Obsolescence pt III — The rise and fall (and rise again?)
As you may have read on this blog (here and here), we’ve been anticipating the current challenges facing the commercial real estate landscape for quite some time and have often opined on the idea of repurposing/repositioning assets most “at risk” of obsolescence. This trend has, very unfortunately, continued and amplified, with numerous new cities joining NY and LA with historically high office vacancy rates (DC, SF and more). Unfortunately, the CRE industry is not going to be able to wait this one out.
One interesting option for mitigating the commercial real estate (CRE) downturn (while simultaneously improving the residential real estate (RRE) shortage) centers around commercial to residential conversions. CRE has lots of available square footage, but low demand; RRE has high demand, but a shortage of supply. Rolling them together seems like a true win-win.
But the process is not simple at all. Commercial buildings are not meant to be lived in and thus do not have the infrastructure (physical or legislative) to support hundreds of full-time tenants. Plumbing (1 bathroom per floor vs 1 per unit), HVAC, electrical, and zoning all need to be updated to support the conversion. It’s more than just putting up walls and building units. You need to repurpose the entire building without tearing it down.
So where to start?
One intriguing idea recently got announced in Boston. The city will launch a “Downtown Office to Residential Conversion Pilot Program” to incentivize the conversion of underutilized office buildings. Like many urban cities with historical and cultural constraints on zoning, building heights, etc., Boston has suffered from supply constraints that have created massive housing inflation.
The program’s final details have yet to be announced, but it is expected to consist of two parts:
Reduced property tax rates for commercial office owners in return for immediate conversions (up to 75% for up to 29 years).
Support from the Boston Planning & Development Agency (BPDA) to streamline the approvals process from other City departments.
Importantly, it appears there will be time limits on the program in terms of application AND construction starts.
On paper, this plan looks to hit the key notes in terms of encouraging residential supply growth: economic incentive (reduced taxes) + speed (streamlined zoning) + action (defined period for executing). Plus, renovation is (apples to apples) more carbon-efficient and sustainable than a new build, so you’re getting some “green benefits” as well. Philosophically, it is aligned with the type of experimentation we’d like to see more of.
It’s also a potential win for both the private and public sector. Tax incentives today can lead to much higher absolute tax dollars in the future should programs like this find support. This can be realized through higher property taxes post-conversion and the potential boost in economic activity that is likely to follow via downtown revitalization/tourism. Like many urban centers, downtown Boston has been slow to recover post covid with commercial vacancies +20% and foot traffic down +40% according to the city’s Downtown Revitalization Report (which is definitely worth at least a skim; we were surprised by the extent of the challenge). Both socially and economically we certainly cannot afford downtown commercial cores to get hollowed out.
For another team converting commercial to residential, see what our friends at NexArm are up to in Sherbrooke, here.
Critics may argue that subsidizing existing commercial owners with city dollars is “unfair” and that architecturally most of the Class B/C buildings are not structurally conversion-feasible (and thus will not “move the needle”), but ideas like this are refreshing and are without a doubt a step forward. Finding novel ways to reuse, repurpose and reimagine existing infrastructure is necessary to solve the next decade's residential supply challenge.