The office glut may ease the housing shortage, but converting them won’t be easy.

The office glut may ease the housing shortage, but converting them won't be easy.

Office-to-Residential Conversions: A Viable Alternative in the Real Estate Market

While the United States grapples with a housing shortage, developers are exploring creative solutions to meet the growing demand for housing. One potential avenue is the conversion of office spaces into residential units. The shortage of housing in the country has reached alarming levels, with estimates suggesting a shortfall of up to 6 million units. Meanwhile, a surplus of office space presents an opportunity to repurpose these buildings and create much-needed homes.

Bobby Fijan, a real estate developer and co-founder of Form Developers, has been at the forefront of the office-to-residential conversion trend. With his expertise in floor planning, apartment development, and property technology, Fijan has successfully undertaken several conversion projects across the United States, including the transformation of an old 1920s Art Deco office building in downtown Philadelphia into 200 residential units. This project broke rent price records in the city at the time.

To shed light on the process of office-to-residential conversions, Fijan sat down with ANBLE for an interview. In this article, we delve into the key insights from the interview and explore the potential of office-to-residential conversions as a viable alternative.

The Process of Office-to-Residential Conversions

Converting an office space into a residential unit involves several crucial steps. Firstly, it is necessary to acquire the property and buy out the leases of existing tenants. This stage is often overlooked but plays a significant role in the success of a conversion project. Once the property is fully vacated, a complete restructuring of the building utilities, including electrical, HVAC, and plumbing, is required. Additionally, significant demolition work is necessary to accommodate the new layout, including the addition of bathrooms and other essential amenities.

In the case of the Philadelphia project, Fijan explains that buying the building included an additional cost of paying the tenant to vacate the property. This prerequisite ensures a smooth transition from office to residential use, as demolition work cannot commence until the building is entirely empty.

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Federal Subsidies and Historic Tax Credits

One aspect that often goes unnoticed in the conversation about office-to-residential conversions is the role of federal subsidies and historic tax credits. These incentives can significantly facilitate the conversion process. Historic tax credits, administered by the National Park Service, are designed to preserve historic buildings. To qualify for these credits, a building must be listed on the National Register of Historic Places. This can be achieved by demonstrating historical significance, architectural beauty, or association with notable figures or events.

Once a building qualifies for historic tax credits, architects create detailed plans outlining the proposed changes. Preservation of the building’s facade is typically required, with materials identical to the original used whenever possible. However, modern building standards, such as accessibility, may necessitate some modifications.

The benefits of historic tax credits are substantial. The government provides a credit equivalent to 20% of qualified expenses. These credits are administered by the IRS as straight-line depreciation, allowing developers to write off a portion of their expenses over a five-year period. Furthermore, tax credit investors, such as insurance companies or high net worth individuals, can provide upfront funding in exchange for purchasing the tax shield.

Another advantage of historic tax credit projects is their impact on the project’s overall capital stack. These tax credits can be added on top of construction loans, allowing for a higher leverage on developers’ cash dollars.

The Implications of Remote Work on Conversion Projects

The shift towards remote or hybrid work arrangements in the wake of the COVID-19 pandemic has not yet significantly impacted the availability of office spaces for conversion projects. Complicated factors, such as lease buyouts and the decreasing value of office buildings, have hindered progress. In many cases, the original owners no longer have full control over the buildings due to declining values, causing uncertainty in project transactions.

Potential Markets and Rent Considerations

Certain markets have shown a greater potential for office-to-residential conversions. For example, Boston recently launched a pilot program that offers tax incentives to convert underused downtown office buildings. However, this benefit comes with rent restrictions imposed by inclusionary zoning regulations. While the real estate tax benefits may outweigh the income restrictions, the immediate impact of this pilot program may be limited to projects already in the pipeline.

When it comes to rental rates, determining whether office-to-residential units command higher rents is challenging. Factors such as location and architectural appeal play significant roles in rental pricing. However, Fijan points out that newly constructed units usually have an advantage due to their ability to maximize space utilization. Nevertheless, many well-designed conversion projects have thrived and become highly sought-after residences.

Office-to-residential conversions offer a unique opportunity to repurpose underutilized office spaces, providing much-needed housing solutions. The process involves careful planning, including property acquisition, tenant buyouts, and extensive remodeling. Federal subsidies and historic tax credits can significantly streamline the conversion process. While the remote work trend has not yet had a major impact, certain markets are more likely to embrace office-to-residential conversions. These projects have the potential to breathe new life into the real estate market, meeting the growing demand for housing in both creative and cost-effective ways.