The future of office buildings is looking grim as remote work continues to keep employees out of the office and vacancy rates reach all-time highs. Commercial property owners are scrambling to find solutions to avoid default, such as upgrading their spaces, converting them into apartments, or selling their assets. However, industry professionals believe that these measures may not be enough to save a significant portion of office buildings.
Fred Cordova, CEO of real estate consultancy Corion Enterprises, predicts that about a third of office buildings are at risk of becoming obsolete. He explains that there will be a division between buildings in good locations with safe environments that will recover and those that will struggle and need to reset their pricing. However, there is another group of buildings, the D class, that are essentially worthless and will need to be demolished. Cordova estimates that at least 30% of all offices in the country fall into this category.
While converting office spaces into residential units has been suggested as a solution, it may not be enough to prevent a collapse in the commercial market. The drop in demand for office space has led to record-high vacancy rates, which can have a detrimental effect on major cities. Falling property values reduce the tax base, resulting in a lack of funding for essential public services, further devaluing properties. This vicious cycle has been referred to as an “urban doom loop” by Columbia Business School professor Stijn Van Nieuwerburgh.
However, experts believe that there may be a way to escape this doom loop through clever public policy. In cities like New York, where there is an excess of office space and a shortage of housing, converting some office space into apartments could be a viable solution. The government would need to play a role in facilitating this conversion. Van Nieuwerburgh suggests that demolishing some office buildings and converting others would be an environmentally friendly approach.
Converting offices into apartments can be expensive due to zoning codes that require natural light and fresh air. Many older buildings from the 1950s and 60s are not suitable for conversion. Additionally, rising construction costs make tearing down an office building and constructing new apartments a more cost-effective option. Cordova explains that the economic model for conversion is challenging, and government subsidies of around 20% would be necessary to make it feasible.
Efforts are already underway to support these conversions. The Biden administration has allocated $35 billion in below-market-rate loans for developers, and NYC Mayor Eric Adams has relaxed conversion eligibility rules. If more states and municipalities implement similar programs, it could incentivize developers to pursue conversions. However, Cordova still predicts that nearly a third of all commercial buildings will not survive the decline in office demand, which he refers to as “the great reset.”
In conclusion, the future of office buildings is uncertain as remote work and high vacancy rates pose significant challenges to the commercial real estate market. While converting offices into apartments is seen as a potential solution, it is not without its obstacles. Demolition may be necessary for some buildings, and government subsidies are crucial to making conversions financially viable. The industry is facing a period of evolutionary change, where adaptability will be key to survival.