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Are empty city office buildings going the same way as zombie shopping malls, or can they be revitalized to become residential apartments and condos? 

That question has many developers, city planners, banks, economists, and commercial landlords scratching their heads. What’s not up for debate is that commercial office space in major cities are experiencing a death spiral, or an “urban doom loop,” as quoted in the New York Times, in the wake of the pandemic, as remote working and high interest rates have limited options for troubled building owners. The future of American cities is riding on a solution.

Across the country, prices are being slashed as they were in 2008, with 50% or more markdowns. The knock-on effect has been a decimation of city budgets with a loss of tax revenue, affecting every aspect of a city’s efficiency and upkeep. Ancillary businesses such as restaurants, hotels, and entertainment venues also are feeling the pinch.

In the same New York Times article, a professor from the New York University’s Stern School of Business estimated that the national office market lost $664.1 billion in value from 2019 to 2022. That has caused businesses and inhabitants to leave, further affecting tax revenue and increasing homelessness. 

Offices to Apartments: Is It Possible?

An often-touted remedy to vacant office buildings is converting them to housing. After all, with an urban housing shortage, surely it makes perfect sense. But is it feasible? There’s more to it than clearing out desks and bringing in beds and baths. 

The good news is that—at face value—it is doable, but as with many commercial real estate issues, it’s complicated.

A shining example of such a conversion is 160 Water Street in New York City’s Financial District, a former 1970s constructed office building, recently revamped as Pearl House, a new amenity-filled 600-unit apartment building.

The obstacles

Money and sustainability are the crosscurrents of resistance, making such conversions difficult. According to economist Stijn Van Nieuwerburgh, a professor of real estate at New York’s Columbia Business School, only 10% to 15% of office buildings nationwide can be converted to residential use due to their heavy carbon footprints and the difficulty in bringing in enough plumbing, light, and air. It’s not impossible, but it’s pricey. 

Another factor to consider is that, like Pearl House, rents would need to be high to cover the construction costs. That means luxury apartments instead of affordable housing, which is not the mandate for most cities.

City Living: A New Reality

Cities as we have traditionally known them—hubs for business—are most likely changing. While certain companies are demanding workers return to the office, for others, the reality is that it’s far cheaper for workers to be remote. And it’s far less expensive for retailers to forgo expensive stores in favor of e-commerce sales backed by robust online marketing.

So what’s left for cities? Entertainment, shows, restaurants, clubs, and socializing. In this respect, the Wall Street Journal contends, American cities are starting to thrive again with tourism up—just not near offices.

An Opportunity for Investors

With the price of office buildings slashed, there is an obvious pull for investors to come in and buy at fire-sale prices. If there is a demand to live in former downtown office areas of major American cities, bold developers will start repurposing newer buildings or tear down older ones. 

A key component to making this work is to make cities attractive places to live once again. With that in mind, creating a new dynamic—a work/life culture where workers can walk to work rather than commute—could be a feasible new model. After all, it’s not that offices are completely empty; they’re just not full. Also, not everyone can work from home. 

Hybrid work models provide a middle ground for workers who are now used to working in their sweats and slippers while doing the laundry and companies demanding face time and usual business practices in the office. This concept is being adopted by city officials across the country, with incentives for developers to build more affordable housing. 

The conversion model is hardly new. Over the last 20 years, almost 80 New York City office buildings have been converted to residences, the most in the country, according to CBRE. Such conversions are credited with converting Manhattan’s Financial District into a livable neighborhood for families rather than a soulless commuter destination. 

Nationally, from 2010 to 2021, 222 office buildings were converted into residential space, with Philadelphia seeing the most, followed by Chicago. A slew of such conversions are in the pipeline for New York. Some will tout the new work/life model, with office spaces beneath luxury residences. Additional conversions are slated for Philadelphia, Cleveland, Los Angeles, and Washington, D.C.

Cash flow in luxury condos is always challenging. Often, they are the domain of affluent investors looking to park their money, leaving the units vacant rather than dealing with the hassle of tenants. 

However, many buildings welcome the short-term and mid-term rental models. Miami is one such city where investors only live for a few months of the year and look to lease their units for the rest. According to a report by the Chamber of Commerce as quoted on Condo Blackbook, Airbnbs in Miami command the 10th highest average daily rate ($290) of all the large cities in the U.S. Smaller pockets such as Miami Beach ($426), Key Biscayne ($571), and neighboring Fort Lauderdale ($297) boast even higher average rates. 

While Miami condo prices are not cheap, offset by the global demand to visit the city, office-to-condominium conversions elsewhere could likely be more affordable, with developers looking to do early business to spark sales. Realizing that there’s nothing developers fear more than empty buildings, Airbnb and other short-term rental sites have specifically targeted them, offering to join forces nationwide. While apartment rentals are the obvious target, savvy investors looking to strike a deal for condos could use the same approach to generate ongoing passive income.

Final Thoughts

The pandemic has dramatically changed the use of office space in major cities. This, coupled with technology (Zoom, Google Meet, etc.), meant that the conventional use of office space was due for a change sooner or later. Time and money spent commuting and the cost of office rents versus tangible productivity meant that the pandemic accelerated the change rather than caused it. 

However, the loss of office space has dovetailed with a chronic housing shortage, and should cities encourage developers to reconfigure empty offices into housing, there could be an opportunity for developers and smaller investors alike.

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Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.

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