Potential for Office-to-Residential Conversion

As the pandemic continues to disrupt the traditional office sector, many cities in the U.S. are exploring new opportunities to repurpose obsolete office buildings into residential spaces. However, according to a recent report by Goldman Sachs, the current state of the office real estate market does not yet support widespread housing development.

The Numbers Behind the Transition

Goldman Sachs’ team of economic researchers, led by Jan Hatzius, found that older office buildings would need to drop approximately 50% in price to make the conversion into housing financially viable for developers. Despite the increasing vacancy rates and declining rents in office properties, many buildings are still considered economically “viable” for their intended use.

Challenges in Converting Offices

Although around 4% of office buildings could potentially be candidates for conversion into residential units, the cost of transforming these “nonviable” buildings into housing still outweighs the benefits. Even in cities like San Francisco, where prices have dropped significantly since 2019, the financial feasibility for developers remains a challenge.

Criteria for Conversion

To meet Goldman’s criteria as “nonviable” for office use, buildings must be located in suburban areas or central business districts. Additionally, these properties should have been built before 1990 and not renovated since 2000, with a vacancy rate surpassing 30%.

Looking Ahead

While the idea of transforming office space into housing may seem promising for addressing the affordability crisis and repurposing underutilized buildings, it is evident that more significant price adjustments and market conditions are required to facilitate this transition effectively.

Converting Nonviable Offices: A Financial Challenge

According to the national price average, the Goldman model indicates that converting a nonviable office at the current average level could result in a loss of $164 per square foot. This implies that office prices would need to drop significantly, to around $154 per square foot or by 50%, for the costs to be covered by future revenues.

Market Break-even Points

Cities like San Francisco, Boston, Los Angeles, and Seattle are edging closer to “break even” levels. However, developers in these markets still require building prices to decrease by more than 30% for conversions to be financially viable.

Government Initiatives Supporting Conversion Projects

The White House launched an initiative in October to facilitate conversion projects for affordable housing near transit hubs. This includes providing lower-cost federal loans to developers. Moreover, the U.S. Department of Housing and Urban Development has announced nearly $4 million in grants to study such initiatives.

Financing Challenges

The Goldman model is based on developers securing financing at a 7% rate. While mortgage rates have decreased since the highs of October, they remain higher than pre-pandemic levels, with the 10-year Treasury yield at 4.31% on Tuesday.

Related Development

As cities move towards transforming offices into residential spaces, a prominent New York developer highlights an essential factor that is often overlooked.

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