Should You Convert Your Distressed Office Building to Multifamily?
by: Aidan Schenck
There’s a newfound need for office buildings, just not for office space. Work From Home has reduced the need for office space thereby creating large vacancies and in some cases, completely empty buildings. So what does the future hold for such assets?
As you might have heard, the United States faces a serious housing shortage. This has resulted in increased rental rates as demand far outpaces supply. Repurposing vacant office buildings that once were extremely sought-after into apartment buildings has become a highly desired adaptive reuse project for many owners. Due to the dire need for housing, local, state, and federal subsidies for repurposing such buildings have been made available and many jurisdictions have lifted zoning restraints on such projects.
The future suggests that this adaptive reuse will likely be here for many years to come. However, despite the promising profitability of such projects, obtaining affordable financing for it in the current economic and global state is a challenge.
In 2021, the country as a whole had its lowest vacancy rates in office buildings since the 1990s. In California there’s been a four basis point increase in vacancy rates in office buildings from the end of 2021 to the end of Q1 in 2022. As of late April, New York City, which is one of the largest in-person working epicenters in the world, only saw a 37.1% office building occupancy rate. Data from Commercial Edge, a real estate data firm, reveals that Office Buildings’ price per sq. foot has dropped in Central Business Districts to $284 when it was once at $400 in 2019 and $370 in 2020.
While office assets continue to struggle, multifamily apartment buildings are holding their value, as many markets continue to see significant rent growth. Due to the housing shortage, there is strong demand, alongside limited supply, significantly increasing rent. Additionally, consumers are willing to pay months of rent in advance and are paying well beyond the original asking price to ensure they have a place to live. On top of all of that, as interest rates rise the cost of living follows. As a result of this shortage combined with rising interest rates, 1-bedroom (1).
These two trends working together have made repurposing office buildings into residential apartments a highly attractive project. Also, this type of project is even more attractive and profitable, as certain parts of the United States have subsidized portions of such repurposing and have lifted many zoning restraints on such projects. This is seen and proven by the increasing popularity of repurposing office assets into apartment buildings. In the past two years, around 41% of buildings that were repurposed into apartment buildings, were formerly failing office buildings. On top of that, between 2020 and 2021, there were nearly 32,000 conversions, compared to a mere 5,300 conversions in 2010 (2).
Given the soaring values of existing multifamily apartment buildings and the decreasing value of office assets, repurposing existing office buildings offers substantial opportunity for experienced sponsors. However, to achieve profitability with this strategy, creative yet efficient financing is direly needed, given the current economic state. Lever Capital Partners can help! Through our expert knowledge of current real estate trends, economic states, and the capital market space, alongside our significant real estate financing experience, we can help you optimize your capital stack by bringing the most efficient capital to the table that’s tailored to your adaptive reuse business plan and strategy.
References:
https://www.noradarealestate.com/blog/rental-prices/
https://www.rentcafe.com/blog/rental-market/market-snapshots/adaptive-reuse-apartments-2021/