With rapidly falling office property valuations that, according to one study, could lead to $800 billion in lost value by 2030, concern about what to do in the sector is understandable.

One of the potential strategies is to convert office buildings to housing. There have been questions about how effective this could be, given issues of building layout and the number of adjustments necessary to enable habitability.

A new National Bureau of Economic Research working paper (meaning not yet peer reviewed) from researchers at New York University and Columbia Business School, with support from the Brookings Institution, suggests “a set of criteria to identify commercial office properties that are physically suitable for conversion, yielding about 11% of all office buildings across the U.S.” The conversion specifically was to “green apartments.”

The paper’s authors were Arpit Gupta, an associate professor of finance at New York University; Candy Martinez, a doctoral student in finance at Columbia Business School; and Stijn Van Nieuwerburgh, a professor of real estate at Columbia Business School.

The researchers noted the “triple forces of rising interest rates, the emergence of remote work, and environmental taxes” and estimated that a building with a pre-pandemic valuation of $100 million would likely have a present value of $38.9 million, a drop of 61% loss of value.

The paper shows a “pro-forma real estate model that identifies parameters under which these conversions are financially viable” as well as “several policy levers available to federal, state, and local governments that could accelerate the conversion, and that may be necessary should policymakers desire the creation of affordable housing.”

The researchers found potential candidates through a six-step process:

  1. Focus on locations in a city where the negative pressures on office are strongest but where there are “strong transportation amenities.”
  2. Consider only buildings constructed before 1990 because often “historic buildings tend to be cheaper, have smaller floor plates, and are more charming, all of which increases their conversion appeal.”
  3. The model works with A-, B, and C buildings that are underused as many tenant companies have employed a flight-to-quality approach toward leased real estate.
  4. Require buildings to have at least 25,000 square feet in size to ensure enough economies of scale for conversion.
  5. Eliminate buildings with a distance from windows to core of more than 60 feet to enable enough light and air circulation as well as room for enough plumbing.
  6. Eliminate buildings with no or few long-term leases left.

The top five metro areas with the highest number of potential conversions were New York-Northern New Jersey-Long Island (634 buildings, 68.4 million gross square feet); San Francisco-Oakland-Fremont (358, 21.2 million); Los Angeles-Long Beach-Santa Ana (254, 16.2 million); Washington-Arlington-Alexandria (155, 11.6 million); and Chicago-Naperville-Joliet (113, 14.0 million).

The researchers then showed a pro-forma for a 212,500 square foot office building that went from $4.12 per square foot rent pre-pandemic to $3.50 post-pandemic. After conversion, with a usable 175,000 square feet, and hard and soft costs of $80 million, plus $10 million in green improvements, given 30 months to design and 18 months to lease up, market rate apartments would command $8 per square foot for a 2033 NOI of $11.5 million (up from $3 million post-pandemic), a net present value in 2022 of $4.1 million, and a 2022 IRR of 16.8%. For affordable apartments, the costs are the same, rent would be $6.84 per square foot, 2033 NOI of $9.2 million, 2022 NPV of -$8.6 million, and a 2022 IRR of 12.1%.