Office conversion prospects judged challenging

Office conversion prospects judged challenging

Data scan identifies possibilities in Toronto, Montreal, Vancouver and Calgary
Monday, June 26, 2023
By Barbara Carss

Canada’s largest cities offer plenty of office conversion prospects for development proponents exploring housing supply options. Real estate analysts with Avison Young recently scanned structural data of more than 26,000 commercial buildings in 14 major North American markets and identified hundreds of possibilities in each of Toronto, Montreal, Vancouver and Calgary that met two key criteria: floor plates no greater than 15,000 square feet; and pre-1990 construction vintage.

In total, about 34 per cent of surveyed buildings shared those characteristics, but sponsors of the exercise acknowledge that the pool of realistic conversion opportunities is likely dramatically smaller. Stephen Silverstein, Avison Young’s managing director of construction management in the United States, calls the analytics “a clear snapshot, as a starting point, of what could be possible for these markets,” while also clarifying that “costs, location and surrounding amenities” will strongly influence the business case.

Speaking during the REMI Show in Toronto earlier this month, Canadian industry insiders agreed that the Avison analytics highlight a basic prerequisite for office-to-residential conversions. Smaller floor plates are needed to accommodate relatively standard unit sizes and configurations between a building’s central spine and its exterior walls.

“It’s a matter of geometry. With a bigger floor plate, you’d end up with something like two windows in a 2,000-square-foot apartment, which wouldn’t be workable,” observed Terry Flynn, now heading his own consulting firm after retiring from a long career in operations and project management, most recently as a general manager with BentallGreenOak.

Combined with the age threshold of 33+ years, it’s presumed the analytics capture a large share of Class B and C office buildings that are facing onerous competition from better quality alternatives as the general demand for space declines. Many of the identified conversion prospects are located in downtown vicinities where there has been a spurt of multifamily development in recent years and both developers/investors and local governments show continued interest in mixed-use projects. A switchovers to residential is presented as an additional angle for asset managers to consider when they devise repositioning strategies.

“People are rethinking how they use office buildings and how they view the entire downtown,” says Sheila Botting, a principal and president of Avison Young’s professional services in the Americas. “Adaptive reuse is an important conversation we are having around the art of the possible.”

The data scan identifies 923 such possibilities in Toronto, 611 in Montreal, 548 in Vancouver and 521 in Calgary. However, Flynn maintained that’s unlikely to translate into affordable housing unless there are incentives to help with capital costs and/or subsidies for incoming tenants.

“Landlords are going to have to be really driven to do this because they’ll have to write down the value of the building, and they’re going to have to get the rents to support all that work,” he submitted. “Most of them have a 10-year horizon on getting their return on investment so that will be expensive space to rent.”

The Urban Land Institute offers more evidence in its recent overview of 28 commercial-to-residential conversions in the United States, encompassing 19 office buildings, four hotels, three industrial facilities and one “other” structure. The projects were undertaken between 2014 and 2021 with 20, including 12 office conversions, occurring between 2019 and 2021. The median cost — covering acquisition, hard and soft construction costs — is pegged at USD $255,000 per unit, translating to CAD $336,600 at the current exchange rate.

“Although developers have made each of the conversions profiled in this report work on a practical basis, there is no cookie-cutter building to convert. Not only is each experience different, but the developers of the projects profiled in this study expect that each subsequent experience will be different,” the ULI report advises. “Because of the unknowns going into a conversion project, the developers pointed out that it is ‘not for the faint of heart’.”

Drawing on career experience that stretches back the 1990s’ real estate market collapse, Cheryl Gray, now consulting to the industry after retiring as head of special projects, operational excellence, with QuadReal Property Group, noted that current presumptions about the future of office demand aren’t definitive either. She suggested many landlords will be more inclined to sit on vacant space for awhile than to make quick decisions about conversions.

“I don’t know that it (conversion) is a solution that’s viable financially and I don’t know that it’s going to solve for affordability when it comes to housing,” she mused.

Turning to the facilities management perspective, Hilary Green, director of change management with Scotiabank’s workplace centre of excellence, reported that her department is exploring the business case for in-house short-term residential quarters in “currently mothballed” head office space. That could potentially augment or replace the hotel space Scotiabank has traditionally booked for staff from outside Toronto who travel to the city for business reasons, but any projected savings would have to be weighed against the required capital investment and operational costs.

“The numbers have to work,” Green affirmed. “We’re pursuing it as a ‘what if?’ That’s something we do in a lot of different areas, just to see if the numbers work.”

Barbara Carss is editor-in-chief of Canadian Property Management.

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