HOUSING CONVERTIONS WILL BE A FIX FOR EMPTY OFFICES -- BUT NOT YET / THE WALL STREET JOURNAL

Housing Conversions Will Be a Fix for Empty Offices—but Not Yet

Old workplaces could be redeveloped into residential property, but it will take time for the numbers to add up in many city centers

By Carol Ryan

In the second quarter of this year, 16.9% of U.S. offices were empty./ PHOTO: ED JONES/AGENCE FRANCE-PRESSE/GETTY IMAGES

City landlords are fighting a losing battle against the home office. 

Converting old workplaces into housing is a solution, but asset values need to fall further for this to happen in big numbers.

Most offices haven’t returned to normal since Covid-19 lockdowns were lifted. 

Occupancy in top U.S. office markets is almost half prepandemic levels, employee swipe-card data from Kastle Systems shows. 

In Europe, occupancy levels are 43% on average, according to Savills.

Vacancy rates are rising as companies let go of space when their leases come up for renewal. 

In the second quarter of this year, 16.9% of U.S. offices were empty, based on CBRE data. 

Vacancies aren’t as high yet in Europe, but are above long-term averages and rising. 

Some older offices are now “functionally obsolete or on their way there,” according to Daniel Ismail, analyst at real-estate research firm Green Street.

One answer could be to convert offices into badly needed homes. 

The vacancy rate in U.S. multifamily rented accommodation was a low 3.1% in the second quarter. 

That is driving growth in residential rents, improving the prospects for turning offices into homes.

But there hasn’t been a flood of conversions yet. 

Since the pandemic began, around 50 U.S. office blocks have been or are being redeveloped into multifamily apartment complexes, according to CBRE. 

In the U.K., which loosened planning laws several years ago to make redevelopment easier, an average of 12,000 new housing units a year have been created from old offices since 2015, official statistics show.

Conversions can be tricky to pull off. Bigger offices are hard to turn into homes as the lack of natural light toward the middle of large floors makes them unsuitable for living in. 

Converting an office into apartments can also lead to a loss of around 20% of the lettable area of a building as residential tenants don’t pay rent for common areas like corridors, as office occupants do.  

The bottom line is that offices must look cheap relative to residential property to make redevelopment profitable. 

According to Olivier Elamine, chief executive officer of European office real-estate investment trust Alstria, the value of residential property needs to be about 50% above that of offices, adjusting for the loss of some leasable space linked to the conversion.

This kind of premium is emerging in some suburban areas, where home prices jumped during the pandemic. 

In many central business districts though, offices are still pricey. 

Despite high vacancy rates, Manhattan offices are 17% more expensive a square foot than large multifamily residential buildings, according to data from Colliers. 

However, this premium has narrowed from an average of 44% for the two years before the pandemic.

For now, big listed office landlords like Empire State Realty Trust and SL Green may opt to give tired offices a “green” refurbishment rather than turn them into homes. 

Demand for sustainable offices is currently strong among corporate tenants. 

But this may change: Office values probably have further to fall amid weak growth in rents and rising interest rates.

There is a long-term solution to the problem of empty offices. 

The bad news for landlords is that values will need to fall further to unlock it.