There’s a ton of discussion in commercial real estate circles right now about the impact distributed teams are having on office space use. There’s no crystal ball, but the outlook for some office towers in CBD’s is grim. Companies are exploring alternative options for how often people need to be face-to-face, and the end result is impacting demand.

Some estimates suggest a 15% reduction, while others predict up to 60%. Here’s a piece from New York Curbed - inflaming Office Apocalypse, New Glut City - check out this excerpt:

“According to Cushman & Wakefield, Manhattan’s office-vacancy rate is around 22 percent, the highest recorded since market tracking began in 1984. When you include sublet space, more than 128 buildings in Manhattan currently list more than 200,000 square feet of space as available for lease, according to data from the firm CoStar. The available space in these buildings alone amounts to more than 52 million square feet: the equivalent of more than 40 skyscrapers the size of the Chrysler Building.”

Every time there’s a real estate crunch, industry titans say, “This time is different.” Well yes, it is.

After nearly 3 years of deliberation, the jury is back and it doesn’t look good for CBD Office. So let’s talk about options.

Conversions.

Office to Residential: It seems logical at first swipe. Take the underperforming CBD office tower and convert it into something people can live in. This is not a new idea. In the mid-1990s NYC made a concerted effort to redevelop lower Manhattan. At that time, about 25M of the 100Msf of office inventory was vacant. In Chicago, the Singer Building and Chicago Motor Club were converted spurring nearly 30 more conversions inside the Loop. Philadelphia converted more than 7Msf (10% of the city’s inventory) into housing and hotels. San Francisco, Boston, DC - all had their moments. They even named it; ‘boardroom to bedroom boom.’

In this context, Office to Residential conversions is typically seen as a win/win for cities. They help attract and accommodate new residents, more sustainably than new construction, while reducing office vacancies. The best projects are historic buildings, saved from the wrecking ball. We love these darling stories.

Challenges:

There are many - but perhaps the biggest is the public sector. Many, if not most, office-to-residential conversions depend heavily on local tax abatement, state and/or federal historic tax credits, and in the case of affordable products, federal low-income housing tax credits. Local policy change has to be a priority. Beaurocracy takes time and in CRE, time kills all deals. Conversions are market-driven, and this market is dynamic with high-interest rates, low values, CMBS defaults increasing, a labor shortage, and materials cost increases. It’s not as simple as saying let’s just convert that building to this use.

Let’s talk about code and compliance too. Land use, design, and development ordinances are created by urban planners. Land use planning, strategic planning, master plans, urban revitalization, economic development, environmental, and infrastructure planning are a few of these concepts. Here in Charlotte, NC - our local planning department just adopted the Unified Development Ordinance (UDO). It took nearly 3 years to adopt, and needless to say, not everyone agreed. The transition to the UDO just started last month. Because it’s a ‘living’ document, development in this area needs a master plan - which is addressed in our 2040 Comprehensive Plan. Here in the Sunbelt, we’ve seen a massive influx of residents over the past 20 years. Covid has accelerated that. As a result, our housing stock has diminished, our schools are overflowing, and our hospitals are struggling to keep up. We’re doing it well, but it’s far from simple.

While we’re in code and compliance, let’s explore some engineering too. We don’t live in buildings the same way we work in them. In traditional office buildings, the riser stacks are generally engineered vertically - with horizontal branching on each floor. The water and waste stack, HVAC, and even the elevators are generally contained to the ‘core’ of the building. Residential demising requires a completely different orientation of these utilities - down to service metering for each unit. This is a very difficult puzzle to solve, that often subjects the project to inflated costs and sometimes, functionality. Drop ceilings are 100% required to house most of what makes an office functional, yet aren’t widely accepted in the residential market. Fire Alarm Control Panels, sprinkler systems, HVAC ducting, Boilers, and even passenger and freight elevator configurations can render an office building useless (or impractical) for conversion.

Gensler Toronto has an algo tool that measures feasibility for conversions. As of last month, their team had evaluated over 800 buildings and less than 25% were suitable for conversion. Of those that are suitable, there’s no mention of affordable. Here’s a link to listen to that conversation.

Vertical Farming:

As someone who is deeply invested in regenerative design thinking for agriculture, vertical farms have a ton of potential. Controlled environments allow farmers to cut back on expensive and unhealthy fertilizers and insecticides, as well as control the temperature, humidity, and photosynthetic input for their crops. Hydroponic systems include nutrient-rich water to feed the plants and increase yields.

Racking allows farmers to take advantage of the vertical space by creating multiple rows of crops on top of each other. The use of vertical space allows farmers to grow exponential yields on the same footprint, reducing the dependency on land mass to grow the business. Repurposed offices could potentially take advantage of vertical farming tenants.

Challenges:

Again, zoning and land use regulation become a determining factor. Farming is generally classified as an agricultural or industrial activity that is not qualified for use in office / commercial zones. Additionally, environmental regulation, food safety, energy, and occupational safety must be figured out. Freight elevators, truck access, and ingress/egress from the building can also limit farming tenants from conversion. If all of that checks out, the final nail in the coffin is generally the lease terms and rental rate. It’s simply too expensive without a substantial change to the traditional leasing methods that are currently servicing these buildings.

So it’s complicated.

There’s little doubt something will need to give. Supply far outweighs demand for traditional offices and that ‘trend’ is likely to continue for many years. With the right mix of public-private partnership, urban planning, and imagination, today’s office buildings will be converted into new use. Some will become dwellings, others will become farms. Many will be dismantled. None of it will be simple.

#TotalTenancy™ | #OrionGrowth | #reFUND