by fnnewz
The demolition phase is approaching.
As remote work keeps employees out of the office and vacancy rates remain at record highs, commercial property owners are desperately trying to avoid default: upgrading their spaces to attract new tenants, converting their space into apartments or simply getting rid of their assets. One veteran industry professional doesn’t think that’s enough.
As the market evolves, says Fred Cordova of Santa Monica-based Corion Enterprises, there won’t be room for everyone, and about a third of office buildings are endangered species.
“There will be a fork… Product in a good location with a good and safe environment will recover. And then we have another group that will somehow hold on and reset their prices,” said Cordova, CEO of the real estate consultancy. “And then there are the others that are basically worthless: class D. You just have to tear them down. “It’s probably at least 30% of all the offices in the country.”
Residential conversion is the much touted solution. And optimists have suggested that federal aid in the form of subsidies to help convert offices into apartments could offer some help to developers suffering from the precipitous drop in demand for office space, but probably won’t be enough to stop some significant role in preventing the commercial market from collapsing, both figuratively and literally.
Record office vacancy rates threaten to send major cities into an “urban doom loop,” where falling property values reduce a city’s tax base, cutting off funding for essential public services that are only dragging on. plus the value of the properties. Stijn Van Nieuwerburgh, a Columbia Business School professor dubbed the “prophet of urban doom” for his research on the topic, said Fortune that we are close to the “event horizon” of that vicious circle of public finances.
However, there could be a partial escape route. Experts say smart public policy could help pave the way for an exit that doesn’t involve a fatal cycle. In New York City and elsewhere, residents face a surplus of office space along with a severe housing shortage. Simply converting square footage from commercial to residential space seems like a simple solution, but the government would have to play a role to get this off the ground.
“At the end of the day, I think the problem is that we have too many offices relative to our future needs, and many places have too little housing. So I think one way or another we’re going to have to convert some of that office space into apartments,” Van Nieuwerburgh said. “That might have to happen in part through demolition. But it would be nice if we could have at least part of it through conversion. “It’s kind of an environmentally friendly way forward.”
Converting offices into apartments can be prohibitively expensive. Zoning codes that require natural light and fresh air make it difficult to adapt large, open-concept office plans into code-compliant apartments. Many buildings erected during the building boom of the 1950s and 1960s simply cannot be converted into housing. And rising construction costs are squeezing potential developers’ margins, meaning that simply tearing down an office building and replacing it with new apartments is often actually the cheapest option, Cordova said.
“(We used to participate in) conversions that cost between $75 and $150 a foot. Now, the market rate is $350. For high-end luxury, it costs $450. The economic model is very challenging for conversion,” stated Córdova. “The way to do it is for governments to provide subsidies for conversion…the government should provide approximately a 20% cost subsidy.”
Those efforts are already underway: The Biden administration set aside $35 billion in below-market rate loans to help developers with these types of conversions last fall, and New York Mayor Eric Adams gave greenlit a policy to relax eligibility rules for conversions last fall. If states and municipalities start pushing their own programs, the end result could be worth it for developers. But even with juicy incentives, Cordova predicts that nearly ⅓ of all commercial buildings simply won’t survive a drop in demand for offices, a trend he calls “the great reset.”
“Evolutionary change does not happen slowly, it happens when it happens. It is not the strongest that survives, but the most adaptable that survives,” said Córdova.
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