A Targeted Approach to Reimagining Central Business Districts
October 24, 2022 | By Sofia Song and Kyle Sellers
People aren’t frequenting central business districts (CBDs) like they used to. Since office workers comprised most of whom visited these city neighborhoods, hybrid or virtual work preferences have rewritten urban patterns at an unprecedented levels. Add in public safety concerns and the hollowed retail and restaurant options, and you have a recipe for underuse.
Valuations of our CBD real estate may hinge on speculation that things will return to normal. But even in the first months after the pandemic began, the Gensler Research Institute reported that people wanted to keep remote work in addition to the office as part of their menu of options. In May 2022, fewer than 10% of office workers in New York City had returned to the workplace full-time, despite the vast majority now spending at least some of their normal work weeks in the office. In early October, office occupancy rates reached a new pandemic-era high, indicating only around 48% of office workers in Manhattan are in the office on a given weekday.
We don’t yet have all the answers for how to remake CBDs, but we do know that both our research and commercial real estate trending indicate that we need a shakeup. Many of those who discuss the future of CBDs cite the stubborn vacancies of today. Concerns about public safety and the new realities of the hybrid work model are two strong headwinds for full occupancies. Notably, our Global Cities research and our Residential Experience Index note a wide preference for a variety of building typologies and a mix of residential and commercial development. Monotone, single-use office districts are not what people want; nor are they what cities need.
The question is, how do we create CBDs that are multi-modal, vibrant, and resilient? By leveraging the buildings we have right now, some suggest that we can diversify our CBDs through office-to-residential conversions. This is a conversation in major cities across the United States — but what is the outlook for actually making this happen?
Premier office space versus “the donut effect.”
To answer that question, we have to begin with the understanding that the U.S. office market is affecting different building classes in different ways. Despite lingering office vacancies, investors still see the appeal of Class A offices in many U.S. cities, especially in the so-called “sexy six” markets of Los Angeles, San Francisco, Seattle, Boston, New York, and Washington, D.C. For example, Manhattan is home to some of the largest post-pandemic transactions to date.
Class B and C assets, however, are struggling. In San Francisco, vacancies topped out over 21% in the first quarter of 2022, with older inventory fairing worse than new construction. In New York City, downtown offices between 20th and 60th Street have vacancies considerably higher than their Class A counterparts. New York’s apparent office sales rebound may look encouraging at first glance, with second quarter 2021 volume only seven percentage points behind where it was in 2019 and the city’s second quarter 2021 numbers triple what they were in the first quarter. But the overwhelming majority of these transactions involve Class A “trophy class” buildings, leaving Class B and C assets out to dry.
Moreover, it’s not just investors who are avoiding lower-class inventory. Tenants who previously occupied B- and C-inventory are going virtual first or migrating elsewhere. This is what economists call the “donut effect” and it happens when people move from dense CBDs to lower-density urban or suburban areas. In the fourth quarter of 2021, suburban offices accounted for nearly 10 million square feet of absorption while offices in central business districts posted negative movement.
This is all to say that we’re on the verge of a fascinating paradigm in which trophy space stays highly valued, or in some cases, gets even better while aging office inventory remains underutilized.
What do we do with underutilized Class B and C office space?
From primary markets to secondary cities, the demand for the most prestigious offices is unlikely to wane, driven mostly by tech companies. But for Class B and Class C assets, owners should take a look at an office-to-residential conversion.
Gensler’s Steven Paynter and Duanne Render recently discussed their plans to convert Class C office buildings in Calgary, Alberta. Even before the pandemic, this mid-tier Canadian market had vacancies of 24%, according to Avison Young. In developing a “scorecard” to assess conversion viability — including variables like form, floor plates, and surrounding context — Gensler’s team identified office assets from which to begin Downtown’s revitalization efforts.
For residential markets, an ever-increasing demand for more units across all incomes supports the financial case for repositioning. Gensler has done the work in analyzing properties ripe for conversion. In exploring Washington, D.C.’s downtown corridor, we categorized offices by archetype and then evaluated how each archetype would support façade and core modification strategies. There are plenty of opportunities for this type of conversion, even on D.C.’s K Street.
Doing this type of conversion isn’t straightforward and there is no one-size-fits all approach. We may look first through the lens of design, but we also know that conversions hinge on social and financial realities. Many landlords are sitting on vacancies because they don’t want to lock tenants into lower rental rates and the resulting lower cap rates. We also know that the cost of conversion is high — so not only are residential conversions likely to produce luxury units, but speculative building also puts a premium on rapid absorption.
Breaking from preconceived notions about how cities allocate space.
Downtowns are typically historic city centers, and we want them to return to the bustling activity of days past. To do so, we must take the pulse of what city residents want and create a better sense of what our city neighborhoods should be from these findings. Not every property will be practically suited for conversion, but we have the tools to identify the best candidates along with a confident understanding of the market conditions we need to make conversions successful.
Office-to-residential conversions can address micro issues such as a building owner’s finances, but also macro issues such as affordability, safety, and the problems associated with office space homogeny in many urban cores. These projects are not just quick fixes for inconvenient assets; they are about how we can help solve our cities’ most pressing challenges.
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