— By Julian Freeman, Dave Wensley and Gabe Pitassi —
With steep vacancy rates impacting traditional office markets due to the headwinds of higher interest rates, short-term economic uncertainty and long-term remote/hybrid work uncertainties, underutilized traditional office buildings may become liabilities before the end of their anticipated economic life. Owners of these properties may consider a conversion — an adaptive reuse or repurposing — to access higher rents and occupancy rates.
In view of nationwide housing shortages, especially in California, converting office to multifamily has received much attention as a logical move. However, such a conversion is not always viable from a financial, structural, legal or location perspective. An alternative option may be to repurpose an office building for life sciences use. Such a conversion, while posing its own unique challenges, may provide more realistic options than a conversion to residential use for many owners and properties.
Challenges in converting to residential
Converting an office building to residential use presents challenges on multiple fronts. Zoning laws vary based on property location and usage, and the property may need to be rezoned to a different classification to allow multifamily uses. Rezoning requires local government approval and public hearings, which can take months or even years to accomplish. Various permits may also require local government approval. Local parking requirements also vary based on property types, and a multifamily building could require more parking spaces than may be feasible for the property in the absence of full redevelopment, with costly underground garage parking. The building code could also have stricter requirements, such as for fire sprinkler and suppression systems, emergency exits or wiring for kitchen setups.
Legal compliance aside, there are practical limitations related to the area surrounding the building and the building itself. The location may be in an area that lacks nearby residential amenities, such as grocery stores or parks. The building may require extensive or costly modifications to the exterior, such as operable windows and balconies. Elevators, stairs and core could need significant modification. The building could also need seismic upgrading to better withstand a lateral-load (e.g., an earthquake). This could include bracing and anchoring nonstructural elements, such as partitions, lights, HVAC equipment, parapets and ornamentation.
Natural light is vital for dwellings, but it cannot reach interior spaces beyond a depth of about 40 to 50 feet. Office buildings typically have floor plates beyond this depth, which makes many of them undesirable for residential conversion. Some buildings may need extensive plumbing modification, HVAC retrofits or asbestos remediation. Such improvements and modifications are often required throughout the entire building, even if an owner is only proposing to repurpose a portion of the building for residential use. For the above reasons, an office conversion to residential use can be capital intensive and prohibitive.
However, a residential conversion may be a viable option if the above legal, structural or financial issues are present to a lesser degree or not present at all. An obsolete office building with high vacancy, small floor plates and a minimal number of reuse hurdles may work, but will likely be hard to find. Favorable legislation is either underway or has already been passed to make more properties feasible for residential conversion. In California, AB 1532 would allow conversion as a matter of right irrespective of local zoning for many properties. This would make office-to-residential approvals ministerial in order to avoid CEQA compliance. At the federal level, H.R. 4759 would expand the investment tax credit to add a credit for qualified office-to-multifamily conversions where 20 percent of the units are affordable.
California recently passed AB 2011, which creates a CEQA-exempt, ministerial approval process for qualifying multifamily housing developments on sites within a zone where office, retail or parking are the principally permitted use, subject to certain requirements. The state also passed SB 6, which allows residential use on property zoned for office, retail or parking, without requiring a rezoning, if certain requirements are met. However, these legislative changes are only expected to help at the margins. Much more expansive legislation and government incentives would be needed to make substantially more office properties viable for residential conversions.
While office-to-multifamily conversions are still fairly fringe due to their complexity and cost, one successful example is the 29-story building at 100 Van Ness Ave. in San Francisco. Originally built in 1974, it was a Class B office building with retail space at the time of conversion. Construction commenced in June 2013 and was completed in April 2015. The building originally had a façade of precast concrete wall panels. This was entirely replaced with a floor-to-ceiling, glass-covered curtain wall. The roof was redesigned to create an open space roofdeck for tenants, complete with landscaping and unobstructed views of San Francisco and the Bay Area in all directions. Positioning the project for the luxury market – and avoiding a seismic retrofit – aided the economic viability of the conversion.
When does a conversion to life sciences work?
Due to the difficulties of office-to-residential conversions, owners have looked to other alternative uses, including life sciences uses. However, finding a suitable office building and successfully converting it to life sciences use while staying under budget is not without challenges. A building suitable for the needs of life sciences use is typically lower rise with small floorplates and higher ceiling clear heights. Typical office floor load capacities may work, but could restrict the kinds of laboratory equipment that can be utilized. In this scenario, the ability to hold heavier loads on each floor may be essential, but potentially not feasible.
Life sciences spaces also require specialized systems and features that can be costly. The building may need upgrades to floor vibration stability to accommodate the use of sensitive microscopy equipment; upgraded electrical and other utilities (e.g., 4000 amps and 25 watts per square foot vs. 2000 amps and 12 watts per square foot for a Class A office building); high-efficiency HVAC and exhaust systems to provide environmental safety, cleanliness and 100 percent fresh air; and a standby power generator and alternative-energy storage system that can provide 24/7 power to ensure the protection of temperature-sensitive products, processes, research data and critical infrastructure.
Further, demand for life sciences products and services is stronger around concentrated life sciences zones. These are often located near major research universities and institutions. The location will also need to comply with local zoning laws.
If an office building is a good fit, a conversion to life sciences use may provide many advantages. The highly technical and specialized work environment of a lab cannot be easily replicated in a home office, so the threat of remote/hybrid work is largely removed with life sciences use. The construction timeline is typically shorter in a conversion than ground-up construction and avoids the uncertainty of a multi-year entitlement process. A life sciences conversion often involves conversion of about 50 percent or less of the building, but conversions may generate higher rents comparable to new ground-up life sciences buildings. Thus, conversions to life sciences use may take less time and cost less than ground-up development, while potentially generating comparable revenue.
The building at 704 Quince Orchard Road in Gaithersburg, Md., provides a case study. At the time of purchase (March 2018), the office building was 36 years old, 60 percent occupied and located in a biotech corridor. The purchase price of nearly $6.9 million ($86 per square foot) was below half the price paid for the building in June 2007. Demolition began in May 2018, and entitlements moved along smoothly with no need to change zoning. The site plan was approved in July 2018, and the building permit was pulled in August 2018. Life sciences labs were constructed, the roof was reinforced, and new systems and air shafts were installed. Ultimately, the third floor was fully leased to a life sciences tenant; the second floor was 60 percent leased to life sciences tenants while keeping 40 percent for office tenants; and the first floor was largely utilized for building amenities. The building achieved full occupancy in March 2020.
While converting an underperforming office building to multifamily use may seem logical given the current oversupply of office and undersupply of multifamily, many properties may not be well suited for such a conversion. Many owners have found that a conversion to life sciences is more achievable and more economically desirable.
Ultimately, additional legislation and government incentives may be necessary for office conversions to be a realistic consideration for most office building owners, but undertaking the analysis of whether an office building is a good candidate for conversion is becoming an increasingly critical exercise given our current climate of rising office vacancy and uncertainty as to future office demand.
— Julian Freeman and Dave Wensley, partners, and Gabe Pitassi, associate, work for Cox, Castle & Nicholson, a law firm specializing in real estate based in Irvine, Calif. This article originally appeared in the October 2023 issue of Western Real Estate Business.