A Policy Overhaul That Could Aid Commercial Real Estate

Workers are coming back to the office — at least some of them. But the American office building is undergoing a dramatic change. And figuring out what to do with the resulting glut of excess office space will be one of the most creative challenges that the country will face in coming years.

When charting the path forward for commercial office space, it’s important to remember that office use was changing well before the Covid-19 pandemic turbocharged the work-from-home trend. Depending on the market, office vacancy rates had already ranged from?12% to 25% .

At the same time, the recent rebound of the return-to-the-office movement in some areas and industries makes it clear that not every office worker is going to spend their day in a home office or sitting at a kitchen island. Instead, signs everywhere point to a future in which the need for office buildings will remain, but they will need to be reconfigured in ways that best suit the new remote or hybrid demands of employers and workers.

Repurposed office space with components such as moveable walls, video call booths and adjustable square footage will remain attractive. Without making these fundamental changes, landlords are being punished, as noted by the fact that we’ve already started?to see defaults on large office buildings .?

For some cities, the current shift in demand for existing office space could turn out to be as much of a challenge as the decline of light industry that hollowed out urban cores?in the 1980s .?

Simply put, in places including Philadelphia, New York, San Francisco and even Denver and Boston, the historical high-rise with one large tenant is just not going to be feasible.??

So, what do you do with all this excess office space??

The easiest answer — what you might call the low-hanging fruit — is the conversion of office space to residential use. There is a continuing interest, especially on the part of the young, in urban living. And there is also a clear crisis of affordability in many cities, particularly multi-family. Remember, some of America’s most sought-after residential spaces — most famously, the urban loft — started life as workspaces. So, on one level, office-to-apartment conversion is as close to a no-brainer as you can get in the real estate business.

On the other hand, a better answer in many cases would be mixed-use. In much of the world, it is natural to commingle offices, medical facilities and retail with residential units. The tallest building on Earth, the?Burj Khalifa in Dubai , offers an attractive mix of residential condos, office, retail, hotels and entertainment. Even many of us with deep experience in the world of the stand-alone office tower see enormous potential in this more balanced approach.

But while several office conversions have taken place, there are numerous obstacles to the broader wave of office space repurposing that must be resolved to prevent some of our downtowns from a new era of blight.

One big hurdle involves financing. If you go to a typical lender for a real estate project, they will ask whether you are financing an office building or a retail center or an apartment building. If you say “yes” to more than one, they’re likely to say they don’t have the crossover expertise necessary to do it. Meanwhile, some lenders have been told by bank regulators?to avoid office projects , even if the building in question is mostly being used for other purposes.

Then there is the enormous and diverse body of largely local regulations governing land use, development, and redevelopment. In some cities, rules on the upgrading of buildings to modern-day ordinances often make conversions of large-floorplate buildings impossible or economically unfeasible. In others, entire central business districts remain zoned solely for office use or retail, with separate tax regimes for residential and commercial making it overly complex to redevelop buildings into mixed-use solutions.?

Most of these local regulations were enacted for a good reason, and one needs to be understanding of the difficulty that local officials may have in changing them. But given the enormity and urgency of the office building’s situation, elected officials and other policymakers need to act and act now. It’s not just the fate of downtowns or property owners hanging in the balance. Many smaller banks are heavily exposed to the office segment, meaning a failure to address the problem could have systemic consequences as well.?

Happily, there is reason for hope. A growing number of local leaders are already hard at work on the problem. New York City created an Office Adaptive Reuse Task Force, which several months ago?released a set of 11 concrete recommendations ?aimed at making 100 million square feet of office space viable for conversion. That comes out to the equivalent of about 2,300 acres of space.

But we need the Federal Reserve to step in to make it easier for banks to lend money for multi-use developments and the federal government to create incentives for repurposing underutilized office space for residential and mixed-use development. By upgrading and modernizing lending and zoning regulations, a new wave of office conversions could spark yet another cycle of American dynamism, one that goes way beyond office and home.