Office Conversion Crisis: Prices Must Be Cut In Half For Residential Shift, Says Goldman Sachs

The listing prices of struggling office properties remain prohibitively high and must fall by nearly half to make their conversion into multifamily homes economically viable.

Those stark findings came from Goldman Sachs economists Elsie Peng and Vinay Viswanathan, who shed light on the deep impact of the shift toward hybrid work models, which has significantly reduced the demand for office space.

“The office vacancy rate increased by 4pp over the last three years to 13.5%, the highest level since 2000,” Goldman Sachs noted, forecasting a further increase to 18% over the next decade. This structural decline has raised questions about the future of these spaces, especially in light of the ongoing residential housing shortage in the U.S.

A Closer Look At Office Viability

Goldman Sachs’ analysis identifies approximately 4% of U.S. office buildings—primarily older, unrenovated structures in suburban and central business districts with high vacancy rates—as potentially obsolete.

The transaction prices for these buildings have dipped by 11% since 2019, with certain cities witnessing a 15-35% drop. Yet, despite these declines, the expected price fall necessary for feasible conversion remains unmet.

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Why Haven’t Office Prices Fallen More?

The report highlights two main reasons for the stagnant office prices: reduced transaction volumes, which hinder accurate price discovery, and barriers that complicate the reevaluation and operation of these properties.

Many lenders, recognizing these challenges, have opted to adjust office mortgages, thereby avoiding immediate property sales and contributing to the surplus of underutilized office space.

This unique market situation could also explain the relative stability in the stock prices of leading commercial real estate (CRE) office firms. Despite a nearly 10% drop since the beginning of the year, the VanEck Office and Commercial REIT ETF (NYSE:DESK) has seen its price increase by 21% from the lows of October 2023.

The Economics of Conversion

Goldman Sachs’ model illustrates the financial impracticality of office-to-residential conversions under current conditions. With an average loss of $164 per square foot anticipated, office prices would need to decrease by about 50%, to roughly $154 per square foot, for such projects to break even.

Despite these challenges, the economists see potential for repurposing underutilized office spaces for other functions, such as life science labs, data centers, and medical facilities. These alternatives, they suggest, might offer more financially viable paths due to lower conversion costs and less extensive modifications compared to residential housing.

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