Converting Offices to Housing Is Hard. These Changes Could Make It Easier

This story was first published by Stateline. Read the original article here. 

Stroll around America's vacant downtowns, and a seemingly obvious solution emerges to the housing shortages and homelessness problems in many states: Why not turn all those unoccupied offices into living spaces? Especially in cities such as Portland, Oregon, where the office vacancy rate in the urban core peaked at an estimated 27% earlier this year?

The answer is as complicated as the mismatched conditions producing the office glut, which began during the pandemic and accelerated in cities with a high percentage of remote workers who continued to work from home.

Nationally last year, office vacancy rates approached a 30-year high of 17.1%, according to CBRE, a global commercial real estate services and investment firm. The drop in business and foot traffic has been particularly grim in Portland, San Francisco and Seattle, but New York and Washington, D.C., also are considering ways to turn more offices into homes.

Modern high-rises lack the plumbing, exterior-facing windows and internal footprint of buildings intended for housing, making it expensive and difficult to convert some buildings. But some states are trying to promote conversions by waiving development impact fees, introducing tax incentives and streamlining zoning changes to spur office-to-housing conversions.

"We have to figure out how we can get units on the ground and how we can do that in ways that we haven't tried before," said state Rep. Pam Marsh, a Democratic lawmaker from southern Oregon who sponsored legislation that would require the state's larger cities to allow commercial-to-residential conversions without mandating zoning changes or conditional use permits.

Marsh’s legislation also would require that local governments waive most system development charges, or impact fees, to help bring down their cost. Those impact fees go toward water, sewer and transportation infrastructure.

The approach is one of the ways state lawmakers, governors and city leaders hope to address the nation's shortage of 3.8 million housing units—while simultaneously revitalizing downtown districts flattened by a drop in visitors and an increase in crime, or the perception of crime.

In California, state Assemblymember Matt Haney, a Democrat from San Francisco, introduced legislation to bar local officials from delaying or denying commercial-to-residential projects. His proposal would allow such projects in all areas of a city, but they couldn't exceed certain height and density parameters. Cities also would have to fast-track permitting.

Haney's proposal comes after Gov. Gavin Newsom, a Democrat, last year signed a law making it easier to redevelop strip malls in commercial districts in California zoned for retail office and parking.

"We have to move fast if we're going to stop our downtowns from crossing the tipping point into urban decay," Haney said in a statement announcing his bill. "This bill stops the bureaucracy and will allow us to move fast to build desperately needed housing and bring life back to our downtowns."

Washington, D.C., last year approved a 20-year tax abatement for eligible commercial projects that convert to housing. New York City wants 20,000 new office-to-apartment conversions over the next decade, according to the mayor's office. In Portland, the city recently waived system development charges for building conversions that comply with seismic upgrades when they become residential structures, according to Oregon Public Broadcasting. To incentivize conversions, the waiver expires in 2027.

But so far, conversions are "a fringe trend at best," according to a Moody's report issued in 2022. Office values and rents would need to drop much further "for the trend to become more than anecdotal," the report found.

There were an average of 39 completed conversions nationwide each year beginning in 2017 and ending in 2021, according to CBRE. That’s a drop in the bucket of the total U.S. office inventory, according to the report. All planned conversion projects add up to only about 2% of available office space. The conversions are concentrated in coastal and northeast states.

Conversions are, nonetheless, moving forward, and have been for some time. So are rezonings that allow for more residential construction in commercial districts. New York City in 1997 rezoned the Financial District to make room for more residential structures. It's now also considering such a rezoning for midtown Manhattan. Los Angeles made similar zoning changes in 1999 that led to a boom in downtown housing units.

Those successes were before the current glut in commercial property, which suggests that there's room for even more conversions, said Mary Kyle McCurdy, deputy director of 1000 Friends of Oregon, an anti-sprawl advocacy group. The bill "makes sense for cities," McCurdy said at a legislative hearing.  

"These buildings are already located along streets, possibly transit lines, that have infrastructure and are currently sitting vacant or partially vacant," she said. "The buildings are not only not using any existing infrastructure, but the fact that they're vacant means existing infrastructure is being underutilized."

While struggling downtowns are one obvious focus of the legislation in Oregon, the measure also could aid the conversion of vacant suburban big box stores into housing or facilitate turning hotels in commercially zoned districts into apartments.

Adaptive reuse can be a climate-friendly strategy to increase housing supply in small- to mid-sized towns, said Nicole Possert, executive director of Restore Oregon, a statewide historic preservation nonprofit. Conversions generally have a smaller environmental impact than new construction, according to the CBRE assessment. They also can retain unique design features, including historical buildings "whose character can't be replicated in a new build," the report suggests.

Smaller-city downtowns "are suffering just as much with housing and affordability and access as downtown Portland is," Possert said. "It's a really widespread problem, even if the solutions might be a little different."

One success Possert cites is the Palace Hotel in Medford, a former single-room occupancy hotel (once known as flophouses) in southern Oregon. The hotel provided affordable lodging from 1893 until its closure in 1972. Commercial activity continued in the hotel's ground-level spaces, according to Restore Oregon. But more than 70 upper-floor rooms languished unused.

"The people in the housing sector immediately start with building new. And that's fine because we do need to build, but it's not the only tool in the toolbox," she said. "And so, this is a way to put more tools in the overall production toolbox. So, it might be easier to deal with existing properties, or at least they should be on par and on the same plate with building new."

Fortify Holdings, a developer with experience converting hotels to apartments, is redeveloping the hotel into 40 smaller apartments that will slot into the existing fabric of the city's downtown. The company's president, Ziad Elsahili, testified on behalf of Marsh's bill, in part because it would waive a large portion of the system development charges, or SDCs, that developers pay when they build new projects.

"This is a major advantage for developers and could really help offset some of the costs for developing and converting these buildings and lead to more housing options," Elsahili said.

But some Oregon cities and parks districts resisted Marsh's legislation at first because of the mandatory waiver of the SDCs. In Springfield, a town of 62,000 about 110 miles south of Portland, the planning staff was concerned about losing money for water, sewer and transportation infrastructure upgrades. Based on their feedback and that of other cities, Marsh amended the bill to allow SDCs for water and sewer in some situations. 

"We have to think innovatively," Marsh said. "All of these things need to be on the table."