Are Residential Conversions the Answer to a Stagnant Office Market?

April 18, 2024

CRE - April Blog 2024

About $820 billion in CRE loans are coming due in 2024 according to MSCI—about 20% of that linked to office properties. As noted in last month’s coverage of commercial real estate trends in Greater Phoenix, concerns about defaults are rising, but we are not yet seeing them in any significant number. (Indeed, in highly amenitized properties in the Camelback Corridor, we are seeing price improvement—a stark contrast, for example, to the weakness in the Central Avenue corridor.) While loans are coming due, lenders seem to be frozen, reminiscent of the “extend and pretend” days of the Great Recession that hit around 2010-2012 for CRE.

The office market in Greater Phoenix continues in a holding pattern, with everyone from property owners to investors waiting for the next shoe to drop. There is an understandable undercurrent of concern related to commercial office space and discussions about what can be done to reuse or repurpose these buildings, including converting offices to multifamily housing. This is not a local issue or conversation—it’s happening across the nation.

Making a Push for Office-to-Residential Conversions

Nationally, the number of office-to-residential conversions is up more than 350%, according to data from RentCafe. While that seems like a huge increase, it represents a tiny fraction of the overall multifamily market: just 55,300 units across the country. Phoenix ranked at #10 in the country as far as conversions, with 1,377 units projected in 2024. The highest-visibility project is Kierland Sky, which will add 420 units to the market.

Still, it is a trend in the early going—one that governments are supporting at a variety of levels. For example:

The Challenges of Converting Commercial to ResidentialAdaptive re-use has been a familiar strategy for years within the retail sector and even hotels. Converting commercial buildings to residential ones, however, comes with an array of challenges, including changes to structures, ventilation, plumbing and floor plans—not to mention the unknowns of rezoning. Add to those the recent issues at the One Camelback property, including the bankruptcy of the subcontractor and construction delays. Moreover, any developer who wants to ride the adaptive reuse trend in Phoenix will be facing serious competition, with a record supply of multifamily product going live in the coming months.

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