, California, and Illinois that highlight the market conditions and factors that made these conversions successful.
The case studies reveal that projects succeeded because of the commitment of local developers and investors with deep ties and experience developing projects in the local market. A clear project purpose and the identification of the target market (e.g., first-time buyers, luxury, homeless, etc.) is essential as this will determine the location of the conversion, the design of the building, amenities to be offered, and cost. The conversions can entail a complex engineering design, especially if existing tenants need to remain operational during project construction. Last but not least, community buy-in is essential in getting the project to start and finish on schedule.