As the commercial market continues to crack, these three assets could be your next big opportunity

Offices across the country are still sitting vacant. nationwide office vacancy rate reached a highest level of about 20% in the first quarter of 2023, according to JLL, and while big tech companies putting pressure on workers Returning to the office, there has been an increase in commercial office delays due to the hybrid work model. The office crime rate rose 125 basis points in May, according to real estate analytics firm Trapp. more than 4%,

According to some experts, this spells trouble for the commercial real estate market and the wider economy. Morgan Stanley analysts are predicting a decline in commercial property values up to 40%A crash similar to the 2008 financial crisis. Fred Cordova, CEO of Korean Enterprises, believes it’s an accident. Already running, But while most companies agree that the office sector is under stress, some are more optimistic than others about the outcome for commercial real estate. For example, UBS Global Wealth Management claims the problem is manageableAnd a 2008-like crash is unlikely.

Peter Margolin, National Broker Network Manager Alliant Credit Union, agree with this. “While we don’t think the CRE market will completely collapse, we do believe there are some markets that are going to struggle more than others going forward,” says Margolin. “This cycle is different from 2008, in which capital markets are still open, albeit not as liquid as they were in previous years. Today, commercial real estate lenders like Alliant are still actively lending on specific asset classes, demonstrating strong demand for borrowers with good credit quality.

Commercial real estate has historically been viewed as a high risk investment, according to the FDIC. Investors who had taken the risk of buying commercial office space are now finding themselves in a difficult position as demand for space has fallen, but there is a way out. “There should be opportunities for property owners to adaptively reuse their vacant office space,” says Margolin.

Reusing Empty Office Space

While remote work is here to stay in some capacity, there is demand for retail space. bounce again from the recession of the pandemic, and from the point of view of self-storage remains promising, There is a demand for multifamily housing expected to decreaseBut housing shortages and rising rents are still options in many markets. Attractive investors at the right places.

“For older, less amenity buildings, multifamily and residential products are popular

conversion. This can include market rate rent, workforce housing, student housing, etc.

Senior housing, and even affordable housing, depending on location and market

demographics,” says Mika Solit, senior project manager at national real estate advisory firm Project Management Consultants, Inc., “Other conversion options are hotels and, depending on the size and configuration of the building, technology use such as self-storage, document storage and life sciences,” says Matt Silvers, vice president of the firm.

But what kind of undertaking is required for these conversions, and can the cost be recouped? When is it appropriate for commercial real estate investors to repurpose office space, and when is it not worth the effort? We asked several experts in the commercial real estate sector to help you weigh your options.

mixed use retail

shopping malls are dying long before the pandemic, and the retail space sector has been shifting towards services since reopening. Mixed-use retailing is gaining momentum as people want more amenities where they live and work. The slowdown in home buying may also be contributing to the popularity of mixed-use space. “Mixed use is the past, present and future,” says Sean Slater, Senior Principal. rdc, This is especially true in areas of the country where demand for multifamily housing is high, such as New York, where investors are increasingly flocking. Developing Class B and C properties In mixed use space.

According to Slater, repurposing office space for mixed-use retail works better than office-to-retail conversion. “Multi-level retail is rarely successful, and offices are rarely at street level, so a mixed-use approach seems most appropriate,” he says. “Street-level retail and food and beverage with residential and small office leased spaces can diversify many vacant buildings without much change to a residential-only conversion.”

It is also better for the future of the economy. Slater says there is still demand for office space and if too many urban Category A office properties are converted into residential accommodation then at some point the supply may fall short. “I believe a patient approach and a move to diversify into individual buildings will create a more stable market,” he says.

Office tenants on average are paying approx 25% more Tenants on the multifamily side can also expect to pay a premium for mixed-use space compared to traditional office space, and for an amenity-packed building. But there are definite challenges, including finding the right management for an asset with multiple use cases.

self Storage

while rentals are Moderate In the self-storage sector, the outlook looks promising compared to other types of commercial assets. Conversion from office space to self-storage can be beneficial for investors holding properties with low occupancy rates.

“While it can be a challenging undertaking, office floor conversion can be rewarding,” says Margolin. “In some cases, for really old spaces, the rent for self-storage can be even higher than what the space is offering for office use. For example, lower floors with less ideal views would be ideal places for storage,” he says.

But investors who choose to repurpose office space into self-storage face obstacles. “The good news is that there’s likely to be plumbing and a lot of lighting already in place for a storage conversion,” says Margolin. “The big issue will be how much work will have to be done with those floors to remove all walls, floors, furniture and other equipment to free up space before converting to storage use. The next biggest cost would be designing the storage units to fit the floor plates and be able to transport the contents to those floors.

Margolin says obtaining financing has become even more difficult but not impossible. “There is a natural tendency for traditional lenders to pull back when the economic outlook becomes more volatile,” but this has created opportunities for non-bank lenders and private equity firms to enter the sector and even more traditional lenders. Opportunity to work with. On-note financing packages and A-note financing. “Financing is generally still obtainable for strong credit borrowers on properties with strong fundamentals,” says Margolin.

multifamily housing

Despite housing shortages and rising office vacancies, conversion from office space to multifamily housing remains a problem unusual solutionAnd don’t expect change because of it critical cost Related to making a switch. “Investors must recognize that on a cost-per-unit basis, the cost of a conversion may ultimately exceed that of a new development,” Solitt says. But it remains an economically viable option in some circumstances. “Owners need to know in detail the economics of their project and determine the market for the additional residential units, as well as have a clear path toward re-authorizing their building for this new use. “

watching state boost conversions have eliminated fees, implemented more lenient zoning change procedures, and even provided tax incentives to redevelopers, but by 2022 Moody’s report Note that office property values ​​will have to decline significantly to make the conversions worthwhile. However, in some areas, it may already be the case that office to multifamily conversion is a good solution.

“Location is a key factor,” says Solitt. “Investors will want to limit jurisdictional and regulatory hurdles that can complicate conversion, but there must also be demand for housing in the area, which drives up values ​​and rents. If the location works out, the building should have a relatively high vacancy rate” so that owners can avoid lease buyouts.

“Ultimately, the building itself is important. operable windows, high perimeter density, and

The shallow floor plate depth are all conversion-friendly features, providing owners with more square footage for eventual living space. Adequate road frontage and open space around the structure also contribute to the preparation for the conversion,” says Solit. “Older, smaller buildings are more amenable to conversion, rather than larger, ultra-modern structures,” says Silvers.

Bottom-line

Reusing office space can be challenging, expensive and downright risky. But even with rising vacancies and crimes among Class A office properties, Some investors may feel that it is necessary to adapt to minimize losses. Of all the options available, mixed-use retail conversions seem to be the trend, especially in areas where live-work-play spaces are in demand, but self-storage and pure multifamily conversions are also viable options in some markets. . The outlook for commercial real estate is still unpredictable. While prices may fall further, demand for office space may also pick up again. It is necessary to evaluate your personal situation before taking any sudden step.

Note by BiggerPockets: These are the views expressed by the author and do not necessarily represent the views of BigPockets.