Converting empty offices into apartments is becoming more difficult

Converting empty offices into apartments is becoming more difficult

Cities hoping to convert empty office buildings into apartments face financing issues, stagnant rental markets and other challenges that hinder their efforts.

Cities hoping to convert empty office buildings into apartments face financing issues, stagnant rental markets and other challenges that hinder their efforts.

Last year, developers created just 3,575 residential units in the United States through office conversions, according to an analysis by rental listing site RentCafe. This represents less than 1% of all apartments built that year through new construction.

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Last year, developers created just 3,575 residential units in the United States through office conversions, according to an analysis by rental listing site RentCafe. This represents less than 1% of all apartments built that year through new construction.

The number of office conversions is expected to rise sharply this year, according to brokerage CBRE, as office vacancies continue to rise and developers see conversions to other property types as an alternative.

Federal and local governments are also trying to boost remittances. The White House said last month that it was updating guidance for existing grants and spending programs to provide billions of federal dollars for these projects. She also said she would seek to convert more government-owned properties into housing.

Some cities, such as Washington, D.C., New York, and San Francisco, are also taking steps to encourage more transfers. Tax incentives and faster approvals are “rocket fuel” for these projects, said Sheila Botting, principal of commercial real estate brokerage Avison Young.

However, the process has always been fraught with difficulties, and few office buildings are natural candidates. Conversions are easiest in old, low-quality, often empty buildings with small floors. But less than 1% of office space in America’s largest cities meets these requirements, according to Avison Young.

In important ways, the conversion process is now more difficult. Slowing rent growth may make apartment conversions less attractive to investors, if this trend continues into next year. Demand for apartment rentals has fallen 1.2% nationally over the past 12 months, according to rental website Apartment List.

Construction loans are also much more expensive than they were 18 months ago, and many banks are now avoiding making development loans. A number of conversion efforts have been put on hold due to rising interest rates.

“It adds enormous cost to the project,” said Stephen Painter, principal at architecture firm Gensler, which specializes in building reuse.

He said his company is working on office conversion projects with thousands of potential apartments that have permits, but they have been delayed while developers try to get financing for the land.

Although more cities are trying to speed up the process, obtaining permits can take years. Long approval times are especially harsh when combined with higher interest rates because developers often have to make debt payments while they wait for the green light.

“This could kill the project,” Painter said.

Even when interest rates are low, office reuse can quickly become expensive. Many require significant interior demolition for the floor plans to work, including extensive plumbing to add kitchens and bathrooms.

Environmental issues, such as asbestos removal or lead paint removal, also drive up costs in older buildings. Transporting construction materials through the densely populated city center and in and out of narrow entrances poses other costly risks.

“It’s like building a ship in a bottle,” said Trevor Martinez, senior developer at Sherman Associates, a company that is converting office buildings in downtown Minneapolis and St. Paul, Minn., into apartments.

If developers can buy old office buildings at a low enough price, conversions can often still be profitable, even as interest rates rise. But some major projects have faltered, and at least two are facing foreclosure.

Developers of One Camelback, a 200,000-square-foot office building in central Phoenix, are trying to turn it into what could be one of the most expensive apartment properties for rent in the city. One website advertises apartments renting for $8,000 a month, with floor-to-ceiling windows and crystal clear views of the nearby mountains.

But the developers, Sagamore Capital and its partners, defaulted on a loan of about $70 million. The project’s lender, Delphi Financial Group, moved to foreclose. An auction for One Camelback is scheduled for later this month, according to documents filed in Maricopa County, Arizona.

In downtown Dallas, developer Wolfe Investments is seeking to convert an 18-story 1950s office tower into apartments, but has recently been fighting foreclosure from its lender, Thistle Creek Partners, court records show. Wolf and Thistle Creek recently entered into a forbearance agreement, according to court records, that would give the developer more time to pay off its debt.

Without large government subsidies, some housing analysts doubted that office conversions would become large enough to help address the U.S. housing shortage.

Some cities may be better off looking to other types of properties for housing conversion, said Ahmed Abu Khalaf, senior research analyst at Enterprise, a nonprofit specializing in affordable housing.

Converting 10% of the current U.S. retail sector to low- and medium-density housing could produce more than 700,000 units, the Enterprise recently published in a report.

“If you only have a one- or two-story commercial building, it might be better to take over, tear it down and build from scratch,” Abu Khalaf said.

Write to Konrad Putzier at konrad.putzier@wsj.com and Will Parker at will.parker@wsj.com

Converting empty offices into apartments is becoming more difficult

(Tags for translation) Apartments

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