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A cocktail of headwinds has kept housing unaffordable for many Americans, but the increasing number of empty offices is unlikely to bring any meaningful relief to the supply-starved market.
The pandemic ushered in a new era of remote work, and it's caused a structural decline in office demand that is set to worsen in the years ahead, Goldman Sachs said. Real estate experts have theorized that office-to-residential conversions could be a promising solution to the supply problem, but strategists at the bank caution that would be neither simple nor cheap.
Office vacancies have climbed four percentage points in the last three years to hit 13.5% — the highest since 2000 — and Goldman expects that to surge to 18% in the coming decade as buildings become older and less viable workplaces.
Goldman Sachs Investment Research, CoStar data
In the same stretch, a combination of high mortgage rates and home prices with limited housing inventory has frozen the US housing market. Current homeowners are reluctant to move and give up lower rates they secured during the pandemic, which leads to fewer buyers and sellers on the market. This has been dubbed the "lock in" effect.
"The imbalance between these two markets has led many investors and policymakers to wonder whether underutilized office space can be repurposed to meet the demand for residential housing," Goldman Sachs strategists led by Jan Hatzius wrote in a Monday note.
Residential housing affordability has declined for the last 15 years and hit a historical low in 2022. While conditions eased slightly last year, tight inventory has nonetheless dragged affordability to all-time lows.
Goldman Sachs
Strategists highlighted that across metropolitan areas with high shares of workers who can work remotely, many of those office buildings look "economically nonviable to operate."
Combined with the lack of affordability in the residential sector, the multifamily-to-office rent ratio is hovering near highs last seen in 2000. The figure approximates the return on a residential investment relative to an office investment.
"We expect that this ratio will increase even more in the next few years if the office vacancy rate continues to increase and residential housing supply remains low," Goldman strategists said.
To be sure, a February report from real estate outlet ResiClub found that office-to-residential conversions have surged 357% since 2021. Yet, according to Goldman Sachs, only about 4% of office buildings look viable for conversion, based on occupancy and whether the property is operating at a loss.
Notably, only about 0.4% of office space was converted to multifamily units in the year prior to the pandemic. That ticked up to 0.5% in 2023, which points to both minimal traction and significant barriers to more conversions.
"The office-to-multifamily conversion rate is quite low, suggesting that there may be substantial financial and physical hurdles to conversion," the Goldman team said. "If the conversion continues at the current pace, it will take another 8 years to convert the 4% of offices that are currently nonviable by our definition."
Based on the current market landscape and waning office demand, Goldman forecasts that conversions will be "uneconomical" for developers in most cases.
"Our analysis implies that only 0.8% of US office inventory is currently priced at a level that makes conversion to multifamily housing financially feasible," the bank maintained. "This number is slightly higher for San Francisco (1%), Los Angeles (1%), and Seattle (1.2%), but it is close to negligible in other metropolitan areas."
