(Brookings Institute) Tracy Hadden Loh, Egon Terplan, DW Rowlands, April 27, 2023

After the September 11, 2001 terrorist attacks that destroyed the World Trade Center, many people wondered if Manhattan’s Financial District—a place that helped coin the American English word “downtown”—could ever recover. Cities throughout the country also questioned whether dense, high-rise districts could be sustained. That same year, San Francisco was reeling from the dot-com collapse as thousands of jobs disappeared, office vacancies climbed to over 20%, and rents eventually fell by over 60%. But within a few years, office demand returned, and these central business districts refilled with workers and activity.^[1]

Today, many U.S. downtowns are facing a similar crisis in the wake of COVID-19. With the pandemic-induced shift to remote work and the slow return of office workers, the demand for downtown real estate—particularly office space—has plummeted. Office utilization averages less than 50%across major U.S. downtowns. Vacancy rates are 27% in San Francisco and over 16% in New York, and increasing. The downtown business ecosystem is also threatened as many small businesses (such as restaurants) are struggling or closing due to lack of customers. Some urban transit systems have lost half their ridership and face a fiscal crisis.

This is not the first time cities have seen a glut of office vacancies. What is unprecedented is both the speed at which this glut has happened, and how it has occurred at a time of low unemployment and rising interest rates.

Many are arguing that the conversion of vacant office space into housingis a key strategy for addressing these challenges and revitalizing downtowns. Proponents of office-to-residential conversion note that since remote work is here to stay, office demand will never fully return to pre-pandemic levels, and the vacant office space can be repurposed into what cities currently need: housing. Moreover, they argue that the expense and complexity of conversions justify public sector intervention and subsidy.

This raises a fundamental question: To what extent are current high office vacancies a market problem whose burden falls on the private sector (property owners and investors) and to what extent do they represent a market failure and policy problem to which government must respond with financial support from the public?

In this report, we argue that office-to-residential conversions are one potential remedy in some circumstances. But the public interest in conversion and the potential beneficiaries must be clearly defined in order to justify any public financial support. It is still early in the shift to hybrid work and many market forces (e.g., office buildings repricing to lower rents) have yet to play out. Governments rushing to provide financial support for conversions could inadvertently subsidize the wrong behavior. Office-to-residential conversions are not a panacea, but rather one tool in a much broader toolkit for downtown revitalization.

This report begins by identifying the five common arguments made by proponents for converting offices into housing. It then evaluates the myths and realities of each argument, using data from cities across the United States. It concludes with six recommendations for what cities should do about conversions and what other long-term strategies they could adopt.

COMMON ARGUMENTS FOR CONVERTING OFFICES INTO HOUSING

The conventional wisdom is that since a high percentage of office workers will continue to work remotely, and downtowns and office buildings are bereft of people, converting empty or near-empty office buildings into housing will add needed foot traffic and breathe new life into downtown and cities.

The common arguments go as follows:

• “Offices are over.” This argument presumes that remote work is here to stay, as most employees with office jobs prefer the flexibility of working from home. Many no longer have to endure difficult commutes, which not only saves money but also gives them more time with their family and community. Therefore, going forward, it’s thought that few employers will require workers to be in the office full time, and a hybrid work week of two to three in-office days will result in a permanent reduction in demand for office space.
• “Too many offices are bad.” The downtown central business districts that proliferated in the mid-20th century are largely single-use office districts. Many argue that these office agglomerations are a monoculture and anachronistic, and no longer appropriate for the dynamic nature of work in the 21st century.
• “Mixed use is better.” The lack of housing and residents make the traditional central business district dead in evenings and on weekends. So, the argument goes: More residents downtown will support a wider diversity of small businesses (such as grocery stores, hardware stores, cafes, and restaurants) and bring needed life to downtown in the off hours.
• “Cities are about to go broke.” This take contends that the decline in office building valuations threatens local government revenues, as lower office values reduce commercial property tax receipts. With high housing demand, conversions will allow cities to maintain or increase property values.
• “Office conversions can solve the housing crisis.” Finally, proponents of office-to-residential conversions say that amid the ongoing nationwide housing shortage, downtowns can be an important part of meeting those needs.

It is clear that some office-to-residential conversions make sense given the number of such projects that have already happened in cities of diverse market strengths and regional contexts nationwide. The critical questions now are: Would public sector intervention to catalyze more conversions be a good thing for downtowns that are struggling with commercial vacancies? If so, how much and what kind of intervention? Are there any potential unintended consequences that could negatively impact cities and metropolitan regions in the long run? And ultimately, if conversions are not the most effective or needed tool for downtown revitalization, what is?

OFFICE-TO-HOUSING MYTHS, DEBUNKED

Let’s dispel the myths behind the arguments on office-to-residential conversion one point at a time.

Myth: Offices are over.
Reality: Office use continues.

The first argument is that “offices are over” because of remote work. While we have all gotten the memo that going to the office isn’t everyone’s favorite thing, and it is true that in some U.S. cities (including New York, Los Angeles, and Dallas) offices are half empty, that also means that they are half full. And across markets as varied as Austin, Texas (where the weekday with the highest office usage since March 2020 was 74% of the pre-pandemic level) and San Jose, Calif. (where the highest daily rate was only 46% of the pre-pandemic level), data suggests that office utilization rates have not plateaued, but are simply increasing very gradually.

In some places, office demand remains high. Downtown Salt Lake City is busier than ever, and ridership on the Utah Transit Authority system is up 26% from pre-pandemic levels. Globally, industry sources assess that office utilization is much closer to pre-pandemic levels in markets such as Paris and Seoul. It is particularly interesting to note that among major Australian cities, there is a 35 percentage point spread in office occupancy between the lowest (Melbourne and Canberra) and highest (Adelaide and Perth, at around 80%) utilization markets.

In the medium and long term, the office-using sector of the economy is growing. While tech layoffs are currently getting a lot of headlines, the long-term trend of the last 80 years is that professional and business services have doubled their job share. Even if hybrid work stays the norm, most people with office jobs will still go into an office a few times a week, whether because it’s required by their employer, to get away from their home, for at-work amenities, or for the productivity and innovation benefits that result from face-to-face interactions.

There is also evidence of demand for new construction, even in places with high office vacancies. Instead of all offices being over, there is a bifurcation in the office market itself. Some downtown office stock—particularly older offices from the 1980s—is facing serious difficulty keeping or securing office tenants. This product is likely to be continually outcompeted by newer and more modern office buildings (known as the “flight to quality”). Thus, even in markets with high vacancy, some cities are seeing new office projects continue to break ground.

Myth: Downtowns have too many offices.
Reality: Downtowns have too little of everything else.

But what about the argument that too many offices are bad for downtowns? Downtowns thrive on being dense centers of activities, and office jobs are very conducive to densification. In fact, office work has grown 22% more dense in the 10 largest U.S. office markets since 1990, with a median of 390 square feet per worker in 2019 (and far less in some buildings). American per capita housing consumption, however, is trending in the opposite direction, dramatically increasing over time. In 2010, the U.S. had 800 square feet of residential space per capita. Inevitably, office-to-residential conversions produce a de facto permanent reduction in the density of downtown. For example, a 500,000 square foot office building would have space for over 2,000 workers. But if converted into housing, it might produce fewer than 500 housing units. Even if every housing unit had two people, that would be more than a 50% reduction in density.

It is true that office utilization is very low right now, and was far from 100% even before the pandemic. No office building is ever “full.” However, with proposals to shift to hot desks and lease sharing, it is also possible a 500,000 square foot office building could support more workers than ever, especially if each worker was only in the office a few days a week. The needed adaptation in many cases is to how office buildings are managed to accommodate different work patterns.

Ultimately, the issue is not that downtowns have too many offices. It’s that there is too little of many other activities. The reduction in in-person office workers has impacted the small businesses that serve them. However, this decline in customers can be solved by adding other destinations or economic activities to bring sufficient people.

Myth: Mixed-use downtowns primarily mean more housing.
Reality: Mixed use can strengthen office demand, but that means range of activities in addition to housing.

People do all kinds of things besides work or stay at home. Cities should make it easier to convert offices into everything else, including housing. Because one thing is absolutely true: Mixed use is better.

In downtowns especially, traditional office buildings could be converted to co-working facilities. Empty basements could house nightclubs. Near universities or hospitals, surplus offices could house campus expansions or life sciences spaces. What was once a small office on the 23rd floor could one day become a distinctive bar or restaurant

The nuance here is that mixed use is better not just for retailers serving the area, but for office demand as well. As shown in Figure 1, across the 45 largest U.S. downtowns by job count, there is a strong positive correlation(R2 = 0.57) between downtown job market share and downtown population share. In plain terms, these numbers suggest downtowns do better as job centers when they have more people living in and around them.

In short, building housing near jobs and amenities is good, but it’s not a substitute for jobs. For example, even after the gradual wave of conversions that followed 9/11, the New York City Financial District has six jobs for every one resident (a live-work ratio of .16).

Read More: Brookings Institute