October 26, 2023

Commercial to Residential Conversions & High Office Vacancies in NYC

Commercial to Residential Conversions & High Office Vacancies in NYC

There are two persisting real estate-related issues after the COVID-19 lockdown period — lack of residential housing and high commercial office vacancies. Consequently, the transformation of commercial spaces into residential units has gained significant traction.

For this reason, below, we’ll discuss efforts by federal and local governments to support commercial to residential conversions, as well as the implications of an impending wave of mortgage maturities and what it could mean for the real estate landscape.

Federal Support for Commercial to Residential Conversions

In response to the pressing need for affordable housing and the potential to repurpose underutilized commercial spaces, the U.S. Department of Housing and Urban Development (HUD) has been actively promoting research and initiatives aimed at facilitating commercial to residential conversions. 

Specifically, HUD will gather empirical evidence to substantiate the benefits and challenges associated with commercial to residential conversions. Notably, HUD’s financial support for research endeavors in this area should play an important role in understanding the logistical, economic and societal aspects of transitioning office buildings into residential units — which will, in turn, foster initiatives in this area.

High Office Vacancies: A Growing Concern

Persistently high office vacancies across urban centers have emerged as a significant concern — not only to the commercial sector, but also to the community at large. Likewise, economic shifts accelerated by technological advancements and the global health crisis have accelerated remote work and altered the demand for office space.

Accordingly, businesses are increasingly considering hybrid work models, and numerous office buildings are experiencing lower demand and high vacancy rates, thereby posing challenges for property owners, developers and local communities.

Additionally, high office vacancies can have a profound influence on urban landscapes. Namely, empty office buildings can reduce neighborhood vitality, decrease property values and strain local resources. There also appears to be general agreement that the current commercial office landscape must adapt different strategies — including repurposing underused office spaces for residential or mixed-use purposes — to align with the principles of sustainable urban development.

To that end, New York City is attempting to address this issue broadly by exploring revisions to existing zoning regulations and provide incentives, such as tax breaks, to facilitate conversions of underutilized commercial spaces. This could potentially encourage property owners to convert their spaces into residential units.

However, this effort is just beginning, and there have been a lot of pushbacks when past proposals were applied too broadly across the city because many neighborhoods didn’t want increased population density. Therefore, it’s important to note that any of the aforementioned initiatives can change from the time of this writing due to the rapidly evolving area.

The Impending Wave of Mortgage Maturities

Another potential challenge in the real estate landscape is the wave of mortgage maturities that may occur in late 2025 to early 2026. These maturities are the result of the cyclical nature of real estate financing: Mortgages secured during the peak of real estate activity in previous years are now approaching maturity, thereby requiring borrowers to either pay off the remaining balance or refinance their loans.

In particular, this will affect those who secured mortgages during periods of high property values. As such, this presents a significant financial hurdle, especially for those owning commercial office property with high vacancy rates because fluctuating property values (since the original loan agreement) affect refinancing options and repayment strategies. While it’s not entirely clear how this will influence the real estate landscape, it’s not unrealistic to expect many forced property sales and at least some degree of financial strain.

Granted, addressing this challenge will necessitate strategic planning, financial preparedness and proactive engagement by all parties directly involved.  However, the key to solving these problems appears to lie with the regulatory and tax relief that could potentially be afforded by governments.

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