Goldman Sachs Says Conversions Are Too Expensive

Since the depths of the pandemic, two things have been clear. One, there isn’t enough housing available for people. Two, given hybrid work and companies exercising a so-called move to quality, a lot of office properties are obsolete and facing still-growing vacancy rates that make them financially unviable.

Many people thought conversions would make sense. Turn the obsolete office buildings into multifamily dwellings. Help the housing crisis and improve the financial position of the property owners. This year, Yardi expects 55,000 apartment units to be converted from office buildings. That has quadrupled in four years. But that’s less than it sounds. Assume an average 75 units per building. That’s 733 buildings in an unusually active year of conversion — a rate at which it would take many years to do all the conversions.

Developers and designers have noted that there can be challenges with office-to-apartment conversions. The physical layout may not accommodate multifamily use. There’s a likely need for many plumbing and electrical changes, updates for residential building codes, elevators, and the like. Pricey.

That goes right to the heart of a new Goldman Sachs study about office-multifamily conversion. The big problem: it costs too much. Far too much. Not just the list of things that need to be done, but the price of the buildings.

According to the study, the overall office vacancy rate has climbed to 13.5% over the last three years, a high point since 2000. Over the next 10 years, the Goldman estimate is that the vacancy rate will climb to 18% “as more firms reduce their demand for office space when their current leases expire.”

They further estimate that “4% of US office buildings—those located in suburban areas or central business districts, built 30 or more years ago, not renovated since 2000, and currently facing vacancy rates above 30%—might be no longer viable as offices.” That percentage might be as high as 14% to 16% in the hardest-hit cities.

But the buildings continue to be too expensive. Nationally, the average price of non-viable office has, according to CoStar data that Goldman Sachs announced, has fallen to $307 per square foot since 2019. Average transaction prices are down 15% to 35%.

“However, because of lack of liquidity in this market, we think these recent transaction prices have not yet started to reflect the current values of many existing offices,” Goldman Sachs says. Various data sources say that conversion costs run from $100 per square foot to $500 per square foot.

Taking a per-square-foot conversion cost of $280 for areas that have been buffeted by remote work, “our model suggests that converting a nonviable office that is priced at the average current level will result in a $164 loss per sqft,” they wrote. “This means that current office prices would need to fall by that much, to around $154 per sqft or by 50%, for the cost to be fully covered by the stream of discounted future revenues.

Clearly conversions aren’t impossible. It’s the idea of scaling that is difficult because average prices would have to plunge. At that point, do owners find it cheaper and easier to give the keys back to the bank? If so, it’s not as though the bank will have the financial interest in doing conversions.

Multifamily Spring:

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