Office Conversions: A Second Chance for Underutilized Space

*Manhattan office-to-multifamily conversions before 2022 were excluded from the data set due to the removal of incentives that changed the landscape for local conversions.

While office conversions to other uses have become increasingly attractive options for older, less competitive buildings, completed projects haven't significantly increased since the pandemic. CBRE tracked an average of 39 completed conversions annually between 2017 and 2021.

Figure 1: Office Conversions by Construction Status and Estimated Year of Completion

Source: CBRE Research, Q4 2022.

But more conversions are on the horizon: Some 42 office conversions have been completed so far this year and 217 are either underway or planned. Of the underway projects, 21 are slated to deliver by the end of the year. However, underway projects may stall due to tighter financial conditions amid slower economic growth, particularly in H1 2023. Despite the robust pipeline, conversions alone won't measurably decrease the surplus supply. Even if every planned office conversion is completed, together with the conversions completed since 2016, only 91.1 million sq. ft. would be removed from the market, roughly 2% of total U.S. office inventory.

Conversions are concentrated in coastal and northeast markets with relatively older office stock. San Diego, Boston, Manhattan, Cleveland and Philadelphia have the most completed conversions since 2016. Boston and San Francisco Peninsula have the most underway. Dallas has several planned and announced projects totaling nearly 6 million sq. ft.

Multifamily has been the most common reuse for outdated office buildings.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.

Figure 2: Office & Multifamily Fundamentals in Major U.S. Markets

*Office reflects Manhattan market data
Source: CBRE Econometric Advisors, Q3 2022.

Conversions are especially attractive in dense markets with limited available land. OTM conversions are most prevalent in downtown areas, particularly in walkable neighborhoods with abundant amenities. Since 2016, several downtown offices in Cleveland, Pittsburgh, Cincinnati, Kansas City, and Philadelphia have been converted. Several OTM projects are in various stages in Washington, D.C., downtown Dallas, and Northern Virginia. Five Downtown Dallas OTM conversions planned within a half-mile radius would delete 5.9 million sq. ft. of office space while adding over 1,300 apartment units.

The average age of the 89 properties converted is 80 years old and they average 184,400 sq. ft. About 90% of the conversions were constructed before 1980. Buildings erected before 1980 account for 30% of U.S. office inventory and have an average vacancy rate of 17%, making them prime candidates for future conversions.

Similar to multifamily conversions, office-to-hotel conversions require significant capital to add more plumbing, HVAC, light, kitchens, bathrooms and finishes. Additionally, zoning variance approval may be required when changing from a commercial to residential use.

CBRE tracked 45 completed office-to-hotel conversions since 2016, with seven underway and seven planned. All but a handful of conversions are in downtown markets and within close proximity to walkable amenities, prominent employers, sports and entertainment attractions, convention centers and restaurants. Multiple conversions have been delivered, or are under construction, in downtown Cincinnati, Houston and Kansas City over the past few years.

Life sciences is a specialty office type, with unique conversion costs and challenges. Yet, these conversions have become increasingly attractive over the past few years due to record-high rents for lab and R&D facilities and weaker demand for traditional office space. Strong demand for life sciences space and limited new supply has propelled the upswing in conversions, especially in Boston, Philadelphia, San Diego, San Francisco and suburban Maryland, where demand for life sciences buildings have been insulated from the impact of remote work because much of its sophisticated work can only be performed within a laboratory setting.

Of the 63 conversion projects completed or slated for completion in 2022, 29 are life sciences properties. As of Q4 2022, there was 26.8 million SF of office conversion construction underway, including 11.4 million SF that would be converted to life science space. Boston, San Francisco Peninsula, and Suburban Maryland accounted for 9.3 million sq. ft. of the conversion construction reflecting persistent demand in these life sciences hubs despite the tight market.

Life sciences tenants need robust infrastructure, making conversion to labs expensive. As of Q4 2022, life sciences fit-out costs in the top three markets ranged from $571-1,075/sq. ft., compared to $140-$275/sq. ft. for office. However, compared with residential and hotels, developers can use more components of an office building in a life sciences conversion, such as lobbies, bathrooms and elevators. Office-to-life sciences transitions require specialized building features and amenities, including higher ceilings to accommodate greater HVAC requirements, clean rooms, vivariums, increased loading docks, more security and, most costly, increased mechanical, electrical and plumbing engineering (MEP). Despite the additional costs, the payoff can be high. In 2021, average lab rents increased by 11%, whereas U.S. office rents increased by only 2%. Boston commanded average lab rates of $99.53/sq. ft. compared to $53.14/sq. ft. for Class A office in Q3 2022.

Only a portion of some buildings may be undesirable to today's office tenants—such as the bottom floors of an older Class A office tower with no views and outdated amenities. For such assets, landlords might consider a partial conversion that transforms an office to a mixed-use development. In many cases, several floors of an office building have been converted to retail, life sciences, residential or other uses. An added benefit: tenants occupying the office floors may even be able to remain during a partial conversion, as work is done around them.

Not every office is suitable for conversion. Several factors determine whether an office building is convertible, including the configuration, floor size, depth and ceiling height. A standard office floor is about 100-150 ft. long, while a typical apartment floor is 65-75 ft. If the building is too deep, many challenges will arise, like inadequate light and airflow for the units at the back of the building. Apartments and hotels also require windows in each room, leaving much of the interior space essentially unusable. While there are some creative solutions, like creating common space, private lockers and storage facilities, gyms and offices, or gutting the area to add light and connectivity, some floorplates are just not compatible with conversions.

Other considerations that will make or break a potential conversion are local zoning requirements and regulations, which vary across markets.

While there are many challenges to overcome, conversions have advantages over new construction:

Pros:

• Generally, less expensive than building from the ground up
• Smaller environmental impact
• Quicker timelines by avoiding zoning and town approvals and demolition
• Retaining unique design features: rehabbing landmark historical buildings whose character can't be replicated in a new build

Converting obsolete offices can help occupiers and investors meet their individual environmental and social targets that have become a priority for many organizations. The reuse of existing structures cuts down on fabricating new materials, reduces the materials that need to be shipped to the site and lessens landfill waste. According to CBRE's Spring 2022 U.S. Occupier Sentiment Survey, 71% of respondents are prioritizing a reduction in greenhouse gas emissions and 49% are committed to reducing resource usage or waste. According to a National Trust for Historic Preservation report, building reuse typically offers environmental savings over demolition and new construction. Although operating more energy efficiently, new construction can take 10 to 80 years to offset the climate change impacts produced during its development.²

Figure 3: ESG Priorities

Source: CBRE 2022 U.S. Office Occupier Sentiment Survey, Q1 2022.
²“The Greenest Building: Quantifying the Environmental Value of Building Reuse,” National Trust for Historic Preservation, March 2016.

Conversion of obsolete offices to another use is one solution that will support the recovery of U.S. office fundamentals. However, at its current pace, conversions won’t have a measurable impact on the more than 4 billion sq. ft. of existing office inventory. If the economy slips into recession as expected, office vacancies will edge higher, particularly for undesirable and outdated office space. Real estate decision-makers will explore solutions to better position underutilized office spaces. Because conversions also generate environmental and social benefits, we’ll likely see more local and federal support. To preserve property tax revenues, we could see local governments lower regulatory barriers that impede conversions and programs that incentivize the transition of unused offices to newer and better uses. The combination of compelling financial and social benefits are likely to stimulate more conversions in years to come.