Office-to-residential conversions might be next urban trend – Sacramento Business Journal – Sacramento Business Journal

Through more than a century of history, the Hale Building in Downtown Sacramento has seen a number of uses: horse livery, church, department store, and for the last couple decades, an office and retail building.
Developer Paul Petrovich, who owns the building, said he’s seeing a vision for its next use: residential.
“It’s a natural evolution,” said Petrovich, who’s already studied what it would take to convert all three floors to residential, or even add a story of apartments to the 111-year-old building at 825 K St. “It’s time to reimagine, or at least be ready to do it.”
Petrovich may not be the only owner or developer who’s thinking that way. Many urban development experts believe in a post-pandemic future, it’s increasingly inevitable that more office buildings are going to be converted to residential use.
“In the near term, empty office space at more affordable rents represents an opportunity for cities to attract a more varied tenant base,” states the Urban Land Insitute’s 2022 Emerging Trends report, released earlier this month. “Over time, the obsolete, redundant space may be repurposed or cleared for other land uses, allowing markets to evolve to offer greater diversity and much-needed housing.”
A sea change as a catalyst
The idea isn’t without precedent. Stately office buildings in cities like Baltimore, Los Angeles and New York City became apartments years ago. New York saw one such conversion as far back as 1979.
Yet the coronavirus pandemic has created a scenario where the idea could accelerate into a trend, even in cities like Sacramento rarely thought of as hotbeds of urban development innovation.
In the first place, even predating the pandemic, is ongoing housing demand. Though the pandemic seemed to hamper leasing at new urban mid-rise projects for a few months, a steady stream of new proposals around Midtown and Downtown Sacramento suggests developers are still bullish on the area’s overall trajectory for residential population growth.
What makes such conversions more likely, however, is what’s happened with the office market. Within a matter of months, many companies found ways to have employees not only work from home but be just as productive as they were in the office. The company executives now talking about a return to the office often couch it as part of a hybrid model. In the long run, many are expected to look for smaller office footprints.
For Downtown Sacramento and possibly other large concentrations of office buildings, that could mean a reckoning. Owners who see extended periods of high vacancy may have to either contemplate a conversion, or see a property become financially insolvent.
Not always a perfect fit
Architectural firm Gensler has worked with both developers and cities on a number of office-to-residential conversions, including studies in cities like Washington, D.C., and Calgary, Alberta, on market conditions that make it a more plausible prospect.
“Obviously, the reality at the heart of why isn’t this more pervasive is economic reality,” said Manan Shah, principal at Gensler’s office in Oakland. In the last couple years, the firm developed a toolkit for plugging in an office building’s attributes to get a sense of how likely or feasible it would be to turn into apartments.
Generally, Shah said, the conditions to make it even possible include the right market conditions, such as a vacancy rate of 15% or more for a long period of time. Even in a good market, he said, there are some buildings that are the last to lease.
Some of the limiting factors for office leasing, he said, make it a better bet for a residential use, such as floor plates of 15,000 or 20,000 square feet, or high ceilings. Modern curtain walls of glass are also less desirable than “punched” windows at certain intervals, which line up well with making sure every residential unit has a window or two.
Typically, the best fits are buildings from the 1950s to 1970s, Shah said. “But it’s not age that matters, it’s the way it was built,” he said. A square block is the easiest to convert; irregular-shaped buildings less so. “If a lot of modifications need to be made, it may not justify the work,” he said.
Then there are the factors outside the building, such as whether the zoning even allows residential uses in commercial areas, Shah said. Lastly, an owner has to be motivated, for a process that will take years and will definitely mean at least a temporary loss of revenue, actual or potential, from building space.
Happening locally? Maybe
Money, of course, is also a barrier. The code requirements for an office building are typically less than for an apartment building. Starting with the obvious, most offices don’t have their own bathrooms, but any modern apartment almost surely does.
Though there’s a federal bill to provide tax credits for such conversions, its chances of passage are unclear, and so far a complementary bill in the California Legislature hasn’t emerged.
With that background, then, back to the original question: Are such conversions going to start happening in the Sacramento region?
One broker, whose firm specializes in urban properties, thinks there’s a good chance they will.
“Obviously, it’s building by building,” said Aaron Marchand, a vice president with Turton Commercial Real Estate. “But that conversion conversation has surfaced more often recently.”
He said he’s working with ownership groups on two different office properties he didn’t identify that could submit plans to convert their buildings in the next few months.
Marchand said in addition to a cloudy office market, many owners are warming up to the idea because they’re finding more receptiveness from lenders to the idea. Sacramento’s multifamily market has stayed hot for more than five years now, and those lenders are taking notice, he said.
Like Shah, though, Marchand said the circumstances have to be right, from extended high vacancy to building shapes and configurations. Because the region’s office market is still relatively early in feeling the fallout from the shift to at-home or hybrid office/home schedules, Marchand said, it may take a couple years for some owners to get to a place where conversion makes sense.
Most likely, it’ll start small, and maybe eight to 10 buildings will head that direction, Marchand said. Some owners may also go through the process of entitling a conversion, but then look to sell the building to someone else to carry out, he added. Being an office landlord and an apartment landlord are pretty different, after all.
However, there is some precedent for turning an office building into a new use in Sacramento. On J Street, both the Citizen Hotel and more recently the Exchange Hotel a few blocks to the west had long runs as office buildings before their owners converted them.
Hotel rooms are typically smaller than apartments, and obviously turn over more, meaning higher potential revenue.
There’s also been a recent proposal to convert an aging office building to housing, but miles from the urban core of Sacramento. Earlier this year, Sacramento County had a proposal to turn a two-story, 1970s office building at 4748 Engle Road in Carmichael into 18 apartments.
Neighbors opposed the move, and the proponent, Alameda-based Wang Brothers Investments LLC, didn’t return a call seeking the proposal’s current status. County supervisors unanimously approved the project in April, but it doesn’t appear to have moved forward since then.
Petrovich said while he’s done a lot of research on the possibility, he’s not ready to pull the trigger at 825 K St.
He has some advantages built in: 14-foot ceilings, and a previous developer did seismic work in the late 1970s that would allow more walls and stairwells, he said.
But in addition to his own offices, he has technology company Skyslope Inc. as an office tenant, and drugstore Rite Aid taking up most of the ground floor.
If those tenants decided to leave, he said, he estimates the rent for apartments ranging from 700 to 1,200 square feet would make it feasible to convert the building.
“There’s been a shift, and I don’t know what the floor is for office,” he said, referring to how much lease rates may drop if more tenants across Downtown decide to leave their space. “I’m preparing myself for what I think is inevitable.”
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