"Office buildings can be converted into forms of commercial property (such as retail), into residential property, or into flexible workspaces. These are perhaps the three most obvious options landlords could consider when repurposing office space"
- Wybo Wijnbergen - infinitSpace
The traditional long-lease office market was already facing challenges before the world had ever heard of COVID-19, with the pandemic catalysing an established trend towards hybrid and flexible working. As such models have become the norm, a vast number of companies across the globe have been leaving their private offices in favour of new workspaces.
Landlords have, of course, been hit hardest by this transformation. High vacancy rates – billions of square feet across the world – are turning office districts into ghost towns, with more than one-third of desks globally sitting empty all week long. Falling revenues and property valuations naturally ensue.
Worsening the blow, the rock-bottom interest rates enjoyed over the past 15 years are no longer there to fall back on during these difficult times. So, when it comes to borrowing to finance redevelopment or new investment, every penny counts more than ever.
Clearly, office landlords have a litany of challenges to face in the current market – and the ugly truth is that the traditional office model (vast spaces leased to few occupants for set, long-term leases) will not weather the storm. In this new age characterised by dynamism and change, movement away from this formerly steadfast pillar of commercial real estate is sorely required.
This narrative has become well-established in recent years. But, crucially, what options are available to office landlords and asset managers needing to pivot away from traditional office buildings?
Positively, there are a number of conversions, and it is apparent that landlords are taking note of these opportunities; in London, for instance, over £2 billion of investment was pumped into refitting empty offices in Q2 2023.
However, the brutality of the economic climate means that there is little room for error. Decisions must be thoroughly considered, calculated and backed by evidence to determine what is both viable and actively profitable, allowing landlords to maximise revenues and property values alike.
Weighing up conversion pathways
Office buildings can be converted into forms of commercial property (such as retail), into residential property, or into flexible workspaces. These are perhaps the three most obvious options landlords could consider when repurposing office space.
The location and specifications of the asset will go a long way to determining the suitability of these options. But there are also general rules of thumb that can be applied – chiefly, we can look at cost of conversion, market demand and growth potential, return on investment, and impact on overall property valuation.
Residential property
Converting into residential property has been touted as one possible solution; housing stock shortages mean that major cities are crying out for residential development. This outstripping of demand has led to climbing rents and property values, marking lucrative opportunities for landlords. One report looking at London, for example, estimates that the capital’s empty office stock could support the creation of 28,000 homes.
While this may appear as an easy and profitable resolution to the empty office issue, there is far more complexity to the situation than initially meets the eye.
Simply put, large volumes of office stock are unsuitable residential properties for a host of reasons: inadequate natural lighting and ventilation, layout and plumbing incompatibility to name a few. Structural work may therefore be required on the limited properties deemed suitable – but a fraction of overall stock – making development a costly process and narrowing profit margins.
Quality control also is a pressing issue. Research has demonstrated that office-to-residential conversion may lead to lower-quality properties than properties built with residential planning permission due to the various challenges associated with conversion. Risk may just outweigh reward for many projects, and landlords face being lumbered with low-quality housing stock that fails to perform in terms of ROI.
Alternative commercial use
Another frequently discussed option is to transform an office building, or office space, into different forms of commercial real estate – retail and hospitality venues being the most common. In terms of structural compatibility, fewer obstacles are involved with conversion into other forms of commercial when compared to residential real estate, making this a simpler and lower-cost avenue to explore.
However, the external climate poses several challenges that have left demand for such spaces low. Retail faces an exodus of its own, with more than 10,000 shops closing across the UK in 2023, spurred on by the rise of online shopping and high inflation reducing consumer spending – the growth potential and sustainability of this option is therefore limited.
Ultimately, the viability of such an option will be dictated by the location of the asset – a retail or hospitality outlet lives or dies by the units in its immediate vicinity. Landlords and asset managers must also have the requisite knowledge of those industries if they are to transform and market the space appropriately.
Flexible workspaces
A third option – one that has naturally gained momentum in recent years – is to transform traditional private office space into flexible workspaces. With businesses changing their approach to how they use office space, demand is at an all-time high for spaces that can adapt to these evolved requirements. Indeed, JLL forecasts that 30% of all office space will be flexible by 2030, with the market predicted to reach nearly £133 billion by 2032.
With strong growth potential and demand outstripping supply, flexible workspaces have the power to command both high rental revenues and boosted property valuations – to the benefit of landlords.
Moreover, in terms of redevelopment, there is significant structural and infrastructural overlap between traditional offices and flexible workspaces, making this a relatively straightforward process and therefore often the most affordable option when compared to other conversion pathways. The initial capital expenditure is therefore likely the lowest of all three options.
A considered approach
From residential and retail to flexible workspaces, every option has its own merits, but will also present unique obstacles. The overwhelming trend across the sector is landlords exploring a range of these options across their buildings – for instance, a tower block with retail units on the ground floor and both offices and residential units on higher floors.
In this challenging market, however, landlords cannot stand still. A pragmatic, measured approach that marries business sense and creativity will take landlords a long way, regardless of the conversion pathway they opt to follow.
Ultimately, the right conversion choice will be determined by a landlord’s individual properties and circumstances, but ensuring they are equipped with all the facts on the matter is crucial to making a strong, evidenced-based decision on the future of their portfolio.
