Urban centers, including downtown Orlando, could be on the verge of a collapse of their office markets as the culture change resulting from COVID19 plays out over the next several years.
As bad as the market was in 2020, a majority of long-term office leases still haven’t come up for renewal, and when they do, landlords should prepare to see an exodus of tenants, according to expert panelists at the National Association of Real Estate Editors conference in Atlanta.
So when those loans come due and the banks decide they don’t want to be in the landlord business, someone like Ed Cross will be in the market to buy those buildings, gut them and convert them to mixed-use vertical villages.
Cross, founder of Texas-based Cross & Co., is a partner in the adaptive reuse of a historic, 31-story office tower in downtown San Antonio, where he said office market is 83% leased but only 20% occupied.
Cross got his start in Houston in the 1980s, when the office market crashed and 90% of all office buildings were in foreclosure. He predicts a similar scenario will play out within the next five years because of the work-from-home culture and aging and obsolete office stock.
“What you’re actually going to see is the banks are going to be very motivated to sell or to do something else before they have to take it over and manage it,” Cook predicts. “Banks are just terrible at managing real estate. They know the minute they take title to it, it loses value.”
Julie Whelan, global head of occupier research for CBRE, said that office conversions are still rare, averaging about 35 buildings per year in the 25 largest office markets since 2016. “But what’s interesting is when you look at what’s planned, I would say that we are looking at about double the amount of planned projects over the next couple of years versus what has happened historically.”
The trend is being led by the demand for urban multifamily space, but other uses include hospitality and life sciences. Despite the uptick, the combined amount of completed and planned office conversions represents just 2% of the amount of office stock.
Whelan and Cook expect banks to capitulate and sell buildings on the cheap rather than try to operate them at less than 50% occupancy. But that doesn’t necessarily mean each office tower is a good candidate for residential or mixed-use conversion.
“Because this is not simple to do,” Whelan said. “And I think right now there are many, potentially a lot, of excited developers thinking that this could be some easy money. But it is not because you really have to understand the location. Because the location and the demographics of that location drive what the demand is in that particular area. Is the building itself suitable from a floorplate perspective?”
She said older or historic buildings with smaller floorplates are strong candidates for conversions. “What we found in our study is that the average age of the building was 81 years old, and the average size of it was 175,000 square feet,” she said. “So what that tells you is that it’s a lower height building that has easier floorplates to work with.”
Dougal Cameron, president of Cameron Management in Houston, is in the midst of transforming the 30-story Esperson Tower in downtown Houston into a residential mixed-use village. The tower was built in 1927, so it hits the sweet spot Whelan described.
‘Our goal is to convert it into what we’re calling a vertical entrepreneurial village where the top 100,000 square feet is residential, the bottom 100,000 square feet is coworking and the middle is whatever everybody else wants,” he said.
Cameron believes the current U.S. office market is anywhere from 20% to 50% overbuilt, and much of the older stock is functionally obsolete. That makes them attractive investments for adaptive reuse for a developer whose willing to think outside the box.
“And in that some of them, you’re gonna have to really get creative,” he said. “If you get an office building cheap enough, it’s amazing the creative things you can do like vertical hydroponic farming and all kinds of other stuff.”
He said the conversion process is slow and expensive. Only a handful of architects in the U.S. have experience completing office tower conversions, which typically involve gutting the building to its frame. Often, the buildings need to be rewired and replumbed to make them suitable for residential use. Natural light is another factor that must be considered, especially in larger-floorplate buildings. In those cases, converters have cut atriums into the center of the building or converted a box tower into a U-shaped building.
Whelan said local governments will likely have to offer incentives or subsidies to offset the financial risk for conversions because it’s not in their interest to allow vacant buildings to deteriorate and drag down values in the CBD. That’s another reason historic buildings, which qualify for tax credits, are being sought after for conversion.
“I think that cities are not going to be able to afford to allow these buildings to go vacant, because along with that is going to come desolate neighborhoods and crime and everything else — and we just don’t need more of that,” she said. “So buildings will drive the use that makes sense. And I think that we can only begin to skim the surface on the creativity that will come.”
But in some cases, the best case might be to demolish the building to create “more green space in our cities to make them more desirable places that pedestrians can access and feel better and I wouldn’t be surprised if we see some of that happening.”
In Orlando, the plethora of low-budget motels have been sold for residential conversion, but no one has committed to an office conversion yet. The closest case was the SOAB building at 200 S. Orange Ave., which was proposed for residential conversion in 2020 by then-owner Lincoln Property Co.
Their plan was to reposition the 10-story building as mixed-use with 143 residential units, maintaining the ground-level restaurant and deli space.
The project was halted when PiedmontOffice Realty Trust, which owns the adjacent office tower and purchased the building for $20 million to prevent the residential conversion. The REIT later initiated a renovation plan to make the building more attractive to office tenants.
Have a tip about Central Florida development? Contact me at lkinsler@GrowthSpotter.com or (407) 420-6261, or tweet me at @byLauraKinsler. Follow GrowthSpotter on Facebook, Twitter and LinkedIn.
