Large Office Buildings Are Being Torn Down
Plus: the question of why converting to residential is so hard
Thanks for reading The Sunday Morning Post! Each week I write about the economy with a focus on real estate and investing from my perspective as a commercial lender here in Maine. Thanks for being here.
There are over one billion square feet of vacant office space around the country right now. Large buildings that were once hubs of industry and commerce now sit either completely empty or are partially occupied with swaths of unused space. In certain markets like Houston and San Francisco/Bay Area, the office vacancy rate is nearly 25%. This is according to the latest National Office Report published by CommercialEdge.
The obvious change came with the pandemic, which saw companies big and small in all corners of the country allow and, in fact, encourage employees to work from home. Not only did many employees actually end up liking this new arrangement, but companies found they could save significant costs by not managing brick-and-mortar office locations in the manner of old. I can say from my perspective from the bank where I work, whole groups of employees like credit analysts, loan processors, and even phone center employees to this day work almost exclusively from home, and sometimes not even in the same state or region where our bank is primarily located. And you know what, it works fine!
But it has presented tough times in certain segments of the economy, especially if you are a commercial property owner who leases space to traditional office-type companies. All classes of commercial office space are suddenly riskier assets. Moreover, the work-from-home era coming out of COVID has hit commercial property owners on the heels of a 25+ year trend in retail towards online sales, which has devastated brick-and-mortar real estate in that category of activity.
It has meant trouble too for communities and urban centers with lots of office workers. New York City Mayor Eric Adams said in February 2022:
That accountant from a bank that sits in an office, it's not only him. It feeds our financial ecosystem. He goes to the cleaners to get his suits cleaned. He goes to the restaurant. He brings in a business traveler, which is 70% of our hotel occupancy. He buys a hot dog on our streets—I hope a vegan hot dog—but he participates in the economy.
In other words, in-person workers fuel the New York City economy, and with many of them working from home, the economy was facing tougher times. As an interesting aside, Mayor Adams said in June 2022 that all New York City municipal employees must return to the office full-time, noting, “I'm trying to fill up office buildings,” but then by February 2023 he had backtracked because so many New York City positions were going unfilled, undoubtedly because there were fewer applicants for jobs that required the work to be done in-person, especially in a city that is as expensive to live in as New York City.
Office Buildings Are Coming Down
Although there has been some recent momentum among large companies to actually bring employees back to the office, workers who wish to stay at home have a lot of leverage. The labor market is still historically hot, which means employers have to meet workers and prospective workers where they are instead of the other way around. And for lifestyle and logistical reasons, lots of people prefer to work from home.
This is only likely to become more pronounced as a younger generation continues to come of age who grew up with the technology that makes working from home more feasible. Plus a lot of younger workers have less developed social skills than older generations, especially those who graduated from high school or college during the pandemic. Many younger workers also have little to no interest in working in a traditional office setting, which, in a more generous interpretation, is not necessarily a bad thing. Any of those among us (including myself) who started a career working in a windowless cubicle with poor air circulation can attest that this is really no way to go through life.
From where I sit in Maine, we’ve also seen “income arbitrage” where people work for a company based in New York City, for example, and make New York City wages, but live in rural Maine where the cost of living is significantly less. A lot of those people don’t want to move back to New York.
How devastating has this new reality been for the commercial office building space? Apart from the vacancy rates, which significantly reduce cash flow to the property owner, transaction prices are also down with investor demand for these types of buildings falling to decade-lows. And now, some of these behemoth structures are actually being taken down. According to Axios, developers actually tore down more office buildings in the first half of 2023 than they built, demolishing 14.7 million square feet of office space while building anew only 4.8 million square feet!
Among some of the higher profile demolitions:
Multiple office/industrial buildings in Manchester, New Hampshire are being torn down to be replaced by apartments.
A San Diego office building is being replaced with multiunit residential apartments.
In Sterling, Virginia, Amazon is demolishing nine office buildings and replacing them with data centers.
In Grandview, Ohio, an office buliding is being torn down and will be replaced by a 160-unit residential complex.
Part of a historical office building in Lincoln, Nebraska is being torn down to be replaced by a hotel.
The above is just a very small sample size. There are literally dozens if not hundreds of these projects going on nationwide right now in which office buildings are being not converted into residential units or something else, but actually demolished so that something new can be built in their place.
Why Converting Offices to Residential is Hard
Intuitively, it does seem strange for full scale buildings to be demolished rather than be retrofitted for apartments. I spoke with several developers and construction contractors this week in researching this article to ask the question why not convert office buildings to residential. One billion square feet of unused office space nationwide is quite a lot needless to say, and in the context of the nation’s current housing crunch the opportunities for residential conversation are pretty intriguing.
No doubt this is actually happening in many places. I was just reading this week about an office building near Dupont Circle in Washington D.C. that is being converted into a 157-unit residential complex. A similar conversion is planned for two nearby office buildings that will be converted into 300 new residential units. Projects like this are happening all over the country, even here in my neck of the woods in Bangor, Maine, which has seen a number of its old brick downtown buildings converted from either office spaces or from being essentially vacant into upscale apartments and condos.
But there are a multitude of challenges in converting office space or the big box-store style of retail buildings into residential units. The developers I talked to this week had several key points:
Building codes for residential buildings are very strict. When many of the office buildings that could potentially be converted were originally built, codes were looser in general particularly for commercial spaces. It can be too costly to convert some of these from commercial use to residential (even if the commercial spaces are vacant) because the costs of bringing them up to code are so high. The costs of converting empty box stores into residential units are particularly daunting.
Utilities need to be set up differently for residential units as compared to commercial. Retrofitting office buildings with new utilities can be very expensive, which makes these projects non-viable. Plumbing is particularly problematic as residential buildings require more piping that is also less centralized than office buildings.
Zoning: a lot of communities have lengthy and expensive bureaucratic processes for changing the zoning on a property from commercial to residential. The amount of red tape and the costs involved without even being sure that an application is even going to be approved make it too frustrating and too expensive for developers to take on these types of projects. This is especially true of vacant box stores, of which they are many around the country, but which are generally located in strictly commercial districts of communities that are not zoned for residential.
Land is still cheap (in some places). In downtown San Fransisco or Midtown Manhattan, of course, there is no available space to build. But in many other areas of the country, it is a lot less expensive to simply build new rental units from the ground-up on open land rather than try to convert a clunky office building.
Parting Thoughts
The technology that makes it easier to work from home is not going away and, indeed, will only continue to become more prevalent. As much as companies would like their employees to come back, many never will. This is going to leave much of these large office buildings sitting empty.
Cites and towns large and small should recognize the opportunities to convert office buildings to residential and partner with developers to make projects possible. At the very least this means streamlining the application process to make these types of projects more feasible at the local level. It could also mean offering tax incentives or sharing some of the costs of infrastructure improvements and utility installation. Not only would this house more people, but it would replace the lost office workers in downtown economies with residents, who also spend money with a multiplier effect. And as much as we like to blame municipal officials for standing in the way of progress, local residents also need to become more comfortable with outside-of-the-box thinking; locals who have been used to such-and-such building being an iconic office building for decades may need to become comfortable with people living there instead.
I suspect given the continued housing needs, the longer many of these office buildings sit vacant or partially vacant the more the pressure will mount for policymakers to make conversions more easy and less costly to do. Or we will see what we have started to witness over the past several years: the full demolition of office buildings with construction of entirely new residential units in their place.
Ben Sprague lives and works in Bangor, Maine as a Senior V.P./Commercial Lending Officer for Damariscotta-based First National Bank. He previously worked as an investment advisor and graduated from Harvard University in 2006. Ben can be reached at ben.sprague@thefirst.com or bsprague1@gmail.com.
Have a great week, everybody!
I enjoyed the read Ben. Nice to be in touch.
One should also consider the social aspects of converting inner city office space to residential use. There was an article in the Australian Newspaper, owned by the Murdoch family who you will be familiar with, no doubt because articles about his relinquishment of his chairmanship of his media companies this week.
The subject of the article was the high resignation rate amongst teachers due to the increasing difficulty of maintaining discipline in schools, and particularly since the advent of Covid. This is apparently a hot topic that elicited more than 500 comments. Many suggested that to spare the rod is to spoil the child. Some teachers were of the opinion that the trend to consider that a child may have been misbehaving because the lesson wasn't meeting their needs put the blame back on the teacher making his position untenable. As a former teacher who left after 10 years, I know the feeling. However, I had a different point of view that is encapsulated in the comment that I have repeated below. Its relevant to the decision as to whether its desirable to build high rise residential buildings or whether it's better to start afresh and better meet the needs of children.
One thing that you point out is relevant is also the question of online shopping and home delivery. That would assist to achieve the ends that I have in mind. Below is the comment:
Birth rate has fallen below replacement levels. Australia is not a child friendly place. Too much pressure on the nuclear family. 77% of urban dwellers report that they don't know the name of the people next door.
In 1908 a basic wage was sufficient to support a stay-at-home wife and three children. The streets were full of pedestrians and kids, not cars. Today two incomes are required to take on a mortgage. No back yards because blocks are small. Children can't play in the street because it's too dangerous. For preschoolers, lack of green space and the lack of opportunity to interact with children their own age gives rise to maladaptive behavior. Add screen time.
Our town planning regime should allow 'build to rent' without subdivision in relatively self-sufficient village sized communities. Cars should be garaged remotely. This would enable a return to pedestrian and child friendly environments where parents and grandparents can combine work with looking after their children. The shophouse form that combines living upstairs with work downstairs is appropriate. The village should provide for home, work, recreation, shopping, child-care, school, communal gardens and nature conservation. There would be less need for a car.
This would reduce travel time and give more time for dads to play with their kids. It relieves the family of the burden of a mortgage, improves labour mobility, better enables people to reach their potential or develop a side hustle and will therefore promote an entrepreneurial culture. If the schoolrooms are scattered about the community in the ground floor sections of houses people can learn to be teachers in the classroom. There is no better way. Kids will find mentors in the local community taking pressure off the nuclear family.
Our cities are just too big. and too hard to change.
I went from teaching to farming. Just let farmers build houses to rent on rural land. Let us get on with it. I write about this at erlhapp.substack.com.