Main Takeaway: Remote work and a potential economic downturn mean that office vacancies will only increase from their current record highs of 17% nationwide. Savvy investors will look to reposition these assets, with multifamily conversions being the most obvious first choice. Regulatory tailwinds for smaller office conversions will also continue to make this investment strategy profitable for the foreseeable future.
Story: With office vacancy rates nationwide at record highs due to rising remote work policies, we are beginning to see a wave of asset conversions. Office to multifamily conversions are increasing, and it’s an important trend that owners and investors need to pay attention to.
According to CBRE, the national office vacancy rate reached a 30-year-high of 17.1% in Q3 2022. Further, only 9% of the office inventory is categorized as Class A built since 2010, meaning we also have an aging stock of this asset class in need of large capex.
This aging stock and surplus of available square footage will weigh on this sector for decades to come, but the need to repurpose and reposition assets is imminent. Already we are seeing record numbers of office conversions underway.
What is the most typical conversion candidate for office buildings? Multifamily. According to CBRE:
Multifamily has been the most common reuse for outdated office buildings. Since 2016, CBRE tracked 89 completed office-to-multifamily (OTM) conversions across 26 major U.S. office markets. The projects collectively reduced office inventory by 16.4 million sq. ft. and added over 14,000 apartment units. Record-low apartment vacancies and sustained, elevated rent growth have made OTM conversions attractive to opportunistic developers. The U.S. multifamily vacancy rate was 3.9% in Q3 2022, and average rents increased 10.4% to $2,143/month.
Most of the office-to-multifamily conversions to date have been of aging office stock. The average age of the above-noted 89 properties is 80 years. Further, 90% of the office-to-multifamily conversions were constructed prior to 1980.
According to RentCafe, over 28,000 apartments in 11,000 former office buildings were created between 2020 and 2021 from office buildings, and they project that number to rise significantly. Further, more adaptive reuse conversions are ongoing than brand-new apartment construction, and 40% of those reuse conversions are former office buildings.
The promising future of adaptive reuse is reflected in the impressive number of projects expected in the coming years — serving as further confirmation of its rising popularity. To that end, Yardi Matrix data shows a total 77,100 future adaptive reuse apartments in various stages of conversion. Of these, some are already undergoing conversion and set to be completed in 2022 and later, while other projects are awaiting approval or are in the planning stages. When it comes to future projects, office conversions are projected to represent 28% of total apartments under conversion — the largest share of all building types under conversion.
Some problems do exist, however, with office-to-multifamily conversion projects:
- HVAC, mechanical, electrical, and plumbing systems are typically not designed for residential use.
- Inefficient office walls are not suitable for residential living.
- Office floorplans are designed to get as many people in a space as possible and are completely irrelevant to modern multifamily layouts and design.
That said, most office stock is older, low-rise, well-located smaller office buildings that opportunistic investors can acquire, convert, and reposition without the significant outlay of capital needed for bigger office conversion projects.
Finally, because office-to-multifamily conversions also have significant environmental and social benefits, the regulatory tailwinds may be such that investors will obtain incentives for redevelopment. For example, a proposed Office To Housing Conversion Act in California aims to make these zoning approvals automatic.
These lower regulatory burdens put upward pressure on valuations and NOIs, making this multifamily strategy intriguing for the foreseeable future.
Expert Take on Office to Multifamily Conversions
“Amid concerns over U.S. housing supply, office conversions are bridging the gap between housing supply and demand. They have brought much-needed residential options to important high-density neighborhoods with barriers to new development.” — Matt Vance, Senior Director Multifamily Research, CBRE
“Commercial-to-multifamily conversions can be one of the ‘all of the above’ solutions we need to the nation’s affordable housing crisis.” — Caitlin Sugrue Walter, NMHC’s vice president for research