To watch our new Horizons video where Ross and Hannah explore this topic please click here or if you would prefer to read about this hot topic please see below:
Where are we now?
Ross:
As office vacancies increase (CoStar reports the national office vacancy rate at a record 13.8%) and affordable housing remains in short supply throughout the US, office to residential conversions have risen to unprecedented numbers. According to a recent report by real estate research firm, RentCafe, the list of conversions quadrupled over the past four years – from 12,100 units in 2021 to over 55,300 at the start of 2024.
Another lever in this conversation is the number of mortgages maturing by the end of 2024, pressuring owners to pay up or restructure their mortgages at a time when vacancies and interest rates remain high. Owners unable to retain tenants, particularly in less desirable buildings, face the risk of losing their properties and turning over the keys.
The intersection of record high vacancy rates with impending lease expirations also contributes to the significant risk for the office sector market. A recent analysis by CRED iQ estimates that over 217 million square feet of office space is set for lease expiration in 2024 and 2025.
With these leasing challenges in most major urban markets, combined with the limited housing inventory, it would appear that the office to residential conversion is ready for prime time.
Hannah:
We are seeing some similar themes in the UK, especially London. There are many reports of office occupancy sticking persistently below pre-2020 levels. When people are in the office, they are more picky about their surroundings, and we’ve definitely seen a flight to quality. This means that older stock, in particular, can be sitting vacant.
At the same time, there has been an increasing focus on embodied carbon, and a resultant expectation that property owners will consider repurposing existing buildings; only demolishing for development where that isn’t practical – although it’s worth noting that in many cases there is no strict policy or legal requirement to do this.
All of this, combined with an ongoing need for additional homes, means that recently the potential for converting offices to residential accommodation has become more attractive both to property owners and the government.
What are the key benefits of repurposing?
Ross:
Though not consistent in each major market, conversions typically take less time and dollars compared to new ground up construction. Our clients have found that the cost of adaptive reuse projects can be 30% lower than demolishing and building anew, subject to jurisdictional union requirements.
This type of conversion can also be a real economic development boost to a neighborhood and surrounding community. One only has to look at the NYC Financial District: in the mid-1990s it was full of obsolete office buildings and major tenants were relocating to Midtown, New Jersey or Connecticut. Through a combination of City legislation (to amend and relax the zoning regulations) and State legislation (to provide tax incentives), “FiDi’” became the fastest growing residential community in New York City and continues to thrive though a mix of residential, office and retail uses.
Conversions also allow for adaptive reuse of building materials, significantly reducing carbon emissions in comparison to new construction. Repurposing spaces for public realm, and converting office spaces to residential amenities can also contribute to the overall health and welfare of the community.
Hannah:
As in the US, in the UK, conversions tend to be cheaper and quicker than starting from scratch. However, the potential for conversions to residential use can deliver benefits for landowners even without the need to actually deliver the change in use. We are increasingly seeing people locking in the necessary approvals to increase value before sale, or to help when refinancing.
In broader terms, central government has been keen to encourage these conversions, as they have the potential to both provide much needed housing, whilst also bringing activity to areas where there are vacant buildings. As a result, in the UK we are seeing various legislative changes to make conversion easier.
Are there legislative incentives for office to residential conversions?
Ross:
Over recent decades, numerous cities have provided support and subsidies for office to residential conversion - post 9/11, zoning and financial incentives allowed for the conversion of 20 million square feet of office space. Similarly, Los Angeles and Philadelphia relaxed parking requirements and offered tax abatements that collectively allowed for the creation of over 12,000 housing units in Los Angeles and conversion of more than 8 million square feet of office space in Philadelphia.
US cities offering tax incentives for conversions are also focusing on tax abatements, rather than direct public subsidies, if to ensure that the public benefit outweighs the cost to government.
Hannah:
That’s really interesting. In England, for a number of years, the government has been trying to encourage conversions to residential property, by removing some of the legislative barriers which would otherwise exist to these changes.
In particular “permitted development rights” – or PD rights - grant blanket planning permission for a whole host of development which would otherwise require an individual planning consent. The PD rights permitting conversion of buildings to residential use have expanded significantly in recent years. This year alone, the cap on the maximum floorspace which can be converted from office to residential in one building has been removed, as has the vacancy requirement. Previously, before being able to rely on these rights, your property had to be empty for at least three months, to ensure that viable, vibrant uses weren’t being terminated to facilitate the switch to potentially higher value residential use. Now there’s no such need to prove that the property has sat empty.
Are there any challenges?
Hannah:
Absolutely – although the ever expanding PD rights can make conversion easier, they are not without their own challenges.
First, many local planning authorities do not like these rights, and see them as threatening the balance of uses in their areas. They have therefore sought, with varying success, “article 4 directions”, which exclude those rights in respect of parts of their administrative areas.
There have also been instances where the quality of the residential accommodation delivered using the rights has been somewhat compromised – extremely small rooms and inadequate natural light are just a few examples. Additionally, there are complaints that the streamlined process means that extra homes are appearing, in respect of which no mitigation is provided, such as contributions to local education, or health services.
Consequently, the procedure which must be followed to enable you to rely on the residential conversion PD rights is becoming increasingly cumbersome. Despite the fact that you do not need to secure planning permission, it is not possible to simply make the change, and instead the local planning authority must be satisfied on a list of topics pertaining both to the quality for future residents, and the impact on the surrounding area, such as internal daylight and noise, and transport impacts.
As the burdens linked to PD rights grow, notwithstanding the expanding scope of the rights themselves, there is a very real possibility that the attraction of PD rights will diminish.
Ross:
In the US, though a popular topic in the media, there are a multitude of challenges to office to residential conversions. Construction costs and regulations on residential construction tend to limit conversion to smaller, older office properties, whose floor plates make for an easier conversion, especially in markets with either high multifamily demand or government incentives aimed at preservation and restoration.
A notable exception is the conversion of 25 Water Street in NYC, formerly known as 4 New York Plaza. The 22 story, 1.1 million square foot office building is being transformed into a 1,300 unit residential tower, the largest transaction of its kind in the US.
What next?
Ross:
Many are arguing that the conversion of vacant office space into housing is a key strategy for addressing these challenges and revitalizing urban centers. Proponents of office-to-residential conversion note that since remote work is here to stay, office demand will never fully return to pre-pandemic levels, and the vacant office space can be repurposed into what cities currently need: housing. Moreover, they argue that the expense and complexity of conversions justify public sector intervention and subsidy.
This raises a fundamental question: are current high office vacancies a market problem whose burden falls on the private sector (property owners and investors) or do they represent a market failure and policy problem to which government must respond with financial support from the public?
Hannah:
It’s fascinating to see that the very similar challenges of too many offices weighed against too little housing have been met with very different solutions with side of the Atlantic, with the UK showing a clear preference for removing red tape, over the US approach of subsidies.
Either way, though, it’s clear that there are real opportunities for those looking to repurpose existing stock for residential purposes.
Wherever you own property, and whatever your proposals for redeveloping or repurposing, Hogan Lovells can help you navigate the complexities of local regulation and policy.
Authored by Hannah Quarterman and Ross Moskowitz.
