The Risks of Office-to-Residential Conversions

Office building owners are grappling with significant challenges in the post-pandemic market. The widespread use of remote and hybrid work arrangements has significantly stalled the return-to-office efforts of office tenants and led to continually high office vacancy rates, which, for example, roughly doubled in New York City between early 2020 and mid-2024, according to the New York City Comptroller’s Office.
While year-to-date vacancies have recently started to decline in major commercial corridors throughout the city, newer, Class A and trophy buildings were the primary drivers of the recent uptick in leasing activity.
Meanwhile, vacancy rates for Class B and C buildings have remained stubbornly high. Coupled with the impact of heightened interest rates (relative to pre-pandemic lows), revenue loss from office vacancies have led an increasing number of owners of commercial office buildings to fall into delinquency under their loans.
While demand for New York City office space has softened, demand for residential space has spiked. Indeed, the need for additional housing is viewed as a crisis across the city and throughout the country. However, residential supply has remained stagnant.
Many current owners and developers have spotted an opportunity amidst the challenges the work-from-home paradigm shift has presented: office-to-residential conversions. The conversion of unused office space into housing can provide an attractive investment alternative for developers, while appealing to policymakers and community members alike. Additional housing supply is critical to the long-term prosperity of the city as well as the quality of life of many of its residents.
Office-to-residential conversion projects have begun to gain momentum. According to CoStar, a global provider of commercial real estate analytics, 50% of first-half 2024 development sales in Manhattan involved office-to-residential conversion projects. High-profile projects in the pipeline include a planned conversion by Metro Loft Management and David Werner Real Estate Investments to transform Pfizer’s former headquarters on 42nd Street into 1,500 housing units.
Similarly, SL Green has announced plans to convert a substantially vacant Third Avenue office building into over 500 units of housing. However, office-to-residential conversions present significant challenges to owners and developers that arise from the interrelationship among the regulatory regime, the legal restrictions and requirements of the site and the physical requirements of conversion; the resulting incremental cost of conversions mean that many potential conversions just do not pencil out.

Conversion Obstacles

The most commonly cited obstacle to conversions is performing the various physical and structural changes necessitated by legal and regulatory requirements and that are otherwise necessary to optimize the value of the units. For instance, deep floorplates common to many office buildings make restructuring the spaces to include adequate light and air for residential purposes highly complex and expensive. Such restructuring may require costly changes such as de-massing buildings to create courtyards and creating lightwells in the building. Similarly, altering existing plumbing and electrical configurations to meet the needs of new residential tenants, especially in the older buildings that are riper for conversion, will impose additional steep upfront costs.