Urban Downtowns: Leading the Way in Office-to-Residential Conversions

The COVID-19 pandemic permanently reshaped the way organizations operate and employees work and, as a result, many commercial office spaces in downtown areas are now vacant.

This has created a unique opportunity for developers to acquire empty office buildings and convert them into more profitable residential properties while providing much-needed housing in cities across the United States.

One urban area that has been leading the way in office-to-residential (OTR) conversions is Washington, DC. According to the real estate analysis group Yardi Matrix, four of the top 10 cities with the highest number of office-to-apartment unit conversions between 2020 and 2021 are located in the DC region. Additionally, DC is ranked as the number one city for adaptive reuse and has approximately 22 million square feet of empty office space remaining.

But what is driving the rise in OTR conversions in Washington, DC?

These are the factors at play in the District and the advantages of taking on a conversion project. Developers can look for these same factors and advantages to identify urban centers in other geographic locations that are also well suited (or soon will be) for this type of development.

1. 1. Incentives

Washington, DC, offers several incentives for office-to-residential building conversions as a way to encourage developers to convert commercial properties.

Tax incentives include tax abatements and exemptions for up to 10 years on new residential construction projects.

Additionally, the DC Department of Consumer and Regulatory Affairs has streamlined the building permit process for office-to-residential conversions. Further, the DC Department of Housing and Community Development offers loan programs to finance the purchase and renovation of a property.

Developers who meet the DC government’s affordable housing requirements may also be eligible for additional incentives.

Governments in other urban centers are offering or may be considering their own incentives. Paying attention to policy in your location may be key to identifying opportunities.

In addition, a recent article from Bloomberg cites the Biden administration’s new plan to help property owners convert empty offices into apartment buildings. The plan includes opening up financing sources and providing technical assistance to make it easier for OTR conversions to move forward nationwide.

2. 2. Zoning Relief

Zoning regulations have been updated in DC to allow developers to convert commercial buildings into residential properties without going through the lengthy and expensive process of applying for a zoning change.

This is where working with an existing building can be especially advantageous for developers – and where an attorney specializing in land use can be invaluable.

As an example, Bohler is currently consulting on the largest office-to-residential conversion project in the District. Aspects of the existing building, such as the penthouse and overall building height, exceeded zoning regulations, thereby requiring relief from the Board of Zoning Appeals.

While a few alterations were still required, the fact that Bohler’s team could point to elements of the existing structure and detail the hardship, eased the process of obtaining an exemption and avoided the need to make more consequential changes. The same outcome might be achieved when extending available space slightly beyond what regulatory agencies typically allow or in other similar situations.

While there may be necessary modifications to the existing building or site layout associated with a conversion, a highly experienced design team can effectively navigate the intricate balance of current regulatory codes, existing building/site constraints, and create a solution that aligns with the developer’s goals.

3. 3. Opportunities to Turn Losses into Gains

Office building owners are often highly motivated to convert their properties into residences to eliminate the financial burden of vacant space.

If the building you own or are considering as a developer also has unique architecture or features, is in an upscale or well-known area – or all of these apply – you may expect to receive higher rent once you convert.

Many individuals, couples, and families desire the vibrancy of urban living and easy access to all the activities they enjoy. In addition, virtually every major downtown in the US has its hidden (or not so hidden) gems – truly interesting office buildings that can be converted into especially attractive living spaces.

The right office-to-residential conversion project may not only meet the needs of those who want to live downtown but may also attract those who dream of life in a showcase building and are willing to pay a premium for it.

4. 4. Downtown Revitalization Efforts

Washington, DC, has implemented several downtown revitalization projects since the COVID-19 pandemic. These include outdoor dining and retail programs, such as the Streatery Winter Ready Grant Program, which provides funding for restaurants to winterize their outdoor dining areas, creating a more vibrant street scene, and other ways of supporting local businesses.

Small business grants have also been provided to businesses affected by the pandemic to help them stay afloat and continue operations, and downtown businesses are among the recipients.

Additionally, the government is continuing to invest in capital improvement projects to create jobs and stimulate the economy in the downtown area.

The renovation of Franklin Park and transportation improvement projects like new bike lanes, pedestrian-friendly streets, and increased public transit options are all examples. These projects make it easier for people to access downtown and increase foot traffic, both of which have a positive impact on retail businesses.

To support the success of these revitalization projects, Washington, DC, launched several marketing campaigns promoting downtown as a safe and attractive destination for residents and visitors.

Concurrently, there’s an effort to bring employees back to their DC offices. However, with so many government, corporate, and nonprofit organizations consolidating even more vacant office space will likely be on the horizon.

Cities across the country are implementing revitalization programs and marketing campaigns like DC’s. They are a signal to developers that an urban center is worth investigating for office-to-residential conversion opportunities.

5. 5. BEPS Energy Star Rating Requirements

Today’s business tenants are looking for progressive and sustainable facilities. Many cities have set Energy Star rating requirements to reduce energy consumption and promote energy efficiency.

This means owners and developers with older office buildings may be required to perform upgrades if they intend to maintain the existing use. Examples of upgrades include green roofs, solar, and venting, as well as improving landscaping to meet the latest environmental standards and energy performance regulations.

While the required Energy Star rating depends on building type and size, the DC Green Building Act of 2006 requires commercial and multifamily buildings over 50,000 square feet to achieve a score of 75 or higher to receive a building permit.  Incentives are given to buildings earning even higher Energy Star ratings.

The effort and expense of making energy-related upgrades to office buildings, combined with the challenge of finding business tenants given decreased demand and current trends, make DC office-to-residential conversions even more attractive for developers. The same is true in cities with similar Energy Star requirements.

Did you know… The Energy Star score is a metric developed by the US Environmental Protection Agency (EPA) which rates the energy efficiency of a building on a scale of 1 to 100. The higher the score, the greater the energy efficiency. Buildings that receive an Energy Star score of 75 or higher are in the top 25% of energy-efficient buildings in the country.

6. 6. Market Conditions Deter New Builds

Several market challenges are making it especially difficult for developers to proceed with new builds or raze and rebuilds in DC.

Although multifamily construction starts rose steadily in 2022, they have since slowed, thanks in part to high construction and labor costs, as well as increases in the cost of capital. According to a recent National Multifamily Housing Council Construction Survey, 84% of respondents are still experiencing construction delays.  This may further constrain the supply of new units.

Developers also face challenges related to changes in the debt market. The Federal Reserve’s attempts to control inflation by raising interest rates has influenced pricing and made it difficult to compare current transactions to those completed in the first half of 2022. Volatility in the debt market has also made valuing assets more complex, which then impacts lending decisions and slows the velocity of sale transactions.

All of this has made securing financing for new projects difficult, making office-to-residential conversions an increasingly viable option for developers who want to maintain momentum in the current market.

Further, projects leveraging existing assets may only require light renovation and, as mentioned previously, these buildings may offer unique features which were approved during original construction and can be retained, even though they would not be permitted with a new build.

How to Succeed with Office-to-Residential Conversions

With factors influencing the continuing trend toward office-to-residential conversions summarized and advantages covered, the next question is how to make your conversion project a success.

Making sure the right partner is at your side is the essential first step.  Developers benefit greatly from working with a land development consultant with boots on the ground.

Like the consultants at Bohler DC, our professionals are adept at navigating this type of project, including managing the many disciplines and teams involved in its completion – permitting, site civil, MEP teams, and others, as well as the extended team of architects, engineers, contractors, land use specialists, and more.

Once your consultant is on board, they will conduct site feasibility and due diligence assessments. This involves evaluating the site and building to determine what will be required to convert to residential use. As part of this effort, the consultant will also estimate the timeline for obtaining the necessary permits and coordinate with the area’s transportation authority to address necessary changes to driveways and curb cuts.

The land development consultant will also assist in efforts to design the building so that it meet the area’s site requirements. These efforts may be related to stormwater management, green area ratio, solar, or other elements, depending upon the project location. Utility improvements such as pipe resizing or connecting the building to the city’s water supply for green roof irrigation may also be needed.

Another vital success factor for office-to-residential conversion is access. Specifically, understanding and preparing for changes in density and flow resulting from the new influx of traffic which is common when residents replace employees.

While office workers typically use public transportation, residents in many cities use their own cars. But even in places where residents also use public transportation, you can expect increased traffic from delivery services such as Amazon, UPS, FedEx, DoorDash, Uber, taxis, and more. Your land development consultant will play an essential role in analyzing and planning for the impact of these new conditions.

Responding to certain regulations and residential use related changes is a heavy lift, requiring tactics such as excavation and traffic management. Your land development consultant will work with the proper authorities to coordinate these efforts and will collaborate with the other agencies and governmental departments that need to be involved at various points in your project.

Seizing the Opportunity Knocking Loudly at the Door

So many urban centers have been dramatically changed by the pandemic and, consequently, developers in Washington, DC, and beyond would be wise to put office-to-residential conversion projects on their radar.

While clearly a complex endeavor, with the right team and approach you can leverage the opportunity with great rewards.

Identifying the right location and building is the starting point, and one of the ways Bohler can assist you in accomplishing your goals.

Already have a building or location in mind? Contact Bohler and let’s talk about how we can help you analyze its potential.