What You Should Know Before Converting Your Office to an Apartment

Factors to Consider When Converting an Office into an Apartment

Even though precautions against a pandemic are becoming less important, the number of empty office buildings in big cities has reached an all-time high and isn’t likely to change much for a while. Even if an employer wants an employee to go back to work in person, this is still true. According to some reports, there is an impending disaster of failing office buildings, and a number of buildings in key markets are likely to be in loan workout talks with lenders. This impending crisis is made worse by a general trend (even before the pandemic) toward office downsizing, rising interest rates and other financial market uncertainties, office tenants’ flight to quality and away from the large number of old buildings, high office rents that don’t seem to go away, and the fact that virtual work seems to be here to stay. If any of these factors (or all of them) have a big impact on a building owner, or if all of them do, how can office building owners deal with this problem other than selling their buildings at a loss or starting a demolition or redevelopment project, if that’s even possible?

Conversion is one way out.

One thing that can be done about an office that has a lot of empty spaces and is losing value is to turn it into apartments or a building with multiple units.

Conversions can be good for a number of reasons, such as the possibility of higher profits, lower material costs, and less damage to the environment compared to building an office from scratch.

Conversions are also appealing to cities and towns that want to preserve the urban fabric, increase the number of rental homes, create more live/work spaces, and help with more environmentally friendly renovation projects.

But conversions have been done much less often than development (or redevelopment) projects that start from scratch.

Since developers don’t do these kinds of projects as often, they don’t know as much about the financial, legal, physical/design, and market risks that come with conversions and how to best protect against them.

Managing the risks of conversion:

A thorough due diligence process that is tailored to the specific issues of a conversion will go a long way toward lowering the risks of the project and making it easier to make a more accurate budget for the conversion.

This should include an evaluation of the target building’s current physical condition, structural issues, and design potential. It should also look at the legal effects of changing the building from an office to a home, the effect of current market conditions, and any other relevant financial and transactional factors.

The goal of all of these checks is to find the “right” building for the conversion that can be finished on a budget that can be trusted (and, most importantly, to rule out others that are unsuitable due to, among other risks, the design challenges they present and the unanticipated costs they could yield).

Important parts of due diligence:

Here are a few important things to think about before converting:

How a building looks and how it could be designed

From a traditional point of view, is the building’s structure sound, and do all of the necessary operating systems and other building parts work?

Think about all of the renovation needs, apart from those for the conversion, that need to be part of the project (such as a need for a new roof or the replacement of elevators or other key building operating systems).

Since it’s likely that the mechanical and distribution systems of a typical office building won’t work for turning it into a home, it would be smart to plan for their replacement.

Are there accurate “as-built” building plans, and can one or more schematic plans be made that explain the design challenges of the conversion?

One thing that could go wrong with the conversion is finding out (after the project has started) that the building plans don’t show key building parts the right way.

Does the building have the physical, functional, and technical parts it needs to be changed?

Some examples are large parts of buildings that can be used again and floor plans (including the width of the building) that are easy to change for residential use. Pay close attention to how deep and how the floor plate is set up, and if it can be used for apartments. Also, check to see if the building has a central core inside. Is the distance from the edge of the building’s interior core to the building’s outside walls right for the number of units and bedroom types you want?

Can the building be changed to fit the need for private kitchens and bathrooms, as well as the engineering, plumbing, and mechanical systems that go with them?

Check how much natural light comes in and if there are windows on all sides of the building. If not, could this problem be solved by creative design, such as taking out parts of the building to make courtyards?

Will the building have amenities for people who live there, like a gym, club rooms, outdoor cooking areas, and co-working spaces, since some people may work from home?

If parking is required or desired by the government, is there already enough parking?

How much “dead” space, or space that can’t be turned into rentable units or amenities without a lot of work, will there be after the conversion?

If a building has too much dead space that will hurt its ability to make money, it might not be worth converting.

Conditions for a change of use
Does the proposed apartment use fit into the building’s current zoning, or do they need to change it? If not, it will be very important to know the process, timeline, and problems that come with getting the needed rezoning and other entitlement approvals, such as building permits.

What building code requirements apply to the conversion, and can they be met with the changes that are planned for the building? Find out what other legal requirements must be met as well (i.e., if the building is designated historic, is in an historic district or overlay, or if neighbourhood review boards will be involved).

Will the government support a change? This could be the case if building more rental homes or fixing up neighbourhoods is a top priority.

This evaluation should also take into account the following:

Are there incentives or money to help pay for a conversion?

Is it a goal to move the building from a single-use office market to a mixed-use market that includes housing?

Will the change from commercial to residential be good for the area?

Conditions on the market and the building submarket:
Think about whether the market conditions are right for a conversion right now. What are the vacancy rates in the submarket where the building is located and in the area as a whole?

Are more and more office buildings being listed for sale or put up for auction?

Is there enough demand for housing for the types and sizes of apartments that are being planned?

How might problems with the supply chain affect the project?
How much do equity and debt capital cost, and how can rising interest rates and costs be managed in an inflationary environment?

Is the building’s location good for turning it into a home? For a conversion to be more likely to work, it must be close to public transportation and other important services (i.e., grocery stores, pharmacies, and restaurants). Also, people should want to live there because of the area around it.

Do the income levels and employment status of the likely people who will live in the submarket support the demand needed for the project?

Are there a lot of other apartment complexes in the same submarket, which might mean that the project would have a hard time getting people to move in?

Structure of the transaction: Who owns the building, how is it financed, and what pressures is the owner under that could affect the sale price, like an upcoming loan default?

Check to see if there are any upcoming regulations for the building (like those about how it affects the environment) that would lower its value even more.

The key is to figure out if the sale price of a building is low enough to fit within the budget for the conversion. If not, would the owner be open to a joint venture or ground lease instead of a sale, which could lower the cost of the project?

The key to due diligence is customising it.

If you want to do an office-to-apartment adaptive reuse transaction, you should start with a thorough due diligence process that is made to find the problems that usually come up during a conversion. With this approach, developers will be able to find ways around the project’s risks before they commit to it. This will be good for the developer, its investors, and the relevant municipalities as a whole.