At what point does conversion from Grade A office to residential start to make sense?
This question was probably unthinkable in 2019, however, finding alternative uses for unused commercial space may very soon become a necessity. Propertywire reports that 73% of businesses are predicting office downsizing, NatWest has sold its recently refurbished offices in Angel which among other things was the workspace for many software developers, and CBRE has highlighted the highest levels of vacant office space since 2009.
While many in the industry are hopeful for a return to the office, the chances that employees who have gotten used to not spending time and money on commuting and having their toaster and loved ones near at hand will be reluctant to return without good reason. Likewise companies which are keen to improve their bottom line will be quite willing to shed excess costs. There are of course factors which work in favour of the office, as a space for meetings, training, events and collaboration as well as being the nexus for social interactions. Finally there is the prestige element, a client feels much more impressed sipping an espresso and seeing the view from the 40th floor of an office, than seeing the wall behind their counterpart on a video call.
This will likely lead to a different type of office space requirement, one that may well benefit firms such as WeWork. One that is more flexible, with greater emphasis on meeting spaces than on working spaces.
But this article is not about that. This is about the millions of square feet of unused space which is being, and will be, left unused.
Office to residential conversions are nothing new, however what has typically occurred in the past is that office blocks built in the 1950s-1980s, which are often in lower density locations are brought up, stripped, re-cladded re-architected and re-purposed as residential property. Sometimes this leads to very pleasant results such as Essential Living’s Vantage Point in Archway:
So at what point does the excess of commercial office space start to make sense as a residential conversion?
Firstly, we need to consider the typical £/sqft rents of commercial properties in different locations. We have used information from Morgan Pryce, Oktra and Devono. As anyone familiar with the office leasing market will know there are enormous discrepancies between the marketed asking rent, and the actual passing rent which vary based on the covenant strength of the tenant, the brand, the term and a long list of other variables.
Picking on two locations in particular; Hammersmith and St James we can see very different levels in commercial asking rents. These differences would also be reflected in residential rents as well.
A rent of £120/sqft per annum in St James may well make a tidy income for a commercial property owner when occupancy is at 80-90% in normal conditions. However, what happens if, as expected, large parts of the formerly office bound work force no longer need to come to the office? For a while companies may be bound by contracts to keep making their office payments, but those on more flexible arrangements or with leases expiring will be quick to reduce their requirements. Maintaining 90% occupancy at £120/sqft may be nigh on impossible.
72% of knowledge economy workers polled said that they would prefer a ‘hybrid’ model of partially working from home, and partially from the office.
So, let’s assume that the people get what they want. 8% of the workforce will always go to the office. 15% will never go to the office. 72% will go to the office for 2.5 days per week. On any given day, an office which previously had 100 occupants will now have only 44 occupants. We can round it up to 50 to provide some extra capacity.
If this turns out to be correct, then the 90% occupancy at £120/sqft will have to change, either becoming 45% occupancy at £120/sqft (for a £55/sqft effective income) with plenty of open space, or 90% occupancy at £60/sqft (again a £55/sqft effective income) as larger spaces are broken up into smaller spaces for different businesses.
At £55/sqft rent, prime, A-grade commercial office space in central London, suddenly becomes viable for residential conversion, for rent or for sale.
This should present a very interesting opportunity for residential investors and developers in securing existing office sites which are relatively disused, in prime locations. Going further, there is a strong argument in favour of vertical mixed use buildings, where several floors may comprise office space and several others may be retail or residential. Such a mix may create some complexities around accessibility as residents, office workers and retail workers and their managers may not look favourably on mixing. Imagine someone coming home from grocery shopping sharing a lift with a group of suits attending an important meeting and a handful of teenage shoppers and you get the picture. However if those can be overcome, as they certainly can be, then the opportunities become very interesting.
In prior work on rental premiums and amenities, factors such as proximity to work and access to amenities ranked extremely highly in the importance of generating residential rental premiums. For young professionals, having a separate lift to their home, and knowing that the office was just a few minutes away if they want, or need to go there, may be a privilege worth paying for.
Whatever the end result, it seems clear today that there are going to be enormous opportunities in this arena and it is one to keep close attention on.
© Treex 2020