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Office conversions playing interesting role in this cycles office market recovery

Office demolitions and conversions are playing an interesting role in this cycle’s office recovery. They decrease competition for tenants, especially between Class B and C landlords, and as empty space is removed from the market, vacancies decline.

The effect of space removals has been unusually visible in recent years due to the dearth of new office buildings. In 2012, the office stock shrunk in a third of the 54 top U.S. markets, and overall demolitions and conversions reduced the net inventory change by about 21.6 million square feet, or 0.3% of inventory, effectively resulting in about a 0.2 percentage point decline in office vacancy.

Over the next four quarters, a fifth of the top 54 U.S. metros and almost half of the 1,400 submarkets in thos metros will have a net loss of inventory.

Conversion to residential usage is the most prominent reason that an office building is removed from inventory. (See Exhibit 1.)

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Condo and apartment conversions comprise 34% of the lost office space in CoStar’s database, and another 13% of office space has been demolished to make way for new residential construction.(1)

Inasmuch as offices are replaced by homes for new residents who likely will want to work nearby, multifamily repositionings benefit both the supply and demand sides of the office fundamentals equation.

Multifamily developers often market transit accessibility as a part of a project’s amenities, and of all the possible conversion/demolition combinations, residential conversions had the closest proximity to mass transit-averaging only a 3.8-minute walk to the closest transit stop. San Francisco, Chicago, New York and Philadelphia have the largest concentrations of transit-accessible office structures that fit the typical multifamily conversion profile (built circa 1930 with 22,000-square-foot floor plates), and office fundamentals in those metros stand to benefit from additional conversions.

Source: Mark Heschmeyer October 21, 2013