Amy C. Stouffer//May 25, 2023
//Amy C. Stouffer
//May 25, 2023
Across the DMV and the rest of the country, commercial real estate professionals are monitoring the supply and demand trends in office and housing. Even pre-pandemic, office space was abundant and housing was becoming increasingly scarce.
When the world was thrust suddenly into a remote work environment, office inventory rose steeply and the severity of the housing shortage — specifically affordable housing — was underlined.
The enigma of real estate is that we cannot produce more of it. So, in working to solve this problem, it is generally a matter of building vertically (which is of course restricted in Washington, D.C.) or adaptive reuse. Consequently, the trend of converting office space to housing is bourgeoning, particularly in the DMV.
According to new data from Yardi Matrix, D.C. ranks first in the nation for having the highest number of office to apartment conversions — 1,147 — from 2020-2021. Also ranked on the top 10 list is Baltimore with 395 conversions, and Hyattsville with 338 conversions.
It is obvious that this trend will not be fading anytime soon, but that does not mean it is the right solution for every developer or vacant office building. Though it may seem like a practical next step in many cases, commercial real estate professionals need to be aware of and thoroughly consider the many complexities these projects entail and the many challenges that can arise. Below are some key questions to ponder before diving in.
How is the office property currently zoned and can a new zoning classification, or exception to the existing zoning, be obtained?
While zoning laws differ from city to city, if a property is not already zoned for residential, there is never a guarantee that a city will modify zoning to permit the office to residential conversion. Furthermore, even if a jurisdiction is willing to re-zone the property to allow the project, that process alone can be a costly undertaking that takes years.
How extensive (and expensive) will renovations be?
Most, if not all, office buildings were not built with residential use in mind. Office buildings generally have larger floor plates and less natural light than buildings constructed for residential use, and lack much of the basic building infrastructure to support the multiple kitchens and bathrooms needed for multi-family residential use.
These necessary structural modifications can cause the costs of converting an office building into a multi-unit apartment building—be it five or 125 units—to add up very quickly.
What is the parking situation?
Most zoning laws require a minimum number of off-street parking spaces for new housing. If the office building does not meet these requirements, parking must be added—and parking is not inexpensive, especially if it involves building a new above- or below-ground lot.
Are tenants a factor?
While an entirely vacant office building may seem like a prime candidate for a residential conversion, the lack of tenants necessarily means there will be no income stream to offset carrying costs during what can be a very lengthy predevelopment process. On the other hand, if there are existing office tenants in a building targeted for conversion, a developer needs to perform the proper due diligence to confirm the length of term remaining on the existing leases.
To complicate matters, any tenant who has a lease with a lengthy remaining term or a valid option to renew the lease could hold a developer hostage and cause a major, costly delay to the project.
What is the surrounding neighborhood like?
For obvious reasons, it is vitally important to consider the surrounding area from the perspective of a future housing tenant. Will it be an appealing residential location? Are there amenities nearby that will make it a nice area in which to live and play?
Does the end goal justify the means?
From a bird’s-eye view, and particularly in an urban market with an overabundance of vacant office space and a limited supply of housing, converting existing office buildings to residential use makes perfect sense. But this type of project requires significant money, planning, time and strategy in order to reach the desired outcome. There are many examples of this type of project being profitable and beneficial to the community, but it is not a straightforward or simple undertaking.
Every good real estate project is defined — both literally and figuratively — by the strength of the foundation. Anyone looking to take on an office to apartment conversion should conduct exhaustive due diligence to ensure there is a good foundation for success and firm understanding of all that the project may entail.
Friedlander Misler Principal Amy C. Stouffer advises clients on commercial real estate transactions, with a focus on acquisitions, dispositions, commercial leasing, real estate development and constructionShe can be reached at [email protected].