The Next Downtown: Financing Office to Residential Conversions 

by Bruce Katz, Florian Schalliol, Andrew Gibbs, and Jonathan Tower · August 3, 2023


As the post pandemic economy takes shape, one thing is certain. The structural impact of remote work dramatically undermines central business districts that over-emphasize traditional office work.  Historically, US office vacancy rates have hovered near 13%. As groups like CommercialEdge and Cushman & Wakefield have reported, office vacancy rates today are nearly 17%, with San Francisco at 20% and Houston above 23%. According to Brookings Institution estimates, office utilization is still less than 50% across major downtowns, indicating further headwinds for cities and landlords. This change also hits city coffers, as lower utilization results in lower office building valuations and therefore lower tax revenue. Estimates vary on the magnitude of the effect on city revenue: NYC’s comptroller estimated a decline of up to $1.1B annually or 1.4% of city tax revenues; places like Atlanta are likely to be affected at a far larger scale given their heavy reliance on commercial property taxes.  From there, the troubles compound: with fewer people coming downtown during office hours, the dominoes are already starting to fall, triggering second order effects on small business performance and transit ridership.

The future of downtowns is already top of mind for local leaders, business chambers and commercial real estate investors given the outsized role these places have historically played in the life and rhythm of cities and metropolitan areas. These stakeholders are already acting to diversify uses of their downtowns. One strategy that has captured significant attention is the conversion of office buildings to multifamily housing. The allure of this strategy is clear: it can help ease the housing shortage in many US metros and stabilize public revenues (including not only collections from real estate and sales taxes but also transit revenues) by keeping downtowns busy.

The discussion of office-to-residential conversions has largely focused on architectural considerations (e.g., plumbing and bathrooms, access to windows, ceiling heights). These architectural difficulties are very real and have made office-to-residential conversions challenging. However, given the recent collapse of office valuations and the opportunity cost of vacant buildings, some conversions may be newly feasible from a financial perspective, especially with creative public-private financing tools. In this newsletter, we first introduce the basics of financing these conversions. Then, we introduce several examples where local leaders are already using a range of tools to make conversions a reality.  We conclude with a call for new financial instruments and local policies and practices.

The Basic Economics of Office-to-Residential Conversions

The economics of office-to-residential conversions (and almost any real estate project) turns on three major categories: the costs of the project, the income that the project will bring, and the financing arrangement of the redevelopment.

There are two over-arching costs for conversions: the purchase or lease of buildings and the conversion costs. For purchasing or leasing the land, these costs are now at historic lows given low rents and high vacancy rates. While the purchase or lease price of the property may be low, the conversion costs for such properties are typically much higher. However, depending on the type of property and the location, the combined cost may still be lower than the cost of new construction.

Turning to the revenues for these conversions, the primary driver is the rental or sale revenue for the new residential units. In some cases, these properties may have opportunities for additional revenue, such as parking or retail space on the ground floor. Given the current housing shortage, such rents may be favorable for these conversions. However, many local leaders will rightfully want to ensure that at least some of the housing units are affordable for low- and moderate-income residents. Keen local leaders will be adept at balancing these needs and bring additional subsidies to the table.

The final major consideration in the economics of conversions is the financing of these projects, which bridges the gap between primarily upfront costs and future revenues. Bank debt is often used to finance up to 65% of these projects; however, the recent growth in interest rates has made construction financing more challenging to obtain. Equity from private investors or developers is typically a substantial portion of the capital stack as well – often around 35%. To incentivize equity investments, however, local leaders need to show that the investors can make their money back, typically with a 15-20% annual return (depending upon the hold period). In addition to the source of capital, the timeline of conversion is important: the quicker the project can be completed, the cheaper the financing can be. For office-to-residential conversions, these projects can often take 1 to 2 years less to get units on the market than new builds.

Tools for Office-to-Residential Conversions

The following list details the many powerful – but sometimes not well-known – tools that local leaders can use to incentivize office-to-residential conversions in their cities. Often, these tools can provide the necessary “boost” to complete a conversion where it would otherwise not be feasible.

  1. Commission Architectural Feasibility Studies: Architecture and engineering requirements can have sizable implications for conversion costs and feasibility. However, these studies are unlikely to be funded by private investors or developers given their exceptionally high risk (investors are unlikely to spend considerable funds if there is a sizable chance the building cannot be converted economically). As a result, local leaders can commission these architectural feasibility studies in their cities (or provide loans to developers to do so) to better understand which office assets are best positioned for residential conversions and provide a “jump start” for investors and developers. Toronto has recently issued an RFP for such a study.
  2. Modernize Zoning and Accelerate Permitting: One of the first steps local leaders can take is to review their local zoning codes and requirements (e.g., parking, Floor Area Ratio) that apply to structures that could be candidates for conversions. These regulations are often legacy codes written for different times with different goals (e.g., accessibility by car and urban sprawl) and do not align with the needs of the moment. By reviewing – and updating – these codes and regulations (e.g., including form-based overlay districts), local leaders can broaden the set of properties eligible for conversions. New York City, for example, took a similar step with its recent Office Adaptive Reuse Study. Predevelopment costs and timeframes can be further reduced with accelerated construction permitting. Boston, for example, has hired a “permitting ombudsman” to serve as a project manager for the various permitting approvals a conversion would require.
  3. Property Tax Abatements: Property taxes are an ongoing cost to office real estate projects. Local leaders can incentivize new projects by providing targeted tax abatements to conversion properties, helping make new conversions feasible. Such incentives have considerable precedent: in the 1990s, New York City created the 421-g program which generated over 12,000 units, totaling over 40% of the growth in housing units in lower Manhattan between 1990 and 2020.  Several cities are now taking this step: in Boston, Mayor Wu recently announced a tax abatement of up to 75% of the standard tax rate for up to 29 years.
  4. Tax Advantaged Equity: The federal government currently has a suite of tax incentives for multifamily housing, including historic preservation tax credits, low-income housing tax credits, new market tax credits and Opportunity Zones. These and other incentives can be layered creatively to help pencil out office-to-residential conversions. Earlier this year, for example, the City of Chicago stitched together Low-Income Housing Tax Credits and Rehabilitation Tax Credits (along with tax increment financing) to enable the largest office-to-residential conversion in the country on a series of LaSalle Street properties. More targeted incentives are under consideration: federal legislation has also been proposed to create a Qualified Office Conversion Tax Credit, via H.R. 419, the Revitalizing Downtowns Act. The bill would create a 20 percent tax credit for expenses to convert office buildings to residential, commercial, or mixed-use properties. Qualifying residential conversion would be required to incorporate affordable housing.
  5. Unique Uses of Government-owned Land (Subsidized Sales, Ground Leases, Joint Ventures / Equity Investments): Many local governments own a considerable amount of property in their cities or towns (or they are held through various local agencies or authorities that local government holds considerable influence over). These properties are particularly interesting because they typically do not pay property taxes. Local governments can use this perk to incentivize conversions. For example, they can provide long-term ground leases and / or enter into joint ventures with investors and developers who agree to the conversion. In the case of joint ventures, cities can also retain an equity stake in the project and participate in the financial upside to recoup their forgone tax revenue. For a simpler path, cities can also gift or sell these properties at a subsidized cost to developers that agree to convert the office property.
  6. Providing Anchor Tenants: Local governments can also increase the revenues of these conversions by committing to bring tenants to the new developments, either by a) renting a number of new housing units via local vouchers or supportive housing programs; or b) leasing unconverted or ground-floor office or retail space (e.g., for non-profits and direct service agencies).
  7. Government Backed Lending: While tax advantaged equity is helpful, residential developments are being curtailed by the current lending environment.  There is a need, therefore, for the GSEs or HUD to increase liquidity for construction lending, potentially by creating a special construction-to-term product for office to residential conversions. In exchange for this new product, the federal government could insist on conditions, perhaps affordability restrictions or expedited permitting.
  8. Direct Subsidy (e.g., from Philanthropy, Local Government): A straightforward way to incentivize conversions is to provide a subsidy to those developers making the change. In Calgary, for example, the city created a grant program that provides $75 per square foot for office-to-residential conversions, which has catalyzed 10 conversions with over 500 residential units to date. Local philanthropy can also play a role in incentivizing these conversions through a variety of means.  In a recent article, we discussed how philanthropies can catalyze the creation of local funds, through the contribution of patient capital. They can also serve as anchor tenants by funding nonprofits that rent units for supportive housing. Philanthropy can also provide grants, low-cost financing, or guarantees to developers, especially to incentivize affordable units or support minority- and women-owned contractors.
  9. Downtown Development Corporations: As we have written before, both Cincinnati and Erie created Downtown Development Corporations to spur large scale regeneration. These nonprofit corporations enable the acquisition of anchor properties in target areas, via patient capital raised via public, corporate, and civic investors. Capitalization of local corporations geared towards office-to-residential conversions could be a critical piece of the financial innovations needed to make this market work.

A Note on Subsidies

Many of these strategies require providing a public or philanthropic subsidy. Given the scarcity of such resources, when providing such an incentive, local public or civic leaders should ensure that their subsidy is enabling or enhancing broader impact objectives of the community. Given the multi-domino effect that office closures may have in many downtowns, simply enabling these conversions may suffice in some cases. In other cases, public or civic leaders can use these incentives on deals that might already be financially attractive to deepen the social value. For example, in the LaSalle conversion in Chicago, the city stipulated that at least 30% of the new housing units must be affordable. Local leaders can also work to recoup their subsidy in creative ways. Chicago uses a Tax Increment Financing structure where some costs may be financed by the increase in future tax revenues. In Boston, the city attached a 2% fee associated with the future sales of office-to-residential conversions; thereby providing a subsidy upfront but a mechanism to recoup the initial loss in tax revenue later. All subsidies, if any, should be strategic and locally appropriate.

The Bottom Line

Office-to-residential conversions are unlikely to work in every market for every property. However, in certain markets and for the right properties – and, with the right tools and incentives – they may work in a surprising number of circumstances.  A toolkit is emerging that combines local policies and practices with the blending of public, private, and civic investments.  The time feels ripe for the creation either of a National Conversion Fund geared towards this purpose or a series of Local Conversion Funds.  A small group of first mover cities, with corporate and philanthropic backing, could make this market and catalyze further state and federal action.

Given the travails of commercial real estate, the next six months will be critical.

Bruce Katz is the Founding Director of the Nowak Metro Finance Lab at Drexel University. Florian Schalliol is the founder of Metis Impact, a mission-driven consulting firm specializing in place-based impact. Andrew Gibbs is a Vice President of Real Estate at Arctaris Impact Investors, an impact investing firm that finances critical public-private partnerships, including office-to-residential conversions. Jonathan Tower is the Founder and Managing Partner of Arctaris Impact Investors. To contact Arctaris with questions or for potential office-to-residential conversion projects, please email This newsletter is part of a broader partnership between New Localism Associates and Arctaris Impact Investors.

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