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Too many cubicles, too few homes spur incentives to convert offices to housing

By Tim Henderson, Stateline.org
Published: April 27, 2024, 5:57am

HERNDON, Va. — Juan Ramirez, watching his dog play in Chandon Park here in suburban Virginia on a Saturday morning, tries to imagine the massive office buildings next to the park becoming apartments and townhouses.

“I guess it’s inevitable. People don’t use offices as much now. I hope it’s affordable. Maybe it’ll bring more young people to town, more taxes for parks,” said Ramirez, 38, who grew up in the area and returned recently to take a restaurant management job after living in Minnesota and Ohio.

Cities and suburbs around the country are struggling with vacant office space as remote work becomes an established post-pandemic reality. States are stepping in with tax breaks and zoning changes to help replace the unwanted cubicle farms with much-needed housing. In suburbs such as Herndon, the answer might be tearing down an office complex and replacing it with a residential building. In more urban environments it might mean renovating and retrofitting office buildings to create apartments.

“Office vacancy has climbed to a 30-year high and at the same time there’s a housing shortage. So naturally the question is, ‘Why can we not convert all these vacant office buildings into housing?’” said Jessica Morin, research director for CBRE, a commercial real estate firm. CBRE research shows converting offices to other uses, mostly housing, is set to peak this year at more than 20 million square feet, up from 6.3 million in 2021.

Some places that started conversions before the pandemic are leading the way: New York state and New York City changed their laws during a 1990s downturn to allow more office-to-apartment conversions in Manhattan, although now there’s a state vs. city standoff on zoning rules to convert newer offices.

Ohio, where interest in city living grew when Cleveland spruced up its downtown for the 2016 Republican convention, now has three cities — Cleveland, Cincinnati and Columbus — in the top 15 list for office conversions to housing, according to CBRE.

Nationwide, 119 office conversion projects, including for residential and other use, are under construction or were completed this year, the most since CBRE began tracking them in 2016. Those projects could add about 44,000 new housing units when completed.

Since 2016, projects representing 125 million square feet of offices have or are slated to be converted to other uses, usually to housing but sometimes to warehouses or laboratories. But despite the recent increase, that represents only about 2% of all U.S. office space.

Impediments to making apartments out of offices include the still-high value of office buildings in some downtown areas in cities such as San Francisco, and the cost of demolishing or refitting old office buildings with plumbing for individual kitchens and bathrooms. Many office buildings also lack windows with natural light, which apartment-dwellers often demand.

That’s why state incentives have played a large part, as well as streamlined zoning that makes project costs more predictable for developers. Some states are further along than others. A new California law allows residential “building by right” in office and other commercial zones, meaning developers don’t have to petition for a zoning change. Washington state passed a law last year requiring cities to ease zoning requirements for housing in existing commercial buildings. And an Arizona bill signed into law this month will allow larger cities to convert more commercial buildings into housing without zoning changes.

Predictable zoning rules are important to developers who don’t want to get bogged down in negotiations and refusals that could sink a project.

“Developers just urge their states and localities to be really transparent, streamline the process, make the unknowns limited, because it’s the unknowns that drive risks,” said Julie Whelan, a vice president at CBRE. “Otherwise, they’re going to go look at the next pasture.”

Incentive programs

In addition to the Ohio cities, Chicago; Dallas/Fort Worth; Houston; Hartford and Fairfield County in Connecticut; the Kansas City metro area; Louisville, Kentucky; Minneapolis/St. Paul; Pittsburgh; Milwaukee; New Jersey; and Washington, D.C., are on CBRE’s top 15 list for rate of office space converted to apartments.

Ohio has two incentive programs for office conversion to housing. A 2020 program for “transformational” projects that could spur further development helped convert four floors of offices to apartments under construction at Playhouse Square in Cleveland. A historic building preservation incentive in place since 2007 helped partly convert Carew Tower in Cincinnati to apartments, said Mason Waldvogel, a spokesperson for the Ohio Department of Development.

Missouri is hoping to replicate that success in St. Louis, where about a quarter of the commercial space, including offices, is vacant. That includes the massive 44-story One AT&T Building downtown, with almost 1.5 million square feet, that sold for $3.6 million this month, compared with $205 million in 2006.

Missouri state Sen. Steven Roberts, a Democrat who represents the downtown St. Louis area, said a bill he’s sponsoring has bipartisan support from suburban Republicans, and is aimed at creating downtown areas in St. Louis and elsewhere where people can live, shop and eat as well as work. The bill was voted out of committee in February and is awaiting consideration by the full Senate.

The bill would create a state tax credit for up to 30% of the cost of converting office space to housing, retail or other uses.

“It’s a creative workaround to make downtown more vibrant and successful. We want to get more restaurants, more stores, more nightlife — and the way to do that is to get more people living there,” said Roberts. “It’s an issue for downtown and also for the whole state.”

Other states have enacted laws to encourage more conversion of offices to housing, according to a Minneapolis Federal Reserve Bank report last year. Laws passed by Florida and Montana in 2023 allow new and converted multifamily housing in commercial areas, and laws in Rhode Island and Wisconsin support conversion of existing commercial and office buildings.

A Colorado bill now in committee would provide tax credits for commercial conversion to housing starting in 2026, supporting Denver’s plans to transition its office-oriented Central Business District to a “Central Neighborhood District.” Denver identified 16 commercial buildings as prime candidates for housing.

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Zoning changes

Starting in the mid-1990s, a combination of state and city laws helped transform lower Manhattan’s business district with more apartments, a process that accelerated after 9/11. A proposal by Democratic Gov. Kathy Hochul to expand the program to newer buildings failed to pass the legislature as part of a broader measure that included requirements for suburban and upstate communities to build more housing. Negotiations are continuing with lawmakers to make the change for New York City this year.

New York City also has begun working on its own rules to allow office-to-housing conversions citywide for buildings built before 1990, said Casey Berkovitz, spokesperson for the Department of City Planning. The state could do it faster and could also create tax incentives that the city cannot create on its own, and that’s also part of current negotiations with the state legislature, Berkovitz said.

“When you have a 20% office vacancy rate and a 1.4% rental apartment vacancy rate, it makes a lot of sense to substitute one for the other,” Berkovitz said. “We don’t want our own regulations standing in the way of that if it makes financial sense.”

In Herndon, town officials last month approved a zoning change that would clear the way for demolition of the Worldgate Drive offices and the construction of a combination of rental apartments, townhouses and “two over two” units with accessory living areas an owner can rent out or share with family members. All apartments would be market rate without subsidized affordable units, Ken Wire, an attorney for the developer, Boston Properties, said at last month’s hearing on the zoning change.

“We believe that by providing more housing in the area, we are adding to the overall supply, which thereby reduces price pressures in the market,” Wire said.

Virginia considered two state Senate bills this session that would have created incentives to convert offices to apartments but neither has passed, said Allison Brown, policy associate for the nonprofit Virginia Housing Alliance. One would have created a state income tax credit for office-to-residential conversion, and another would have allowed more residential building in commercial areas if they included affordable housing.

The Worldgate Drive housing plan may spur Herndon to change its zoning rules to allow similar projects without zoning changes, said Elizabeth Gilleran, the town’s director of community development.

Herndon wants to “retain its sense of community and historic small-town feel” but also keep a strong commercial tax base that has helped support the town’s tax coffers when home values inevitably rise and fall, Gilleran said. The town recently approved conversion of a small office park and a hotel to homes. But offices and other commercial buildings will remain a key component of the town’s suburban building mix as density grows with a recent new commuter rail stop that opened in 2022.

“The town doesn’t wish to become a bedroom community,” Gilleran said.