In a recent blog titled “The Changing Face of U.S. Housing Demand,” I posited that the U.S. needs to provide about 9.7 million units of net new housing over the decade from 2019-29. Of this, 6.9 million homes (71%) would comprise owner-occupied housing family and 2.8 million rental housing units (29%), primarily multi-family). With this blog, it’s time to zero in on one pivotal follow-on question: Where can we get the added housing — especially needed rental units? And I think a good part of the answer may be from converting what is becoming effectively vacant office and retail space across the U.S. to housing.
In addition to traditional reasons of poor location or bad management, this is now space that has been essentially and perhaps irrevocably vacated for two previously unknown reasons:
The rise of e-commerce which has come at the expense of brick-and-mortar retail — a growing phenomenon accelerated by the COVID pandemic
The more recent shift from working at the office to work at home — but also brought on by the pandemic
What is not yet known is: Whether and to what extent commercial life reverts back to some form of pre-pandemic normalcy? Or, are these pandemic shifts likely to persist if not further accelerate?
Recognizing the lack of clear-cut market evidence to clearly support one position or the other, what’s suggested is to engage in a bit of a thought experiment. Let’s speculate about what we can not fully prove but yet may well be.
What We Know
Before getting to the thought experiment, I briefly review a bit of what we do know.
As of late 2021, the national commercial real estate brokerage JLL notes that there is about 4.3 billion square feet of office space in the nation’s 50+ largest metro markets (20% of which is vacant).
There is an even larger inventory of 11.7 million square feet of competitive retail space (of which only a reported 5% is officially vacant but includes subpar or marginal tenants and increasingly excludes non-competitive space no longer part of the brokerage inventory). For example, another brokerage firm CBRE has forecast up to a 20% reduction in U.S. retail inventory by 2025 — especially for what is becoming functionally or economically obsolete Class B/C mall space.
This total inventory of 16 million square feet of major metro competitive commercial space is just a 16% share of what has been previously estimated as a total inventory of about 97 billion square feet of commercial building space (as inventoried in 2018 by the University of Michigan). The Michigan study reflects a more generous definition of non-metro as well as non-metro commercial inventory — including but not limited to stores, offices, schools, places of worship, gymnasiums, libraries, museums, hospitals, clinics, warehouses, and jails. For purposes of an illustrative thought experiment, we’ll limit ourselves to the 16 million square foot figure in metro markets as the most likely to experience re-use and re-occupancy — at least in the near-term.
Regarding non-store retail including e-commerce sales, the U.S. Census estimates that e-commerce accounts for 11-12% of nation-wide retail sales (including dining) as of 2020-21. The private data firm Claritas provides a somewhat higher estimate, indicating that non-store retail accounts for an estimated 15.6% of retail sales (including dining) as of 2022. This is a figure expected by a range of prognosticators to further increase in the years ahead.
And finally, estimates of the magnitude of the long-term shift to work-at-home post-pandemic vary widely. No one really knows. To give just one (of many possible) examples, the brokerage firm CBRE estimates that the average U.S. office employee will spend 24% less time working in the office than pre-pandemic. So, why continue to inhabit all that excess space?
The Thought Experiment
Now to the “thought experiment” — essentially a test in which one imagines the practical outcome of a hypothesis when physical proof may not be available. This thought experiment is aided and abetted by just a little math.
Out of 16 billion square feet of competitive metro area office and retail space, assume that 10 - 20% becomes redundant and therefore candidates for conversion to another use — namely residential.
Next assume a residential pattern mostly centered on moderate size multi-family units averaging 1,000 net rentable square foot per residential unit (or 1,250 gross square feet including hallways, elevators, exercise rooms and other common area).
Finally, assume a simple 1:1 replacement of existing commercial for residential space (equivalent to the amount of space within the existing building footprint whether as an adaptive reuse or demolition followed by new structures).
The net result would be capacity to re-develop obsolete commercial space with about 1.28 - 2.56 million new residential units. This level of production capacity could meet up to 90% of the forecast demand for 2.8 million net added rental housing units by 2029.
In effect, redeveloping existing and potentially redundant commercial space in the nation’s major metro areas conceivably could handle most and maybe all of the need for added multi-family (primarily rental) housing need nationwide over the current decade.
Factors Affecting this Transformation
Obviously, the outcomes of a strategy for converting excess commercial to needed residential use will vary — perhaps significantly so — from what is estimated with this rudimentary thought experiment. A couple of considerations:
Redevelopment of obsolete retail space is more critical than for office space since retail accounts for at least 3/4 of the potential inventory of building space ripe for use transition. Redeveloping retail is more likely cost effective than office with more design flexibility including the option of full tear-down for new multi-family structures, with housing requiring lower parking ratios than retail so that some of what is now excess parking area can support yet more housing development.
Office space may have the advantage of more substantial existing structures, location in higher amenity settings (often on less trafficked streets) and existing verticality for higher prestige and urban density including condo units.
This conversion will likely not happen overnight but can gain momentum with a few well-placed and highly visible initial projects in one metro market after another. Conversion impetus will further pick up once it becomes clear to existing owners and investors that there is no return to yesterday. Rather, the shift away from office and retail need is no temporary phenomenon but a radical restructuring of how Americans live, work, shop and recreate.
Getting to yes! can be facilitated by supportive communities, public agencies and elected officials — possibly seeded early-on with a few well tailored project incentives. Think re-zoning and associated regulatory abatements, infrastructure upgrades and, where pivotal, financial incentives. The path forward won’t always be easy but can be productive. Avoiding blight, restoring neighborhoods and urban vitality, and supporting the work-live balance now preferred in the post-pandemic new, new normal.
