Local office asset values too high to justify housing conversions?

In the Wall Street Journal, Carol Ryan breaks down why the idea of widespread office-to-home repurposing projects may be little more than castles in the air. Unless office costs drastically plummet — or planning regulations are relaxed, as with the U.K. — no company will find it financially feasible to convert.

Vacancy rates are rising as companies let go of space when their leases come up for renewal. In the second quarter of this year, 16.9% of U.S. offices were empty, based on CBRE data… Some older offices are now “functionally obsolete or on their way there,” according to Daniel Ismail, analyst at real-estate research firm Green Street.

One answer could be to convert offices into badly needed homes. The vacancy rate in U.S. multifamily rented accommodation was a low 3.1% in the second quarter. That is driving growth in residential rents, improving the prospects for turning offices into homes.

But there hasn’t been a flood of conversions yet. Since the pandemic began, around 50 U.S. office blocks have been or are being redeveloped into multifamily apartment complexes, according to CBRE. In the U.K., which loosened planning laws several years ago to make redevelopment easier, an average of 12,000 new housing units a year have been created from old offices since 2015, official statistics show.

Conversions can be tricky to pull off… The bottom line is that offices must look cheap relative to residential property to make redevelopment profitable. According to Olivier Elamine, chief executive officer of European office real-estate investment trust Alstria, the value of residential property needs to be about 50% above that of offices, adjusting for the loss of some leasable space linked to the conversion.

This kind of premium is emerging in some suburban areas, where home prices jumped during the pandemic. In many central business districts though, offices are still pricey.

This article originally appeared in the Wall Street Journal. Read the whole thing here.

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