Challenges Abound Converting Offices to Residential
Converting vacant office space into residential units supposedly has become all the rage in the post-pandemic era, in Pittsburgh and nationwide. But is it, really? And do such conversions make economic sense? That depends, says the president-emeritus of the Allegheny Institute for Public Policy.
“There are several potentially serious obstacles to conversion,” reminds Jake Haulk, a Ph.D. economist (in Policy Brief Vol. 24, No. 35).
“First are zoning or other legal covenants or restrictions on building use. There are cost and/or financing restraints and there are possible problems regarding the fitness and conditions in the structures being considered for conversion,” he says.
And then there’s the question of potential demand for multi-family, high-rise residences at the rental rates necessary for profitability, Haulk adds.
“Assuming the municipal governing bodies are willing and able to remove zoning constraints and other legal limitations, the question becomes primarily an economic one,” the think tank scholar stresses.
“In short, can or will a conversion project be profitable for the owner?” Haulk asks. “Of course, each city will have its own set of conditions that will determine to what extent economic viability of projects will exist and how many projects could work.”
And with what degree of public subsidies and in what form. And whether such public subsidies are ever acceptable.
Haulk notes that in Pittsburgh, recent (not including 2022 and 2023) sale prices for class B office space have dipped to $95 per square foot. It had been averaging around $125 before the COVID effect.
“Assuming a fairly low (compared to the national level) conversion to residential space cost of $150 per square foot, the total cost of purchase and conversion would be $245 per square foot,” and, obviously, considerably higher for luxury apartments, he says.
The latest available figures put the rental rate on a two-bedroom, 1,000-square-foot apartment at $20 per square foot or $20,000 per year. The monthly rent would be $1,666 (the current monthly average.)
“Would an investment of $245 per square foot in a 1,000 square foot ($245,000) apartment be financially viable?” he asks.
“Assuming a 3 percent annual rent increase and 7 percent discount rate over a 10-year period, the rental income over the period would have a present value of just over $158,000. And if the investor horizon for return on investment is only 10 years, the purchase would not happen,” Haulk concludes.
But what about for a 20-year horizon? Haulk says the 7 percent discount rate would produce a present value of $266,340, which would cover the investment, assuming the apartments would always be 100 percent leased and does not factor in unexpected maintenance, mandated repairs or upgrades.
“If these assumptions are not met, the relatively small profit expectation would not justify the investment,” Haulk says.
While the economist says there is plenty of discussion and research being done on the problems created by the high vacancy rates in office space in cities across the country, there are, in fact, few conversions in terms of percentage of unleased space around the country.
“Expectations of profitability are almost certainly too low for many structures and, therefore, the call for more government assistance will increase,” he cautions.
Colin McNickle is communications and marketing director at the Allegheny Institute for Public Policy ([email protected]).
