Almost from the start of the COVID-19 pandemic, the transition of millions of office workers to remote work locations has sparked talk about commercial-to-residential adaptive reuse. Since the U.S. has a serious housing shortage, the notion of converting some of those underused office buildings into residences seems like an elegant solution. Bolstering the commercial real estate market while creating more places to live are just two potential wins. Job creation and the generation of tax revenue are two more of many additional benefits of a successful conversion.
So, why aren’t commercial-to-residential conversions happening on every block of every major city and in most suburbs?
The answer is rather complex, with a combination of economic, legal and practical factors contributing to the reluctance of developers to move on these projects. Entanglements connected with permitting, toxic contamination and code conformity are some of the factors that make it much more difficult to accomplish a conversion than to start a blank-slate project on a vacant lot. Underlying these issues is the basic fact that conversions are risky and expensive.
This reality, combined with the numerous social and economic benefits of conversions, justify proactive government policies that provide owners incentives to adapt existing commercial properties to new uses. Given the obstacles standing in the way of these benefits, an additional impetus is needed to unleash the badly needed solutions that smart property conversions can provide.
One idea for providing this impetus is legislation introduced in both houses of Congress known as the Revitalizing Downtowns Act (H.R. 4759/S. 2511). These bills would provide a 20% tax credit for qualified property conversion expenditures. The credit is modeled on the current-law historic property rehabilitation tax credit and can be used for buildings that are at least 25 years old at the time of the conversion.
The bills didn’t stand a chance of passage in 2022, but the National Association of REALTORS®, along with more than a dozen other real estate–related trade groups, sent a letter to the sponsors of these bills in October, urging them to modify and expand the legislation before it’s reintroduced in 2023.
Among the changes listed in the letter are the following, which are designed to broaden the impact, effectiveness and appeal of the legislation:
- Expand the types of properties eligible for the credit to include shopping centers, industrial buildings and hotels. This could vastly enlarge the potential of the incentive.
- Extend the tax incentive to real estate investment trusts. Currently, REITs are not able to pass credits through to their shareholders, so a mechanism would be needed to make the benefit available to these entities, which own nearly 15% of all commercial real estate.
- Provide a bonus credit for properties located in low-income areas. This recognizes that conversion projects in economically distressed areas entail additional financial risks.
- Promote the conversion of properties into affordable housing by enabling states to use tax-exempt bonds to reduce financing costs.
An expanded version of the Revitalizing Downtowns Act could propel a new wave of private investment in older buildings that could lead to the creation of affordable housing and significant job growth. It could also increase the likelihood of attracting sponsors from both sides of the aisle, which is vitally needed in today’s political environment.