Beyond Residential: Office Conversions To Life Science, Industrial And Other Uses
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 (aka, an adaptive reuse or repurposing) to access higher rents and occupancy rates. In view of nationwide housing shortages, especially in California, converting office to multi-family 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 science, industrial in-fill, or another use or uses. Such conversions, while posing their 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 multi-family 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 multi-family building may 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 may 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 and parks. The building may require extensive and costly modifications to the exterior, such as operable windows and balconies. Elevators, stairs, and core may need significant modification. The building may also need seismic upgrading to better withstand a lateral-load (e.g., an earthquake), including 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 approximately 40-50 feet. Office buildings typically have floor plates beyond this depth, which makes many office buildings undesirable for residential conversion. Some buildings may need extensive plumbing modification, HVAC retrofits, or asbestos remediation. Often such improvements and modifications are 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 and 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 multi-family conversions where 20% of the units are affordable. California recently passed AB 2011, which creates a CEQA-exempt, ministerial approval process for qualifying multi-family 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. (See Cox Castle & Nicholson’s previous Client Alert on AB 2011 and SB 6 for more details https://www.coxcastle.com/publication-governor-signs-new-housing-legislation-allowing-residential-development-on-commercial-properties). However, these legislative changes are only expected to help at the margins, and much more expansive legislation and government incentives would be needed to make substantially more office properties viable for residential conversions.
When Does a Conversion to Life Science Work?
Due to the difficulties of office to residential conversions, owners have looked to other alternative uses, including life science uses. However, finding a suitable office building and successfully converting it to life science use while staying under budget is not without challenges. A building suitable for the needs of life science use are typically lower-rise with small floorplates, and higher ceiling clear heights. Typical office floor load capacities may work, but may restrict the kinds of laboratory equipment that can be utilized, so the ability to hold heavier loads on each floor may be essential but potentially not feasible. Additionally, life science spaces 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% 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 science products and services is stronger around concentrated life science zones, 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 science use may provide many advantages. The highly technical and specialized work environment of a lab cannot easily be replicated in a home office, so the threat of remote/hybrid work is largely removed with life science 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 science conversion often involves conversion of approximately 50% or less of the building, but conversions may generate higher rents comparable to new ground-up life science buildings. Thus, conversions to life science use may take less time and cost less than ground-up development, while potentially generating comparable revenue.
Converting to Other Uses
Neither residential nor life science uses may be the best option for some owners and properties. Instead, an office conversion to industrial, medical office, or hotel use may have greater potential, or a vertical mixed-use conversion could create an optimal combination of uses.
- Industrial: Warehouses are necessary to assemble, store, and deliver goods and products, whether they’re bought in-person or online. An older suburban office on a large land plot that is already zoned industrial, and either vacant or with short term leases, could be a good candidate for a conversion to industrial. It should be noted that because the uses differ greatly, an office to industrial conversion almost always requires demolition of the existing structure and ground-up construction. But, perhaps surprisingly to many, the significant increase in demand for warehouse and distribution facilities, including industrial outside storage (IOS) facilities, particularly in urban infill areas, has resulted in greatly increased rental rates for such industrial product in many locations that sometimes outpaces office rent returns in certain markets. This can justify conversion from office to industrial use, which historically has not been a typical redevelopment opportunity.
- Medical Office: A medical office building is specifically developed for health care providers. These buildings typically include patient waiting rooms, exam rooms, operating rooms, and specialized building systems. An owner can save on ground-up development costs with this type of conversion, since a waiting lobby and offices are already in place, but medical offices usually require upgraded plumbing and electrical systems in comparison to traditional office. They will need to comply with zoning and healthcare codes as well.
- Hotel: The modifications in a hotel conversion are similar to those of a multi-family conversion, such as more plumbing and bathrooms, similar finishes, and modified HVAC. Parking can also be a significant issue in hotel conversions, depending on the mix of uses and the local zoning laws. While hotel units require less space than apartments, hotels are considered operational buildings, and will need to be designed and built out for 24/7 operations.
- Vertical Mixed-Use: Vertical mixed-use refers to multiple different uses combined in the same building. Various use combinations can be utilized in a vertical mixed-use conversion, such as converting a portion of an office building to residential use and other portions to a hotel while perhaps maintaining some existing office. A vertical mixed-use conversion has many of the same land use and regulatory challenges as other conversions, but can result in a more scalable redevelopment scenario to each market and also better manage the conversion cost for portions of the office building.
Conclusion and Takeaway
While converting an underperforming office building to multi-family residential use may seem logical given the current over supply of office and under supply of multi-family residential, many properties may not be well suited for such a conversion. Many owners have found that a conversion to life science is more achievable and more economically desirable. If neither multi-family residential nor life science uses are feasible, a conversion to other uses such as industrial, medical office, hotel, or vertical mixed-use can be explored and may present a workable solution to optimizing a building’s profitability under changing market conditions. 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.
If you would like to know more about office conversions or how to evaluate whether your project may be a viable candidate for conversion from office to an alternative use, please contact Dave Wensley, Julian Freeman, or Gabe Pitassi.
This alert can also be found on the November 2023 edition of Western Real Estate Business.