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Throughout California office buildings continue to suffer from historically high vacancy rates and the state appears to be redoubling its efforts to tap into these underutilized resources as part of an ambitious plan to increase housing units. 

A significant regulatory change came on July 1 with the passage of A.B. 2011, the Affordable Housing and High Road Jobs Act of 2022. S.B. 6, the Middle-Class Housing Act of 2022, took effect the same day. These laws expedite the approval process — reducing red tape and bureaucracy — for converting commercial properties zoned for retail, office or parking into housing.

On Feb. 17, A.B. 1532, the Office to Housing Conversion Act, was introduced to further incentivize the conversion of offices into condos and apartments. It has been referred to committee.

The bill categorizes office-to-residential conversion projects as by-right developments, thereby relaxing the permitting and review process for these projects and restricting a city’s or county’s ability to require certain permits, regardless of zoning.

A.B. 1532 also would establish an office-to-housing conversion fund, to partially subsidize such conversions.

Office Vacancies

According to CBRE, office vacancies reached an average of 17.1% last year, the highest percentage in three decades. Of course, some cities have been hit much harder than others.

In San Francisco, for example, office vacancies have topped 25%. As a result, increasing numbers of commercial landlords are defaulting on their loans — more than 3.38% of commercial office loans are now materially delinquent — a spike from a year ago, according to Trepp Inc.

While an overabundance of office space is not unheard of, the velocity at which office vacancies are increasing is troubling. Indeed, in some cases, the rate of tenant departures has resulted in so-called zombie office buildings — where vacancy rates have topped 50% or more.

According to a report released this summer by the McKinsey Global Institute, the post-COVID-19 new normal of companies embracing some type of hybrid work model may result in the value of office buildings being diminished by $800 billion globally.

Furthermore, the report reveals that hybrid work is here to stay — with office attendance hovering at approximately around 30% below prepandemic levels.

According to McKinsey, “Cities and buildings can adapt and thrive by taking hybrid approaches themselves. Priorities might include developing mixed-use neighborhoods, constructing more adaptable buildings, and designing multiuse office and retail space.”

With the demand for residential housing heating up and political pressure to address housing shortages increasing, many owners and developers are exploring the potential of converting office into multifamily communities.

And while there undoubtedly is a societal upside of more affordable housing and sustainable development resulting from conversion, the process itself involves significant economic and legal hurdles.

Design and Structural Impediments

Office conversions can be cost prohibitive — up to $500 per square foot. There are many reasons for the high costs, but a primary factor is that offices are designed and constructed much differently than multifamily residential buildings.

Major construction obstacles include deep floor plates and high interior square footage — a configuration that limits access to light and air, making it difficult to design liveable units with abundant natural light. Some developers are attempting to address this issue by retrofitting buildings with light wells in the center of the building’s floor plates.

Additional challenges include a lack of balconies and operable windows, and — since most office buildings have just one or two bathrooms per floor — the need to install hundreds of bathrooms and kitchens along with the necessary plumbing and ventilation. The higher costs are exacerbated by the added expenses associated with upgrading heating, cooling, ventilation, plumbing, gas distribution and electrical systems for residential use.

Finally, residential developments must comply with strict disability regulations and be accessible to all residents.

Repurposing an office building into housing can also have a profound environmental impact. Proper waste management, energy efficiency and sustainability measures must be considered. However, if done properly, communities may ultimately benefit from a reduction of carbon footprints resulting from reduced commutes and expanded use of public transportation resources.

Zoning and Land Use Challenges

Zoning laws are varied and relatively dynamic — especially with regard to the allowable densities of a residential development.

The pitfalls and politicization of zoning present major challenges for office-to-housing conversions, especially in California. Historically, most cities in California don’t allow residential development in commercial zones. However, as described above, California state lawmakers are interceding in local governance, in an effort to make it easier for California developers to transform commercial properties into apartments, condominiums and townhomes.

The state legislative efforts typically declare housing a statewide concern, rather than a municipal affair as described in Section 5 of Article XI of the California Constitution, and apply those state-level efforts to all cities, including charter cities.

Some local governments are resistant to these perceived intrusions into their traditional authority, and may challenge the evolving legislation directly or may attempt to sidestep these actions indirectly through other means.

Building Code Compliance

Building codes are just as complex and varied as zoning laws. Retrofitting aging office buildings that were permitted and constructed under outdated building codes and zoning regulations means that the developer will likely face an obligation to comply with current codes and regulations.

An office-to-housing conversion project must meet a complex maze of residential code requirements, including fire safety, earthquake resistance, proper ventilation, access to natural light and easy access to emergency exits.

In late June, however, the California Building Standards Commission voted to loosen these code requirements and simplify adaptive reuse of empty office and retail structures, allowing developers more flexibility in this regard. Such projects can reduce the carbon footprint of construction and help revitalize communities, according to an American Institute of Architects California news release.

Parking and Transportation

Residential buildings customarily require more parking spaces than office structures, so converters may face the need to retrofit and expand parking facilities when repurposing aging offices. Developers are wise to do their best to ensure that the converted housing has access to public transportation for its residents.

However, A.B. 2097 went into effect last year, and is aimed at eliminating minimum parking requirements. This law prohibits local governments from enforcing minimum parking requirements on residential or commercial development if it is located within one-half mile of a major transit stop.

Conclusion

While the challenges are significant, the potential for the adaptive reuse of aging office buildings into multifamily communities creates a solution that is beneficial to both the struggling office building market and much-needed housing.

Typically, older buildings — modest, mid-rise structures built before World War II — are more suited for conversion. Newer office towers typically have limited natural lighting, larger floor plate areas and windows that won’t open, and are much more challenging to convert.

There are myriad benefits in office-to-housing conversions, and as a result many municipalities are embracing the concept of such adaptive reuse as a way to restart revitalization of downtown districts, increase property values and bolster tax revenues.

In addition to mitigating a deepening housing crisis, the reuse of underutilized buildings has a sustainability appeal, reducing construction materials and modernizing buildings with more energy-efficient and climate-friendly systems.

In the end, however, a conversion project from office to residential must be a financially viable project for the developer. These statewide efforts to facilitate such conversions do not change the fundamental business considerations for a developer, but, at some point, the efforts may help bridge the gap from a nonviable project to a viable project.

To achieve that, projects will require careful planning and coordination with community stakeholders, as well as lenders, architects, engineers, contractors, politicians and others.

Steven Otto is a partner at Crosbie Gliner Schiffman Southard & Swanson LLP. The article was published in Law360 here (subscriber only).