This CoStar News article, authored by Katie Burke, highlights the ongoing challenges and creative solutions U.S. developers face in dealing with empty office spaces in major cities. Emerging market real estate investors can draw valuable insights from these developments, learning how shifts in property usage and market demands can influence investment strategies and property valuations.
Source: CoStar News
Author: Katie Burke
The language in marketing materials listing office properties for sale across the United States is concise — but touts the potential for big changes: "Perfectly suited for conversion," a San Diego listing states. In Baltimore, creativity is encouraged: "Reimagine it as a multifamily residence." And, in case prospective buyers of a New Jersey office property didn't know, some things have been taken care of: "Already zoned."
Owners of U.S. office properties and their brokers, looking to quickly sell after a precipitous drop in demand and a dwindling pool of interested buyers, are pitching sometimes empty buildings for uses other than a place for desks, conference rooms and coffee stations.
Those who list distressed or high-vacancy office properties are sometimes trying to sell them as potential conversions to apartments, self-storage facilities, and even entertainment venues. The shift represents a new level of eagerness to build interest in these properties that may be older, face pressure from lenders, or have nonexistent leasing activity.
"You need to be extremely creative for some of these buildings," Jake Levinson, the director of Northern California brokerage services for brokerage Ground Matrix, told CoStar News. "Unless you can give them away for almost nothing, it's hard."
Only a small fraction of office buildings are structurally or otherwise suited to be converted to housing, and revamping other buildings to different uses faces other challenges. Outside the country's major cities, the conversion pitch becomes increasingly difficult. Take the hospital-turned-office property at 2300 Fall Hill Ave. in Fredericksburg, Virginia, for example, a 1950s-era building with hundreds of thousands of vacant square feet. Now it could face another conversion, this time to residential.
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"It would be a tremendous amount of office space for our market to absorb, not to mention the cost of upgrading the layouts, the loss of usable square footage and cost to upgrade the mechanical systems," Coldwell Banker Commercial Vice President and Managing Broker Ben Keddie, who is listing the property, told CoStar News. "With all of these costs compared to the softer office market, a residential conversion is the only viable option."
Then there's the Spreckels Building in downtown San Diego, a city that has long faced a housing shortage so acute, its average monthly rent of about $2,430 makes it one of the nation's most expensive residential markets. The historic office building at 121 Broadway is largely vacant and "perfectly suited for conversion to residential, hotel, or creative office," according to Cushman & Wakefield materials.
Influenced by macroeconomic factors such as the increased cost of capital, investment activity in the United States office market has reached a record low with sales volume down by more than 55% compared to this time last year, according to CoStar data. Buyers funneled $35 billion into the national office market in 2023, a figure that appears high on paper but actually represented a near 15-year low.
With buyers and lenders both parked on the sidelines to wait out any uncertainty, those eager to close a deal are realizing that marketing a property as its original use as an office isn't always enough to generate the amount of interest they might have been able to attract prior to the pandemic.
Restoring Relevance
While the conversion technique is getting used for office properties listed across the country, it is especially so for buildings further from central business districts. Some are in need of costly capital improvements and face a mounting risk of becoming permanently obsolete.
Determining the best way to pitch office properties given the current market "has become a national, multibillion-dollar question," Levinson said. "We need to figure out a way to activate some of these buildings and help support a market where conversions are fiscally viable. If we were able to do that, we would see a much easier recovery process because, for some properties, conversions are really all you can do."
Throughout the depth of the pandemic, soaring vacancy rates and the increasing permanence of flexible work policies sparked a broader debate over the value of office space versus the possibility of having it serve a separate function.
Multifamily conversions, in particular, have become a frequent topic among city officials, developers and property owners as a way to reposition buildings that otherwise stand little chance of surviving as viable office space.
"There's a general understanding right now that we're over-officed," said Phil Mobley, CoStar's national director of office analytics. "Part of the solution to that is likely to repurpose some of the existing offices for other uses, and major cities are beginning to throw their support behind the idea, at least conceptually."
Boston has launched a tax incentive program aimed at converting outdated office buildings into housing. There are six proposals so far that could result in upward of 215 units. In Chicago, Mayor Brandon Johnson is backing more than $151 million in public funding to support the redevelopment of four downtown office towers into 1,000-plus apartments.
Almost 70 million square feet of office space, roughly 1.7% of the total national supply, was in some stage of a conversion to another use through the first three months of this year, according to a recent CBRE report. That's a notable jump compared to the pipeline in the second half of 2023 when about 60 million square feet, or roughly 1.4%, was underway.
Office conversion completions are expected to more than double in 2024 compared to last year, CBRE Director of Office Research Jessica Morin said, and of the 120 office conversion projects nationwide, one-third of them are slated to become reimagined multifamily properties. To compare, an average of about 45 conversions were completed annually between 2016 and 2023.
While the overhauls have been viewed as a way to remedy the country's record-high office vacancy rate — it has climbed to nearly 14%, according to CoStar data — conversions can face various hurdles.
Issues such as complicated financing, environmental challenges and stagnating markets have proven among the biggest challenges for those looking to transform some of the nation's older office buildings. Then there are the physical attributes of the properties themselves that can deliver their own set of headaches, such as irregular floor plans, unsuitable locations or aging mechanical systems that would be too expensive to fix and reuse.
Limited Conversion Opportunities
That's a high bar to clear, Mobley said, adding that rough estimates show only about 2% of the nation's office supply could successfully be converted into some type of housing.
"Institutions and public real estate investment trusts are just out of the game, at least in terms of acquiring new properties, so what's left are the private buyers and owner-user types," he said. "It all comes down to pricing. There's a recognition now that office values are lower than they were, but it's difficult to accept that loss until you have to."
For office properties listed for sale, potential conversions can serve as somewhat of a fallback strategy among investors who aren't yet sure they want to preserve a building's original use.
Northwind Group, a New York-based private equity firm, last month issued its first office loan in three years for a New Jersey office tower that, while it will remain office space for the time being, could be reimagined if the market doesn't make enough of a rebound.
"It is already zoned so it could easily be converted into residential," Ran Eliasaf, Northwind's founder and managing partner, told CoStar News. "Obviously that won't happen right away, but it's always good to have a backup plan."
Combined with other factors such as the building's relatively low acquisition cost and increased interest among prospective tenants, the possibility of a conversion helped reduce any risk in financing the deal, something brokers are tapping into in order to land buyers. Of the listings for office properties larger than 50,000 square feet that have hit the market within the past month, roughly 10% have touted the potential to convert the existing structures into some form of multifamily use, according to CoStar analysis.
One Charles Center, a downtown office tower in Baltimore that's headed for auction, is being pitched as a chance for prospective bidders to "reimagine it as a multifamily residence with retail, promising substantial value-add potential," according to JLL marketing materials.
In Austin, Texas, where annual apartment rates soared more than 16% toward the end of 2021, the building at 1200 East Anderson Lane that served as tech giant Apple's first office in the city is now entirely vacant and — if the future owner is able to rezone the property — floated as a possible multifamily redevelopment.
Reimagining some of those properties would also buoy cities' central business districts in a post-pandemic era in which fewer employees commute to an office far less frequently than their schedules half a decade ago.
"City centers would just be better," Levinson said. "All over the country, they're in really bad shape because people don't want to come to an office anymore. You have to get the government more involved, especially with these larger buildings, and figure out the types of uses that are better suited for the area."
Yet even without government assistance, Levinson is still leveraging the increasing popularity of potential conversion opportunities with a San Francisco office he recently listed at 308-310 Seventh St. in the city's SoMa neighborhood. The 15,000-square-foot building housing a local design firm's headquarters serves as office space for now, but the broker said he has another option in his back pocket if necessary.
"Aesthetically it would be an interesting office, and that's how we're marketing it," Levinson said. "We're starting off with commercial, but the zoning in the area could allow for a single-family home. If we don't get any traction on the commercial front, we'll hit the ground running on a residential play."
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