It seems like it was only yesterday when America’s downtown business districts thrummed with life—rivers of people making their way to and from their offices, queueing up for hot lunch places, meeting for après-work drinks. Memories!
Since onset of the coronavirus pandemic, though, the pulse of those once-thriving districts has subsided to a faint quiver. Sidewalks once clogged with pedestrians are largely empty, since many white-collar workers are working remotely rather than returning to their high-risk, high-rise office buildings. Tourists are largely staying away, too.
That doesn’t bode well for the long-term future of office buildings and hotels in these neighborhoods. Some will likely shut down for good. But an abundance of vacant commercial real estate could be transformed into what the real estate market is most desperately clamoring for: housing.
“That’s going to free up a lot of commercial space, which can be converted to affordable housing,” U.S. Housing and Urban Development Secretary Ben Carson said of the pandemic in a June 24 Fox News interview. “We are very much looking at that right now, looking at ways to be able to facilitate that transformation.”
The nation is in the throes of an unprecedented housing shortage, setting off bidding wars and driving home prices to new highs—even amid a recession. These repurposed buildings could become opportunities to increase the much-needed supply of residential real estate.
“Office-to-residential conversions would be a win-win solution in some cities where you’re seeing declining lease renewals and a massive shortage of housing,” says realtor.com® Senior Economist George Ratiu.
But hold on. Many of these offices and hotels are in crowded city centers, which many residents are fleeing for suburban and rural areas where they can get more square footage for their money—and more social distance from their neighbors. So even if those spaces are converted into apartments and condos, will people want to live in them?
However it plays out, it seems America’s business districts are poised for a metamorphosis. A few tech companies, like Slack and Twitter, made waves by announcing their employees can work remotely forever, and many other employers expect to move to a hybrid schedule when COVID-19 is finally under control, according to several surveys. Employees would stagger their in-office time, coming into the office only a few times a week.
“I don’t think the office sector is dead or going away,” says Ratiu. However, “companies will shrink their office footprint.”
These shifts aren’t likely to happen immediately. Many office tenants are locked into multiyear leases that can stretch into decades. That’s likely to prevent a wave of commercial foreclosures and building owners from going under.
It’s possible that some buildings could become hybrids, with a few office floors, a few residential floors, and retail on the ground floor.
As for hotels, just under half of available rooms are occupied, down more than a third from the previous year, according to a survey hospitality data and analytics company STR conducted from July 26 through Aug. 1. Some of these properties won’t survive the pandemic, creating more available commercial real estate.
“The longer this goes on, the bigger effects there will be,” says Brett Theodos, a senior fellow at the Urban Institute, a nonpartisan research group based in Washington, DC.
Cleveland case study: Office-to-residential conversions helped revitalize downtown
We’ve been here before.
Most recently, commercial-to-residential conversions became common after the Great Recession, particularly in the Rust Belt, the Midwest, and struggling cities. These were the kinds of places where office, industrial, and retail buildings stood vacant, bitter reminders of the companies that had long left or gone out of business. The conversions helped revitalize fading downtown districts.
In Cleveland, old factories, office buildings, and department stores have been reimagined as higher-end apartments with waterfront views catering to hip, young professionals and sophisticated baby boomers. About 60 buildings in the city, which lost the North American headquarters of BP Oil about two decades ago and had witnessed the slow death of the steel industry, have undergone the transformation with the help of state and federal tax credits. More are in the pipeline.
Of the city’s roughly 4.5 million square feet of empty commercial space in the mid-2000s, about 2.5 million has been turned into housing and hotels, according to Joe Marinucci, president and CEO of the Downtown Cleveland Alliance.
“It’s really been the fuel to accelerate the residential development downtown,” says Marinucci. The adaptations have also helped the remaining office stock. “If we can decrease supply we can also increase the demand for the existing office supply.”
These 850- to 900-square-foot units typically rent for around $1,400 a month, he says.
“It certainly helped to revitalize the energy and the urban scene in downtown Cleveland,” says David Wagner, principal at Hanna Commercial Real Estate in Cleveland.
Some office and hotel buildings are attractive for conversions
Office and hotel buildings may be easier to convert than other forms of real estate. Offices often have floor plans that can be partitioned, elevators are available, and cable and Wi-Fi infrastructure is already in place. Those located in urban downtowns on the edge of residential districts could be particularly appealing to developers.
The problem is plumbing, as most have only a few bathrooms per floor. Installing plumbing can be an expensive retrofit.
Hotels may be more attractive conversions as they’re already divided into individual spaces complete with their own bathrooms. Plus, they typically already have common spaces as well as parking.
The short-term outlook for both industries doesn’t look good. For office buildings, gross leasing volume fell by a record 53.4% in the second quarter of this year, according to a recent report from JLL, a commercial real estate company. Tenants let go of about 14 million square feet of office space, the biggest loss since 2009 around the time of the Great Recession.
New York and San Francisco, both hard-hit by the pandemic, were responsible for more than a quarter, 26.7%, of all of the occupancy losses, according to JLL.
“We won’t see the full impact on offices until these leases end,” says KC Conway, chief economist of the National Association of Realtors®’ CCIM Institute, which represents commercial real estate professionals. “Most of them probably have three to five years to go.”
Many hotels are in similarly precarious positions. More than half of the 600-plus hotel owners in a recent survey said they’re in danger of losing their properties to foreclosure due to the pandemic, according to a recent American Hotel & Lodging Association survey of more than 1,200 owners, operators, and employees. It was conducted July 23–27.
Nearly a fifth of U.S. hotel properties are still closed since March, according to STR, a global hospitality data and analytics firm.
“Many are going to close” for good, says Richard Rubin, CEO of Repvblik, a Los Angeles–based firm that turns commercial space into housing around the country. The firm primarily retrofits hotels in the Midwest. “We could be talking about somewhere between 15,000 and 25,000 hotels that could shut down by the end of 2021.”
His company turned a six-building Days Inn in Branson, MO, into Plato’s Cave, 341 studio and one-bedroom apartments. The complex includes a clubhouse, gym, and renovated pool.
Will anyone be left downtown to live in these conversions?
Even if scores of older, underwhelming offices and vacant hotels are transformed into beautiful new housing units, it remains to be seen whether they’ll attract tenants. Since the urban lifestyle is less of a draw—and for many, a turnoff—during the pandemic, developers will have to price their projects carefully.
“Over the last decade as the urban renaissance has taken place, a lot of people have been willing to pay a steep premium to live downtown,” says realtor.com’s Ratiu. “What the pandemic has shone a spotlight on is that cost may not have been worth it for some people.”
However, it may be too early to write the obituary of urban office buildings and hotels, as many did in the wake of 9/11.
“There was a feeling that this would be the end of central business districts because of terrorism. But businesses continued to want to locate there,” says Charles McNally, a spokesman for New York University’s Furman Center for Real Estate and Urban Policy. “There’s reason to believe demand will rebound.”