With the shift to hybrid work models, there is much more unused office space available that, if converted to residential use, could help mitigate the dearth of affordable housing in the US market. To date, the economics of such a shift is not supported by the differing pricing dynamics in these two asset classes. But a variety of developing factors may make conversions more attractive and feasible for investment. The Deloitte Center for Financial Services predicts that office-to-residential conversions could become profitable within the next five years. We estimate that around 14,700 affordable units in central business district (CBD) areas across the country can be added by 2030, assuming approximately 20% of converted square footage can be earmarked for affordable housing.
Estimates suggest that there is just shy of one billion square feet of available office space in search of tenants in the United States,1 nearly 1.5 times the amount from the end of 2019.2 With a shortage of nearly three million homes,3 the US housing sector has emerged as a likely recipient of the unused downtown office space. So far, the US commercial real estate industry has been slow to respond: Between 2016 and 2021, there were, on average, 31 housing conversions from office products per year, totaling 188 projects.4 And while many Americans are still working from home, at least part of the time—a trend that will likely continue—only 217 conversion projects are in the immediate pipeline for completion.5
Government and business leaders appear to be taking notice.6 Some political leaders at the local and state levels have put forward legislation or called for action specifically supporting office-to-housing initiatives. These actions could provide incentives for real estate developers to provide Americans with clean, affordable, and safe places to live. Here are some of the initiatives in the works so far:
City governments have provided these types of incentives for conversion projects before. In the early 1990s, New York City passed the 421-g tax abatement program, incentivizing 13 million square feet of downtown Manhattan conversions. And Philadelphia passed its own abatement program in 1997, resulting in 180 building conversions.10
When considering these types of conversions, one of the biggest challenges owners and developers face is whether—and when—their investments will pay off. We anticipate that, by 2027, shifts in rents, valuations, acquisition costs, and conversion costs, in addition to added government-backed incentives, could allow developers to achieve a net profit on conversions of underutilized office space in favor of residential space (see sidebar for further information).
Layout aside, two valuation assumptions could deter developers in the near term: comparable rent and vacancy levels. The median asking rent for an apartment unit in the United States is around US$22 per square foot (psf). With US office rents still averaging US$37.38 psf,11 a 41% pricing concession in addition to an amortized cost of conversion is a tough pill to swallow. Additionally, developers would be unlikely to convert a building with a below-average vacancy that is still operating best as an office building.
What’s behind our prediction? By filtering the estimated total inventory of CBD office buildings in the United States with asking rents less than US$35 psf with at least 30% vacancy, we estimate that approximately 170 million square feet of CBD office space is viable for conversion.12 We considered any buildings with a class A designation to be unlikely for future conversion, as vacancies are unlikely to persist in the long term due to flight-to-quality tenancy trends supporting occupancies in this class profile. Therefore, of the total CBD space assessed viable for conversion, class B and C products totaled 70 million square feet and were used in our conversion feasibility model.
The Deloitte Center for Financial Services forecasted rent declines for class B and C office assets, coupled with shifts in cap rates to the mid to high 7% range, which would price class B and C offices at approximately US$372 psf by 2027. This is down 6.6% from today’s prices, or a trajectory of –1.4% compounded annually. As hard and soft costs could abate with inflation-reduction efforts over the coming years and added benefits of increased government incentives, potentially offsetting conversion costs by as much at US$55 psf,13 we assume the cost to convert could near US$150 psf on average over the same time frame, down from US$213 psf at the end of 2021.
Offsetting these costs of acquisition and conversion for developers are the anticipated increased implied value of new residential assets upon completion. Assuming continued multifamily rent growth and corresponding compressions in cap rates, multifamily assets could trade for approximately US$545 psf in 2027, up from US$438 psf at the end of 2022. Multifamily properties would need to sustain a 3% compounded annual growth rate for rents over the next five years to achieve these valuations. Assuming this valuation growth trajectory, 2027 would be the first year in which revenue from the sale of residential assets could be expected to offset the costs of acquisition and conversion.
Over the years, high conversion costs may have deterred developers from converting underutilized office buildings into affordable residential buildings. However, since 2020, several new government-enabled incentives have been announced to provide supply-side solutions to help address both the shortage of affordable housing and the increasing number of vacant office spaces. Several regions are making progress in developing tax policies that will make these conversion projects feasible, with several developers already moving at the opportunity:
A combination of some of the benefits provided by local governments can make the math work for conversions at scale. In particular, government incentive programs can help make conversions more feasible by easing restrictions around zoning and density, providing direct financial subsidies and tax abatements, and waiving off or redistributing infrastructure upgrade costs to a longer time horizon.
Currently, real estate owners face financing issues due to elevated interest rates. But they don’t have to go it alone. Public/private collaborations with lenders focusing on community development, government agencies, and impact funds may help with this transformation. Affordable housing remains at the top of agenda for the federal government, with US$213 billion planned in government incentives to support affordable housing under the US$2.25 trillion infrastructure plan.18 Proposed legislation was modeled after the 2022 Revitalizing Downtowns Act, which aims to provide tax credits for such conversions.19
More centralized land use planning, inclusionary zoning, and state-level initiatives can make way for more market-rate developments with designated affordable housing that can help address the affordable housing gap. Distress in the office sector could lower valuations in the next two to three years. This may provide an opportunity for collaborations among developers, government bodies, and lenders to prop up the affordable housing shortfall and revitalize downtowns. Stronger relationships between developers and local and state municipalities could be what’s needed right now, especially in addressing the dearth of affordable housing in the United States.
Emma Goldberg, “What would it take to turn more offices into housing,” New York Times, December 27, 2022.
View in ArticleCushman & Wakefield, MarketBeat US National Office Q4 2019, April 2019; Cushman & Wakefield, MarketBeat U.S. National Office Q4 2022, April 11, 2023.
View in ArticleHarvard Joint Center for Housing Studies, The state of the nation’s housing 2022, December 2022.
View in ArticleCBRE, “The rise and fall of office to multifamily conversions: A real estate investigation,” March 14, 2023.
View in ArticleOlivia Lueckemeyer, “More cities giving away money for office-to-resi projects as threat of obsolescence grows,” Bisnow, April 12, 2023.
View in ArticleGoldberg, “What would it take to turn more offices into housing,” New York Times, December 27, 2022.
View in ArticleKatherine Carlon, “City leaders unveil ‘once in a lifetime’ plan to bind wounds of bleeding LaSalle Street corridor,” Bisnow, September 26, 2022.
View in ArticleJacob Wallace, “D.C. launches conversion abatement fund as planned downtown projects stall,” Bisnow, February 9, 2023.
View in ArticleJack Witthaus, “California's $400 million office-to-housing conversion fund lures investor applicants,” CoStar, March 7, 2023.
View in ArticleGoldberg, “What would it take to turn more offices into housing,” December 27, 2022.
View in ArticleCushman & Wakefield, MarketBeat US National Office Q4 2022.
View in ArticleCoStar data, accessed April 7, 2023.
View in ArticleWashington Post, “The model city for transforming downtowns? It’s in Canada,” May 18, 2023.
View in ArticleDavid Brand, “The country’s biggest office-to-apartment conversion is underway inside the old Daily News office,” Gothamist, April 13, 2023.
View in ArticleSebastian Morris, “Developers close on $535M loan to redevelop 25 water street in financial district, Manhattan,” New York YIMBY, December 29, 2022.
View in ArticleMiriam Hall, “Buyers begin moving into Harry Macklowe’s one wall street residential conversion,” Bisnow, February 24, 2023.
View in ArticleGreg Cornfield, “CIM group-led partnership begins office-to-resi conversion in LA,” Commercial Observer, March 7, 2023.
View in ArticleMegan Henney, “What’s in Biden’s $2.25T infrastructure and tax proposal?,” Fox Business, March 31, 2021.
View in ArticleEvan Liddiard, ”One aid to making buildings convertible,” National Association of Realtors, December 27, 2022.
View in ArticleThe authors wish to thank Gaurashi Sawant and Samia Hazuria for their extensive contributions to the development of this report. We would also like to thank our colleagues Darin Buelow, Renea Burns, and Jeff Smith for their insights and guidance.
Cover image by: Natalie Pfaff
