All eyes are on the office sector, watching as it largely unravels in the aftermath of the pandemic. And as the billionaire developer, Ross Perot Jr., recently told Fortune, “it’ll be years before we really understand the damage the pandemic did to the world,” adding that for one, “it broke the habit patterns of millions of people that used to go to work every day in a real office.”
Office vacancy rates have reached record highs in many major markets as employees lean into remote and hybrid work. With that, office property values are falling at a time of high interest rates and tightened credit (which in turn raises borrowing costs and generally makes it more difficult to borrow or even refinance). So it’s likely there will be an increase in delinquencies and defaults, with some office owners turning in the keys.
But here’s the thing, there’s also a housing market shortage. Which brings us to the question a lot of people are asking: why not convert these empty, obsolete office buildings into housing?
On Monday, Boston Mayor Michelle Wu announced a residential conversion program for downtown offices, to “meet City goals of creating housing units Downtown and having more consistent foot traffic throughout the week to support Downtown businesses,” the release said.
The pilot program intends to offer the owners of “underutilized” downtown commercial office buildings a property tax break of up to 75% of the standard residential tax rate for up to 29 years in return for “immediately” converting their properties to residential homes. In allowing those buildings to qualify for the residential tax versus the commercial tax, there’s an added discount, as the commercial property tax rate is $24.68 per $1,000 of value, and the residential property tax rate is $10.74 per $1,000 of value.
Despite what looks like an enticing inventive, there are some caveats. Applications for the program will only be accepted through June 2024, and they’re expected to begin accepting applications in the fall of this year. Additionally, projects have to comply with the proposed zoning standards and energy efficiency. They’ll also need to start construction by Oct. 2025. And here’s the big one: to “recoup the forgone tax revenue,” the city will require a 2% payment on future sales of the property.
Projects will be facilitated through the public-private partnership program that’s administered by the Boston Planning & Development Agency, Mayor's Office of Housing, and the City of Boston Finance Cabinet, and enter into payment in lieu of taxes agreement. A more detailed draft of the plan is set to be released next month.
In their view, this is a way to solve two problems with one single action, given the average home value in Boston is slightly over $706,000 and the average rent for all property types is $3,201 per Zillow. And active inventory for sale in the Boston market fell 56.7% between May 2019 and May 2023, according to Realtor.com data. Meanwhile, according to data cited in the release, downtown office space vacancy rates are approximately 20%.
“We must take every possible action to create more housing and more affordability so that Boston’s growth meets the needs of current and future residents,” Mayor Wu said, in the release. “This program will help us take advantage of the opportunity we have to rethink Downtown as a space where people from all over come together to collaborate, create, live, and play.”
Whether this pilot program will actually result in the city’s intended outcome is unknown. From Fortune’s previous conversations with commercial real estate executives, it’s clear that the conversion process is much more complex than most people think. And in some cases, it doesn’t seem to make sense (financially)—even if we all want it to, according to Craig Deitelzweig, president and chief executive officer of New York City-based commercial real estate firm Marx Realty.
“On the properties that I’ve looked at, it really doesn’t make economic sense, and it’s more of a pipe dream,” Deitelzweig recently told Fortune. “Because really, if it doesn’t work for office, it doesn’t work for residential, usually, as well, and the basis would have to decrease so dramatically for those economics to make sense.”
On the other hand, Fred Cordova, chief executive officer and founder of Santa Monica–based commercial real estate brokerage and consultancy firm Corion Enterprises, seemed to be a bit more optimistic about the possibility of converting offices to housing. Although, like Deitelzweig touched on, the price isn’t there yet, in Los Angeles, at least.
“I think you’ll see some more conversions from office to multifamily,” Cordova previously told Fortune. “The values still have to come down to about $100 per square foot, and they’re not there yet. $100 per square foot for the office space translates into $125 per [rentable] square foot for multifamily because you lose about 20% of the rentable space when you convert; that’s the magic number.”
He continued: “It costs about $250 to $350 per square foot to convert these buildings, so there’s a gap right now. But if you can plug that equity gap, which I think there’s a play to do so through a private partner with the city and state and that’s what we’re working on, then you can convert some of these buildings.”
Both executives were speaking generally, and mostly about their markets—all the while, Boston’s newly announced incentive wasn’t in play. So it’ll be interesting to see whether an incentive of that scale can make the difference in converting offices to housing.
