October Commercial Real Estate Newsletter
What's in this issue?
> New lease on life for office buildings: Can these be turned into housing? > With CRE loans in distress, what does the future hold? > What's fueling the demand for extended-stay hotels?
New lease on life for office buildings: Can these be turned into housing? Three years after the great office exodus, is converting empty offices to living space feasible? In the midst of a nationwide housing shortage, repurposing vacant offices into apartments seems like a no-brainer.
According to an analysis by National Association of Realtors, 22 of 27 metro areas have the right market conditions to make these conversions financially feasible, adding as many as 43,500 much-needed housing units. The potential is particularly promising for Class B offices, where office market rates are lower than apartment rent on a square-footage basis. However, converting office space to suitable housing is more complicated than it appears and here’s why:
Zoning regulations: Depending on the state or locale of the office building, zoning laws and codes can restrict the overlap of commercial and housing properties.
Major structural changes: The expense of extending the plumbing features, changing HVAC systems, adjusting ceilings and walls, and adding access to daylight can more than cancel out any revenues from converting offices to residential spaces.
One long-term solution to these hurdles is converting these buildings into “neutral” spaces. That is, they’re designed to be easily converted to meet the current need, whether it’s office, housing or retail. In fact, according to a lengthy report by McKinsey, the future is hybrid, where all three are co-existing on the same floor.
With CRE loans in distress, what does the future hold? An analysis by CRED iQ sent shockwaves through the commercial real estate sector, revealing that 70% of the 50 largest metro areas experienced an uptick in distressed commercial real estate loans. As property owners struggle with vacancies and higher interest rates, it sets off what the Wall Street Journal describes as a “doom loop scenario” threatening the solvency of regional banks and the ability of property owners to recover their investment, creating obstacles in the future for financing. How did we get here?
Low interest rates combined with rising property values fueled a demand for the commercial loans from 2015-2022, presenting a lucrative win-win for lenders and property owners alike.
Now that interest rates have doubled and commercial property sales are down 74% from a year earlier, that spells trouble for lenders and property owners.
As building vacancies choke off income streams, elevated interest rates from the past year offer no room for property owners to refinance and make cash flow.
As a result, landlords are forced to default, resulting in the bank either writing down the value of the mortgage or owning the property outright.
When buying activity resumes, experts forecast lower property values. While that will certainly set the table for opportunities for new investors, the lending environment may bring challenges as banks look to balance their exposure.
What's fueling the demand for extended-stay hotels? In the hospitality business, extended-stay hotels mean higher margins:
Rise in remote workers who blend work with travel
More revenue-generating square footage than full-service hotels
Visitors need less housekeeping and fewer services
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