55K+ Offices Will Become Apartments in 2024

Over 55K Office Spaces Set for Conversion to Apartments in 2024

A transformation is reshaping urban skylines: office buildings are increasingly being converted into apartments. From a modest start of 12,100 conversions in 2021, the trend has escalated to a striking 55,300 scheduled for 2024.

A new era: A recent RentCafe report reveals a remarkable trend: over the past four years, the conversion of office spaces into apartments has quadrupled, nearly doubling each year. This shift reflects a growing desire to repurpose workspaces into residential units, echoing a change in how we view and use urban spaces.

By the numbers: Office-to-apartment conversions now account for 38% of the 147,000 apartments planned in future adaptive reuse projects. This marks a record since 2020, underlining a profound change in urban redevelopment. This surge is fueled by the upcoming maturity of $150 billion in office mortgages, sparking a rush to transform these spaces to meet the rising demand for residential units before the bill becomes due.

Fun fact: Interestingly, the office buildings selected for conversions are relatively younger, averaging 72 years old, which is 20 years younger than those converted earlier. This choice likely reflects a preference for buildings that require less refurbishment and align more closely with modern living standards.

Top converts: Washington, D.C. leads with 5,820 units transitioning from offices to apartments in 2023, an 88% increase from the previous year. New York City follows with notable projects like the transformation of New York's iconic Flatiron Building. Dallas-Fort Worth also identifies over 50 buildings, including downtown skyscrapers and suburban offices, for potential residential conversion.

➥ THE TAKEAWAY

Rethinking urban landscapes: In 2023, the U.S. saw its highest office vacancy rate at 19.6% in urban areas, the most since 1986 and 1991. This move to convert offices into homes marks a significant shift in urban design, catering to future housing needs. It also demonstrates the commercial real estate industry's agility in responding to crises and adapting to changing trends in asset preferences.

To Inflate Values, Office Landlords Offer Cash Gifts, Discounted Loans

In an effort to boost property values amidst a deep crisis in the office sector, landlords are increasingly using cash gifts, discounted loans, and other financial engineering tactics to boost rents.

What happened: Office landlords are resorting to concessions like cash gifts and reduced rent to keep annual rents and building profits high, ultimately inflating values. CBRE found the average free-rent periods on leases in high-end office buildings in major U.S. cities rose from 6.8 months in 2019 to 10.1 months in 2023. Cash payments to tenants for construction work also rose by 37% during the same period.

The problem: While legal, these underhanded tactics make publicly available property valuations somewhat unreliable. Brokers also point out the actual sales prices of buildings remained relatively unchanged despite surging vacancies and falling share prices of public office landlords since 2019, which indicates these tactics must be working.

Asterisk valuations: Analysts are having difficulty determining the office market's true state. For instance, SL Green Realty (SLG) recently sold a Manhattan office tower, 245 Park, at a $2B valuation—after offering a roughly 6% discount on the building's debt to the buyer, Mori Trust. Green Street estimates that high-end office building values have fallen 35% since the start of the pandemic.

➥ THE TAKEAWAY

Big picture: The use of concessions, side deals, and undisclosed transactions in the office sector led to inflated property valuations and limited transparency. While the worst of the crisis may be behind us, the true state of the office market is difficult to decipher due to this kind of financial engineering. But one thing’s for sure—someone’s getting ripped off. 

US commercial real estate is experiencing one of its largest price declines in over fifty years, according to the International Monetary Fund (IMF). This downturn, significantly more severe than previous ones during rate hike cycles, is attributed to recent aggressive monetary tightening and the shift towards remote work affecting office values.

Since March 2022, following the Federal Reserve's initial interest rate increase, property prices have fallen by over 11%, erasing the previous two years' gains. This decline is distinct in its severity compared to the relative stability or minor losses in past periods of tighter monetary policy. The current situation is similar to the notable downturns of 1983-1984 and 1988-1989.