Could Boston's Plan To Convert Office Space To Housing Save The Commercial Real Estate Market?

Boston Mayor Michelle Wu recently announced a program aimed at alleviating the city's housing crunch. The program, which involves incentivizing landlords to convert their empty downtown office space into housing, could also stave off what is expected to be a bloodbath in the downtown office market nationwide. 

It's no secret that the commercial real estate market, especially the office sector, is facing challenges. Many investment analysts expect low occupancy combined with drastically increased interest rates will create a perfect storm for the industry. Some of the more dire predictions are that another 2008 is in store, with billions of dollars worth of toxic assets and mortgage defaults crippling the industry. 

Boston's Plan Can Alleviate Two Major Problems At Once

That's what is so intriguing about the plan in Boston — the ability to possibly kill two birds with one stone. The pandemic changed the way people live and work in terms of commuting downtown and driving back to the suburbs every day. Even as many CEOs demand workers return to the office, it's clear that there is more office space available than the market needs. 

Considering that most office REITs and commercial investments depend on occupancy rates above 95% to pay investors, even a small decrease in occupancy will put a giant squeeze on the industry. At the same time, cities like Boston are experiencing a major shortage in housing.

Cities around the country are monitoring Boston's plan to convert much of what will be vacant commercial space to residential property. If it works, it may represent a lifeline for an industry in troubled waters. 

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How Did Boston Come Up With This Idea?

Boston's Downtown Revitalization report, released in October, details the condition of the city's core, and it isn't pretty. Vacancy rates in downtown office real estate are in the 20% range since the pandemic. Numbers like that could lead to the kind of foreclosure crisis that would unsettle an already nervous real estate market and banking industry. 

This motivated the Boston Planning and Development Agency to contract with a private company to advise on the possibility of converting some of the empty downtown commercial and office space to housing. The consultants found that a partnership between the city and private industry is the only way forward to complete the conversions. 

The conversions will be expensive, and converting commercial properties into housing has several challenges, including:

• Adding extra bathrooms
• Configuring spaces with sufficient light
• Providing climate control to dozens of tenants per floor instead of a handful
• Recalibrating electricity to accommodate home appliances
• Cost of designing new floor plans for residential spaces
• Material costs 
• Labor cost

How The Plan Works

It will be difficult for commercial property owners struggling with low occupancy and high-interest rates to come up with the capital for the effort, so the city will offer participating buildings a property tax reduction of up to 75% for 29 years as an incentive. A streamlined approval process will speed applications along more quickly than the traditional permitting method. 

The plan encourages building owners to keep the ground floor of buildings as retail spaces. To participate in the program, property owners must agree to enhanced energy efficiency standards and comply with Boston's inclusionary zoning rules by allocating a significant portion of the residential space to affordable housing. 

Owners must also agree to pay the city 2% of the sale price if the building is sold. This would allow the city to recoup some of the property tax revenue it is sacrificing to make the program possible. 

A Different Aim With an Old Approach

Converting commercial real estate to residential in downtown cores is not a new idea. Many cities, from Los Angeles to New York, have instituted similar programs, but most were geared toward repurposing the affected areas as higher-end housing.

Boston's plan — the Downtown Residential Conversion Pilot Program — will be a partnership between the public and private sectors in Boston. The program's mission is to increase affordable housing while repurposing empty buildings. If it works, it might be among the most prominent examples of an urban renewal project that increased affordable housing in a city desperately short of it. 

Boston's Plan Could Serve As A National Example

The lack of affordable housing and an overabundance of commercial real estate is not unique to Boston. Almost every major metropolitan area in the United States is struggling with these issues, so many city leaders are watching how it works. It won't take long to find out. Interested building owners must submit their applications by 2024 and start construction by October 2025.

If the program succeeds, investors, bankers and city governments across the country will have a viable model for alleviating their commercial real estate vacancy issues while adding energy-efficient, affordable housing. It wouldn't completely eliminate the lack of affordable housing or fill all the vacant commercial space, but the chance to put a sizable dent in both of those problems at once is a great opportunity.

Will It Work?

Only time will tell whether Boston's plan works. What is obvious is that the challenges facing the office and commercial real estate market need innovative solutions to prevent another wave of toxic assets from washing out the economy. If that can be done while helping to add affordable housing to the mix, the plan could be a win-win situation for investors, renters and local government. 

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