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How office conversions turn a 'defunct product' into new urban housing

That empty high-rise office building in your downtown district may soon be turned into a housing complex.

Cameron Management, owner of the Niels and Mellie Esperson Buildings in Downtown Houston, is planning to turn the iconic Esperson complex into an amenity-filled combination of new luxury apartments and workspace, a move known in the industry as an office conversion.

"Our goal is to create not just optionality, but a community of people," Dougal Cameron, CEO of Cameron Management, told Yahoo Finance in an interview.

Cameron's firm acquired the building in 2005 and has already spent $3 million in planning expenses. The firm expects to finish the project within 5 years as part of a $50 million makeover, and will offer rental units ranging from $1,500 to $8,000 per month.

Despite the economy fully reopening, office occupancy rates have not fully recovered as remote work still remains on the table. Data from commercial real estate giant CBRE found that the national office vacancy rate hit 17.3% in the fourth quarter last year.

"Developers, investors, and communities are wondering what is the fate of these vacant office buildings," Jessica Morin, head of office research at CBRE Americas, told Yahoo Finance in an interview.

A growing number of cities and states are looking to transform those vacant office buildings into residential units — a solution that could help with housing shortages.

The Niels and Mellie Esperson Buildings in Downtown Houston, TX
Courtesy: Cameron Management; The Niels and Mellie Esperson Buildings in Downtown Houston, TX (Courtesy: Cameron Management)

In New York, Mayor Eric Adams unveiled plans in January to turn some obsolete office buildings into brand new apartments to help the Big Apple's affordable housing crunch.

Adams' office conversion strategy includes specific proposals to ease zoning restrictions, and offering tax credits to property owners. The plan could add up to 20,000 new apartments over the next decade, Gothamist reported.

Washington D.C. led the way in the number of repurposed buildings during the pandemic, according to a report compiled by RentCafe research team. Along with Philadelphia and Chicago, these three major cities accounted for 15% of the total apartment conversions nationwide.

The number of office-to-apartment conversions in the U.S. is expected to triple this year, to 34 from 11 in 2022; those projects alone, however, won't measurably alter the surplus supply of office space, according to CBRE.

When taking into account all of the projects from 2016 to 2022, as well as upcoming proposals and those underway, office conversions cover less than 2% of the office stock, Morin said. The 89 completed housing conversions that have been tracked by CBRE since 2016 have amounted to more than 14,000 apartment units.

"[This] isn't going to be a single solution for housing, the housing shortage, or for this oversupply of office space," Morin said. "And a lot of that's really just due to the challenges in making a conversion happen."

'Reinventing new urbanism'

The major perk for developers to repurpose old buildings and turn them into residences is the speed of construction. At times, developers can also save themselves from demolishing a building and starting from scratch.

"You're kind of reinventing new urbanism because you're taking a defunct product that is not really serving its purpose for offices, but can strive to be something else," Eddie Mastalerz, a principal architect at ARC3 Architecture in Saint Petersburg, Florida, told Yahoo Finance.

Meanwhile, the adaptive reuse of old office buildings isn't always an easy route, and has led to some architects using a compatibility assessment scorecard as a method to evaluate properties.

"It's a really inexpensive and quick way to assess buildings," Dean Strombom, a principal architect at Gensler who's also working on the Esperson complex conversion project, told Yahoo Finance.

"We find doing that [scorecard] about 70% of those [buildings] we've tested are not suitable for conversion," Strombom added. "Despite people's wishes to magically convert something from office to residential, we can tell very quickly whether that's viable or not."

And for buildings that do get an architect's stamp of approval for conversion, repairs can come with a hefty price tag.

"The price of office buildings hasn't dropped to a point that makes many of these conversions pencil out, but for the ones that are happening, it's an interesting cost basis," Morin added.

As a general rule of thumb, according to Morin, the cost of the office per-square-foot would need to drop below $100 for office conversions to work out. However, it's dependent on the market and project.

Some developers are racking up due diligence costs even before the deal is secured.

“[Costs] go into the six-figures sometimes and we will spend that amount before we are awarded the deal,” Victrix CEO Anoop Dave said on CBRE’s podcast. "

"It's cheaper to know upfront. Our calling card is we've done our homework and therefore it's going to be smoother than it will be with another party,” Dave added.

Regulatory constraints

While these conversions are picking up steam, some cities like New York have loads of red tape and zoning laws that restrict adaptive reuse projects from moving forward.

But other large cities are taking notice, and creating new incentives to unleash a wave of housing conversions over the next decade. Some of those perks discussed include tax benefits or tax credits, such as historical preservation tax credits or national tax credits to help developers profitably turn offices into apartments.

In California, the state's 2023 budget allocates $400 million in incentive grants for office-to-residential conversions, while in Denver, city council considers converting some downtown office buildings into housing.

Dawn Cohen works on an oil painting of downtown Denver, in City Park in Denver, Colorado, U.S., November 16, 2017. REUTERS/Rick Wilking
Dawn Cohen works on an oil painting of downtown Denver, in City Park in Denver, Colorado, U.S., November 16, 2017. REUTERS/Rick Wilking (Rick Wilking / reuters)

Meanwhile, another reason that adaptive reuse of existing buildings is gaining traction could be for its environmental benefits.

"The reason why these incentives are offered is because these projects are very difficult," Dave said. And sometimes the incentives don’t play well with the property deal.

Data from JLL, a commercial real estate firm, shows the gap between the average price per square foot of residential and office rental space has narrowed from 12% in 2009 to 8.6% in 2022.

"You can't just layer one [incentive] on top of another and there's a lot of leakage with the incentives. We've seen that as a double-edged sword...where in high times people are like, 'You get these incentives,' and they're overbid for [building], and then they get into trouble," Dave added.

Dani Romero is a reporter for Yahoo Finance. Follow her on Twitter @daniromerotv

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