Turning Empty Offices Into Apartments Is Getting Even Harder
Only 3,575 apartment units were converted from office space last year. The already fraught process now faces even more challenges.
Cities hoping to convert emptying office buildings into apartments are running into financing issues, stagnating rental markets and other challenges that are bottling up their efforts.
Developers last year created just 3,575 apartment units in the U.S. through office conversions, according to an analysis by rental listing site RentCafe. That amounts to less than 1% of all apartments built that year through new construction.
The number of office conversions is poised to increase sharply this year, according to brokerage CBRE, as office vacancies keep rising and developers see conversions to other property types as an alternative.
Federal and local governments are also trying to give conversions a boost. The White House said last month that it was updating guidance for existing grants and spending programs to make billions in federal dollars available for these projects. It also said it would seek the conversion of more government-owned properties into housing.
Some cities, such as Washington, D.C., New York and San Francisco, are also taking steps to encourage more conversions. Tax incentives and faster approvals are “rocket fuel” for these projects, said Sheila Botting, a principal at commercial property brokerage Avison Young.
Even so, the process has always been fraught with difficulty and few office buildings are natural candidates. Conversions are easiest in older, lower-quality and mostly empty buildings with small floors. But less than 1% of office space in the biggest U.S. cities ticks those boxes, according to Avison Young.
In significant ways, the conversion process is getting even harder now. Slowing rent growth might make apartment conversions less attractive to investors, if the trend persists into next year. Asking rents for apartments have fallen 1.2% nationally over the past 12 months, according to rentals website Apartment List.
Apartment conversions from offices
6,000
4,000
Estimated 400,000 new apartment units completed in 2023
2,000
1290 apartment units converted from offices
0
2010
’15
’20
6,000
4,000
Estimated 400,000 new apartment units completed in 2023
2,000
1290 apartment units converted from offices
0
2010
’15
’20
6,000
4,000
Estimated 400,000 new apartment units completed in 2023
2,000
1290 apartment units converted from offices
0
2010
’15
’20
6,000
4,000
2,000
0
2010
’15
’20
1290 apartment units converted from offices
Estimated 400,000 new apartment units completed in 2023
6,000
4,000
2,000
0
2010
’15
’20
1290 apartment units converted from offices
Estimated 400,000 new apartment units completed in 2023
Construction loans are also far more expensive than they were 18 months ago and many banks now shy away from development lending. A number of conversion efforts are on hold because of higher interest rates.
“It adds a huge amount of cost to the project,” said Steven Paynter, a principal at architecture firm Gensler who specializes in repurposing buildings.
His firm is working on office conversion projects totaling thousands of potential apartments that have permits, but are delayed while the developers try to land financing, he said.
Although more cities are trying to speed up the process, getting permits can take years. Long approval times are particularly brutal when combined with higher interest rates because developers often have to make debt payments while they wait for the green light.
“That can kill the project,” Paynter said.
Even when interest rates are low, repurposing offices can get expensive fast. Many require major interior demolition to make the floor plans work, including extensive plumbing work to add kitchens and bathrooms.
Environmental issues, such as asbestos abatement or removing lead paint, also run up costs in older buildings. Moving construction materials through densely built downtowns and in and out of narrow doorways poses other costly hazards.
“It’s like building a ship inside of a bottle,” said Trevor Martinez, senior developer at Sherman Associates, a company turning office buildings in downtown Minneapolis and St. Paul, Minn., into apartments.
If developers manage to buy old office buildings for a low enough price, conversions are often still profitable, even with higher interest rates. But some major projects have hit the skids, and at least two are facing foreclosure.
Developers of One Camelback, a 200,000-square-foot office building in central Phoenix, are trying to convert it into what would be one of the city’s most expensive rental-apartment properties. A website advertises $8,000-a-month apartments, with floor-to-ceiling windows and crystal-clear views of nearby mountains.
But the developers, Sagamore Capital and partners defaulted on a loan of about $70 million. The project’s lender, Delphi Financial Group, has moved to foreclose. An auction of One Camelback is set for later this month, according to documents filed in Maricopa County, Ariz.
In downtown Dallas, developer Wolfe Investments seeks to convert an 18-story, 1950s office tower into residential apartments, but has recently been fighting off foreclosure from its lender, Thistle Creek Partners, court records show. Wolfe and Thistle Creek recently entered into a forbearance agreement, according to court records, which would give the developer more time to pay off its debts.
Without large government subsidies, some housing analysts have doubted office conversions would ever become large enough to help address the U.S. housing shortage.
Some cities might be better off looking to other property types for housing conversions, said Ahmad Abu-Khalaf, senior research analyst at Enterprise Community Partners, an affordable-housing nonprofit.
The conversion of 10% of the existing strip retail in the U.S. into low and medium-density housing could yield more than 700,000 units, Enterprise recently published in a report.
“If you only have a one-floor or two-floor retail building, it may be more feasible to do acquisition, raze it and build from scratch,” Abu-Khalaf said.
Write to Konrad Putzier at konrad.putzier@wsj.com and Will Parker at will.parker@wsj.com