Commercial-to-residential conversions are on the rise nationwide, creating affordable housing in ways you never imagined. Developers and landlords of vacant commercial spaces are responding to the robust demand for housing while potentially boosting their property values and rental incomes after the economic fallout from the COVID-19 pandemic. With zoning requirements, regulatory challenges and other hurdles standing in the way, developers are turning to the experts at Milrose Consultants for help in navigating the process to ensure compliant—and successful—conversions.

Industry experts gather at panel discussion 

Last month, Elliot Chiger, Vice President of Sales from Milrose Consultants, led a panel discussion with distinguished industry leaders who offered insights into the current state of the commercial-to-residential conversions market. Read on as we explore the challenges and opportunities the sector is facing, along with which cities are topping the list for these conversions and the types of buildings being converted. (Can you guess which type has overtaken office buildings?). We also take a particularly close look at New York City and California.  

Fixing the fallout 

There’s no denying that the COVID-19 pandemic had a profound impact on the commercial real estate market—particularly the office space sector. With the sudden shift to remote working, landlords were strapped with higher vacancies and falling rents. Now, over four years later, the fallout is even greater than expected as some employers have made remote or hybrid work permanent, thus leaving a greater surplus of vacant office and commercial space. Complementing this problem is a crippling urban housing shortage. So, what is the silver lining to all of this? An increase in affordable housing, thanks to an uptick in commercial-to-residential conversions.  

Resurgence of commercial-to-residential conversions 

According to Rent Café’s analysis of Yardi Matrix data, in 2023, cities across the country saw a 17.6 percent increase of new conversions from outdated buildings (12,713, to be exact), compared to the year before—following a two-year lull. Even more impressive is that there are 151,000 rental apartments in the works—58,000 of which are slated for conversion from vacant office spaces. As this trend is expected to continue for the coming years and potentially reshape urban real estate landscapes, this is great news—not only for those seeking affordable housing, but for landlords and developers. “We are seeing increased interest, particularly from lenders who have borrowers who are interested in commercial-to-residential conversions,” said Jonharold Cicero, Esq., partner at D’Agostino, Lederman, Landesman, Rivera and Miraglia, LLP. “This interest is due to the new laws that are coming into play—especially the ‘Section 45x Advanced Manufacturing Production Tax Credit,’ which offers a generous period of time for ground-up construction. This will be something to keep an eye on to push this movement forward.”  

Here is a snapshot of the top cities with the most converted apartments, as well as the top types of conversions carried out in 2023.  

Source: RentCafe’s analysis of Yardi Matrix data. 

Source: RentCafe’s analysis of Yardi Matrix data. 

Up for the challenge 

For developers and landlords, repurposing underused commercial properties comes with challenges, but it can also lead to wins on many levels. While developers may see shorter project timelines and considerable savings in comparison to traditional “ground up” construction ventures, landlords might also recoup lost rental incomes and see an increase in property values. 

To achieve these wins, developers and landlords must first address the challenges and considerations that come with the job. These include: 

• Zoning and regulatory barriers: Local zoning laws may restrict residential use in areas designated for commercial activities. Compliance with updated building codes—such as fire safety and accessibility—can increase costs and complexity. 

• Structural and design restraints: Office buildings often have deep floor plates designed for open-plan workspaces, which are difficult to adapt into livable residential units with adequate natural light and ventilation. Additionally, load-bearing structures, ceiling heights, and elevator placement can limit flexibility in redesign.  

• Financial viability: High costs for retrofitting—including changes to plumbing, HVAC systems, and insulation—may deter developers. Economic uncertainty or fluctuating demand for housing are other factors that can make these projects risky.  

• Community resistance: Existing residents or businesses may oppose conversions due to concerns about overcrowding, loss of commercial activity, or changes to the character of the neighborhood.  

• Impact on local economies: A decrease in office spaces may negatively impact adjacent businesses—such as cafes and retail shoppes—that depend on daytime office workers.  

“I would definitely say this is not a new experience,” said Adam Rolston, founding partner and creative and managing director of INC Architecture. “Architects have been tackling commercial-to-residential conversions for a long time. I think the problems are very specific to typology.” Contributing to the conversation relating to structural and design restraints, Eytan Solomon, P.E., LEED AP, and senior associate at TYLin-Silman, added: “Before starting a project, you must first know the original construction of the building to avoid problems with future construction. Conducting probes, opening the finishes, and examining existing drawings can save thousands of dollars on technical investigations.” 

Where zoning is concerned, Robert Holbrook, executive director of the Building and Land Use Approval Streamlining Task Force stated: “There are two different pieces under zoning resolution. The first is called ‘Article 1, Chapter 5,’ which is a section of the zoning resolution that provides more flexible rules for the conversion of existing commercial buildings through residential usage. The second section is the use allowed by zoning. Commercial districts allow for commercial or residential districts, making for a mixed-use district.” 

Long-lasting benefits 

The challenges of commercial-to-residential conversions bring a positive impact to communities and neighborhoods that can have possible long-lasting benefits.  

These benefits include: 

• Addressing the housing shortages: First and foremost, repurposing unused office spaces—and hotels—can help alleviate the housing crisis, particularly in urban areas with a high demand and limited land availability.  

• Sustainable development: Adaptive reuse reduces environmental impact and demolition and construction, thus conserving materials and energy. Additionally, this revitalizes aging buildings that might otherwise deteriorate. 

• Economic revitalization: Conversions can stimulate economies by bringing in new residents who support nearby businesses. Additionally, increased residential density in urban centers may attract investments in infrastructure and amenities.  

• Improved urban aesthetics: Repurposing empty or deteriorating office buildings may well enhance the visual appeal and vibrancy of urban areas.  

“Rezoning has a tremendous effect on who will have an eye on the neighborhood,” Cicero stated. “Will it be a New York-based investor, developer real estate family or a national publicly traded company in New York or another area? The answer will determine how the area changes over time.” 

Hotel conversion: The new player on the block 

Although office space conversions have been the talk of the town for quite some time, equal time must be given to hotels. Yes, hotel conversions topped the 2023 adaptive reuse chart, and more than 4,500 apartments have been created nationwide, accounting for more than one-third of adaptive reuse projects in the country. New York City is the region to watch as the city has a significant number of underperforming hotel properties. So, why are hotel conversions on the rise? The answer is simple. These properties have the infrastructure that is essential for conversion. From plumbing to electrical systems, converting these properties is a cost-effective and quicker way to create housing units, especially in urban areas.  

Source: RentCafe’s analysis of Yardi Matrix data. 

New York City 

According to Moody’s analytics second quarter data, the office sector’s vacancy rate in New York City hit an all-time high of 20.1 percent since the pandemic—which equates to one-in-five office spaces that have remained vacant. It should also be noted that the value of New York City’s office space dropped by 40 percent. This is significant since it’s the first time in Moody’s history that the 20 percent threshold has been reached in nearly 50 years! “Time is inevitable,” said Holbrook. “All buildings age and economies change as technology changes. New York City has a long history of adaptive reuse in many ways. For example, many of our manufacturing buildings were printing presses that no longer needed to be so. They were then turned into office buildings for a while and are now finding a third generation.” 

How then are developers meeting the challenges and complexities of adapting these spaces in New York City? Read on for a unique set of solutions and opportunities: 

• Conversion costs and tax implications: The estimated cost of conversion-per-square foot in New York City is between $300 and $500. For tax purposes, the capital-intensive costs for conversion would need to be capitalized during the construction phase. It’s important to note that any assets that might be abandoned within the building would bring an immediate tax deduction for the property owner for the total remaining underappreciated value of the property.  

• Cost segregation study: A “cost segregation study” is a tax strategy used by real estate owners to accelerate depreciation deductions and reduce current income tax liabilities. This study allows for the depreciation period of a building to be shortened to five, seven, or 15 years. This is a noticeable contrast to the typical 27.5-year depreciation life of a residential building. This then results in a substantial initial tax deduction and reduced tax obligations.  

• The Office to Conversion Accelerator Program: Established by Mayor Eric Adams, this program provides a streamlined process for developers by offering a single point of contact to navigate zoning, permitting and other hurdles to ensure that office conversion projects can be completed in a code-compliant and timely manner.  

• New York State incentives for conversions: New York State offers two property exemption programs that may offset the costs of an office-to-residential conversion. These include the Affordable Neighborhoods for New Yorkers Program (ANNY—or 485-x—and the Affordable Housing from Commercial Conversions Program (AHCC) —or 467-m.  

• Federal tax incentive—As part of the Inflation Reduction Act of 2022 (IRA), federal tax credits are available to multi-family developers whose buildings meet certain energy-efficient criteria. Some of these improvements include windows, doors, insulation, and heating and cooling systems.  

California 

Commercial-to-residential conversions are gaining traction in California as the state battles its ongoing housing shortage, high rental costs, and limited housing supply. In Los Angles alone, hundreds of thousands of units must be added to meet housing goals outlined in that city’s Regional Housing Needs Assessment (RHNA). In the downtown area, sections like the Financial District and Historic Core have a significant inventory of older, underused office buildings. Programs like Los Angeles’ Adaptive Reuse Ordinance (ARO) have already facilitated successful conversions of older buildings, particularly in downtown areas.   

Challenges to Commercial-to-Residential Conversions in California 

Regulatory and zoning barriers 

• Zoning restrictions: Many commercial zones do not permit residential development, which then requires time-consuming and costly rezoning or variances. 

• Local resistance: “Not in My Backyard” opposition often delays or halts projects due to concerns about density, parking, or changes to neighborhood character.  

• Affordable housing mandates: Requirements under California’s Middle-Class Housing Act (SB 6) and the Affordable Housing and High Road Jobs Act of 2022 (AB 2011) for affordable housing quotas in new residential projects can add to project complexity. 

High costs of conversion 

• Retrofit costs: Adapting older commercial buildings to meet residential building codes—particularly for fire safety, plumbing, and insulation—can be prohibitively expensive.  

• Seismic retrofits: In this earthquake-prone region, seismic upgrades for older commercial buildings can significantly increase costs. 

• Utility and infrastructure upgrades: Office and retail spaces often lack the necessary infrastructure for residential use, such as individual plumbing systems, kitchens, and HVAC systems.  

Design limitations 

• Building layouts: Many commercial buildings have deep floor plates with limited windows, which makes it difficult to create residential units with adequate natural light and ventilation. 

• Parking constraints: California cities often require parking spaces for residential projects, which can be challenging to integrate into existing commercial structures. 

Economic uncertainty 

• Market demand fluctuations: The success of conversions depends on local housing demand and economic conditions, which vary widely across California. 

• Developer hesitation: High land and construction costs—combined with uncertainty about zoning approvals—discourage some developers from pursuing conversions.  

Environmental and historic preservation restrictions 

• Strict environmental laws, such as the California Environmental Quality Act (CEQA), can delay or block projects from moving forward.  

• Buildings with historic designations often face additional restrictions, thus limiting design flexibility.  

Opportunities for Commercial-to-Residential Conversions in California 

• Addressing housing shortages: Conversions provide a viable way to increase supply without requiring new land development. 

• Adaptive reuse incentives—California cities such as Los Angeles and San Franciso offer adaptive reuse programs and tax incentives to encourage the repurposing of older buildings. Additionally, federal and state historic preservation tax credits can reduce costs for converting historic commercial properties.  

• Environmental and urban revitalization benefits: Adaptive reuse reduces both waste and the carbon footprint associated with demolition and new construction, thus aligning with California’s sustainability goals. Also, adaptive reuse can revitalize struggling downtown areas by turning vacant malls and office spaces into vibrant mixed-use communities.  

• Economic and social benefits: Large-scale conversions can create jobs by generating employment in construction and related industries and revive local economies with nearby dining, retail, and transit infrastructure. 

Are you considering a commercial-to-residential conversion project? Milrose Consultants is your trusted partner in navigating zoning regulations, permitting challenges, and architectural complexities to bring your vision to life. With years of expertise in adaptive reuse and compliance with local laws, we streamline the process, from planning to completion. 

For deeper dive into the topic, watch our panel discussion. 

Contact us today to start transforming your commercial spaces into thriving residential properties. Let’s create innovative housing solutions together. Schedule your consultation now!