Summary
Owners of office space have begun to unload their properties at heavily discounted prices—evidence that stakeholders believe the soft office-space market is here to stay. While local rules, zoning laws, and other market factors can make converting office space into residential space complex and expensive, conversion is a viable option for some properties, especially where tax credits and local government incentives are available.
The Upshot
- Office property vacancies are especially high in many of the country’s metropolitan areas.
- Because high interest rates are making it difficult for owners to refinance their properties, and many stakeholders believe the remote work arrangements prompted by the pandemic are here to stay, office space is selling at steep discounts.
- In many states, government tax credits and other incentives are offsetting some of the high costs and stresses associated with commercial-to-residential property conversions.
- Property conversion can be an especially compelling option for owners of older office buildings that are no longer attractive to modern office tenants, as well as high-net-worth families and certain developers on the hunt for a bargain.
The Bottom Line
The owners of vacant or underutilized office buildings should consider assessing the viability of converting property into residential space in light of government tax credits and other incentives that may be available to offset some of the high costs associated with office-to-residential property conversions.
Short of tumbleweeds blowing down Main Street, nearly all signs point to an office-space sector in distress. With major office tenants not renewing leases or downsizing, office vacancy rates in the United States are at historic highs.
In San Francisco, office vacancy stands at 30 percent—an all-time high for that city. Vacancy rates in Houston and Atlanta exceed 20 percent. And, at 16.1 percent, first-quarter office vacancies in Manhattan reached a record high.
In a sure sign that landlords are pessimistic about the prospect of refinancing their property or securing the capital necessary to fund the office building improvements necessary to attract new tenants, the owners of office space have begun to sell their property for much less than it was once listed.
In the first quarter, office prices in Manhattan were 26% lower than they were at their peak in 2017, with New York City’s Mayor, Eric Adams, telling Bloomberg that Big Apple landlords should turn their vacant office space into housing.
While local rules and zoning laws can make converting office space into residential property complex and expensive, conversion is a viable option for some properties, especially where tax credits and local government incentives apply. A firm that converts out-of-date offices into apartments recently purchased a JPMorgan Chase building in New York City’s Financial District for 7% less than it sold for 10 years ago.
In Chicago, city leaders have launched La Salle Street Reimagined, an invitation for proposals to adaptively reuse underutilized office buildings in an area where 5 million square feet of commercial space stands vacant. The initiative is offering $197 million in tax-increment financing to cover a portion of the costs of conversion.
In California, lawmakers have approved $400 million in incentives for commercial-to-residential conversions, including $105 million in grants to fund the conversion of commercial space into affordable and market-rate housing.
Republican legislators in Wisconsin released bills in early March that would, among other things, grant interest-free state loans of up to $1 million to developers trying to convert empty big-box stores and office buildings into affordable housing. There are also proposals in that state that would make it difficult to challenge rezonings for new housing.
And in Washington, D.C., a program authorized last year would offer a 20-year tax abatement to property owners who add 10 or more housing units and change a building’s use.
Even with these government incentives, converting commercial property into housing is not always financially feasible. Local regulations—such as a rule in New York requiring each bedroom to have a functioning window—can make it difficult to convert modern office buildings with deep interiors into residential properties.
Still, converting office and retail space into residential property might make sense when obsolescence is the alternative, or when an older building bears features exuding prewar charm that might be attractive to potential residential tenants, but not to modern office tenants.
With offices in some of the hardest-hit markets in the country, Ballard Spahr understands the regional issues, local laws, political climate, and distinct market characteristics that affect distressed property of all classes. That perspective, coupled with our extensive experience in real estate development and finance, tax-exempt financing, litigation, taxation, and bankruptcy, gives the members of the firm’s multidisciplinary Distressed Assets and Opportunities team the insight to help property stakeholders identify various options. Find an overview of our capabilities related to distressed office buildings here.
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