The impact of the coronavirus pandemic on surplus office, hotel and retail space is set to create a wave of residential conversions across the world. While some commercial property segments have seen periods of relative weakness, city residential values “have been growing strongly in most markets,” making real estate players grapple with questions around alternative uses that could boost the value of buildings where occupier demand may fall further in a post-covid world, says Adam Challis, head of EMEA living research and strategy at real estate services firm JLL.
“It’s too soon to point to real evidence of conversions to residential due to the pandemic, but there’s no question that there will be quite a lot of activity as a result of changing dynamics over the next couple of years,” Challis notes.
The pandemic has accelerated the hybrid model of working remotely and in the office, particularly in Europe, where more activity involving residential conversions from offices is expected relative to other regions, Challis says.
In the US, domestic travel pattern data shows the country is largely moving back toward its former office occupancy levels, whereas in the larger cities of Asia-Pacific, office occupancy rates are very close to pre-pandemic levels due to socio-cultural factors such as presenteeism, he adds.
Office conversions to residential are likely to involve older office blocks with a lack of ‘green’ efficiencies, in sub-markets where residential demand has created new urban areas for living, supporting residential values, Challis explains.
Pre-pandemic, these growing neighborhoods – typically fringe locations to high-value residential – already tended to see a greater proportion of repurpose due to a relative change in market values between residential and office. “This is a trend that has been around for some time and, post-pandemic, it will only accelerate,” Challis says. Struggling hotels can also get a second life as residential with the aim to offer affordable units in hot markets with high rents – a play already attracting investors in the US. According to Real Capital Analytics, so far in the US only the hotel sector has seen a notable surge in distressed sales, making up 8 percent of the $10.6 billion of hotels traded between March 2020 and February 2021.
“We have seen a significant uptake in investment activity in the space, in markets like Arizona, Utah and Colorado,” says Malcolm Davies, partner and managing director at George Smith Partners, a capital market services provider based in Los Angeles. “Covid has impacted significantly the hospitality industry, but some of these hotels were probably struggling prior to the pandemic, so a trend that was already occurring has been exacerbated.”
Investors are buying old hotels “way below” replacement cost and converting them into co-living micro apartments, Davies says. This makes an “attractive” investment proposition that performs well and can see robust demand from occupiers, as rents for these micro units are approximately 30 percent lower than a traditional apartment, he adds.
“The key is to make sure that the amenities are great – with a pool, a fitness center, a place for occupiers to work if they need to – because the units are small, about 350 square feet. And then a good property management company that helps investors lease up and create a community.”
Lenders such as LaSalle and Pacific Western Bank are actively backing these conversions across the US, as they provide long-term financing opportunities. “I would anticipate seeing more lenders stepping into this type of opportunity as the year goes on,” Davies says.
Retail in the UK is another notable segment for repurposing opportunities, due to higher online penetration and, crucially, higher density of stock compared with continental Europe. Land Securities, the UK’s largest property company, is planning to convert some of its retail space, which makes up most of its current property portfolio, into residential homes. Meanwhile, property developer Ballymore recently acquired the Broadwalk Shopping Centre in north London with the intention of converting a large proportion of the site into homes.
The conversion of shopping centers to alternative uses, including residential, has just started in the UK but it will accelerate with the pandemic, says Stephen Springham, head of retail research at Knight Frank. “A lot of shopping centers are very challenged – values have plummeted and there’s a lot of vacancy,” he explains.
“They were built in the 1980s or 1990s and haven’t really had any investments since, so a lot of them are struggling and many investors are now looking at shopping centers and thinking, ‘What they can be now?’”
However, conversion to residential is more complicated than it seems, Springham notes. Investors need to make sure the relative value of the alternative use is still higher after adding up all the costs to get there.
“You don’t just buy a shopping center, knock it down and turn it into flats. You have to stack up decommission, demolition and construction costs,” Springham says. “These costs are only offset where residential values are significantly higher than retail values, but there aren’t many locations at the moment where we see this – apart from central London and certain centers in the southeast of England.”
In these locations, Springham is seeing a few examples in progress – rather than finished projects – which are pointing in the direction of redevelopments of shopping centers into mixed-use schemes, with a big focus on residential. The conversion of the Nicholsons Shopping Centre in Maidenhead, a town located 25 miles west of London, is one such project.
The property, which had fallen into administration, was acquired by Tikehau Capital and partner Areli Real Estate well below its historic value. The plan is to replace it with higher value residential, office and retirement uses, and regenerate the town center. The new scheme will include 346 new homes and 307 senior living homes – as well as 30,000 square meters of new office space and up to 60 shops and restaurants.
Similarly, Native Land has recently embarked on a strategy to acquire town center retail assets for repurposing and redevelopment. Its most recent acquisition is a former Debenhams department store in Guildford, a town located 27 miles south-west of London, where the UK property developer is consulting on options for a residential-led mixed-use scheme.
“As the UK high street evolves, opportunities naturally present themselves to reposition and repurpose redundant assets to ensure the continued enlivenment of the town center,” says Robert Harris, managing director of acquisitions at Native Land.
Location and scale
Finding the right locations for schemes with residential as the main income driver is crucial. “We have tended to focus on redevelopment opportunities in fundamentally robust UK towns and cities, with strong demographics and access to key UK conurbations,” Harris explains.
“We also consider the potential for operator-led demand, for student, senior-living or build-to-rent products, so we look for an affluent professional catchment, perhaps a strong university location, or downsizers seeking a home for the next stage of their lives. Not every building or site may be physically suitable for conversion or redevelopment, and in particular it needs to provide a scheme of sufficient scale.”
Also, for Daljit Sandhu, co-founder and chief operating officer of lender Précis Capital Partners, which specializes in residential developments, scale is key when it comes to backing retail-to-residential projects. “If it’s a repurpose, it needs to have a certain scale for us, especially if you want to convert it to any of the operational real estate assets like student or private rented accommodation – they work best when there’s a hundred units or more because they can benefit from the communal spaces and back-of-house investment in M&E [mechanical and electrical systems] and service amenities.”
Sandhu expects that if there is a wave of financings for such projects across the UK, it will be seen within the next 12-18 months, as it takes time for investors to work out the situations and get the planning approval before financing opportunities present to lenders.
Other lenders are seeing opportunity in the sub-£50 million ($71 million; €58 million) lending market to back residential conversions in the smaller single unit type of retail, as the pandemic rushes the demise of the high street.
“We’ll see a lot of repurposing of ground-floor outlet-type properties in exchange for enhanced planning from local authorities for the upper parts,” says Ben Barbanel, head of debt finance at OakNorth Bank. “For example, say you have a retail shop with some space above, the council may say it’ll grant permission to develop flats above if you give the council the space on the ground floor for something like a council office or a community center.”
Whether it is through struggling retail, hotel or office assets, more conversions into residential accommodation will arise globally. In that sense, market participants are optimistic this repurposing play will be a problem-solving opportunity, one that not only enhances market values, but also meets occupiers’ housing needs.