Although the commercial real estate market is still solid, recent wobbles in the market (coupled with an unprecedented boom in the residential market) have more investors thinking about commercial-to-residential property conversions.
This kind of project may seem daunting from a legal and logistical perspective. Still, in places with a housing shortage, local governments are bending over backward to ease zoning laws and even offer tax breaks to ambitious developers. It’s never been easier to turn your old warehouse, office building, or hotel into multifamily housing.
So, does it make sense for you? Well, it depends. Even if local market conditions are favorable, converting a commercial property into a residential one is a long, expensive, and complicated process. But it can also be a very lucrative one. Before you find a realtor and sell your property, read our advice on converting your moribund commercial property into a valuable residential asset.
Zoning comes first
The first hurdle you have to clear is also the most important: local zoning laws.
Properties zoned for commercial use are often prohibited from being used as residential space and vice versa. One study from the University of California at Berkeley found that nearly half of all commercially zoned property in California’s four largest metro areas are expressly prohibited for non-commercial use. So the first step in your conversion to multifamily will be determining whether you’re allowed to convert — and if not, how to request for rezoning.
The good news is that because of the meager housing stock available in the US, many local planning departments are open to rezoning commercial properties. But as with many government processes, it’s going to take some time and a lot of paperwork.
Typically, the process will go something like this:
The first step is to submit a detailed application for rezoning. This application will describe the property and your renovation plans and will have to be accompanied by a substantial fee (sometimes as large as several thousand dollars). Make sure you figure this fee into your budget!
- Analysis and amendment (if necessary)
The planning department will scrutinize your plans and make any necessary corrections or suggestions. If they require changes, you’ll have to revise your application before proceeding to the next step in the process.
- Public feedback
Once your application has been finalized, it will be opened to public scrutiny and comment for a specific period. There will also be a meeting of the local zoning commission that’s open to the public, where your rezoning project will be presented and where local citizens can voice objections. After this meeting, the zoning commission will make a yes/no recommendation on your project.
- Official signoff (or denial)
The commission’s recommendation then goes to the desk of an official who has final say and will generally sign off on that recommendation. If your application is denied, you can amend your plans and reapply — but you’ll usually have to wait a certain amount of time before reapplication. You’ll also have to pay another application fee. If you get denied again, it might be time to consider just selling your property.
Understand your retrofit
Getting a signoff on your rezoning application is just the first step. Next, you’ll have to physically convert your commercial property into one that’s safe, appealing, and habitable as a multifamily property.
Your renovation will consider several main areas:
Multifamily and commercial properties have to meet different building codes, so your conversion will almost certainly require you to undertake some electrical and plumbing work to make each residential unit habitable. Before you get the ball rolling on your conversion, have your contractor assess how much work the property will require — and how much it will cost.
Safety could arguably fall under the umbrella of building codes, but it’s important enough to treat it as a separate issue. You must ensure your renovation meets safety regulations regarding ventilation, air quality, noise, fire, and other areas.
Commercial properties can come with some features that may be less than ideal for a residential property. Large parking lots and centralized exits and entrances are acceptable for commercial properties, but multifamily buildings have different needs. You may have to undertake significant landscaping redesign to make the property more welcoming and accessible, add staircases or elevators for increased egress, or potentiallyhave to make the building handicapped accessible according to the Americans with Disabilities Act (ADA) guidelines.
Many commercial buildings — offices and warehouses — have very deep floors, with little natural light penetrating the center of each floor. This isn’t a problem with commercial properties, as this space can be used for storage or other purposes. But in a multifamily space, every unit should have some natural light, which can present redevelopment challenges.
As far as industrial finishes, leaving them in place (with some polish) could work in your favor. Features such as exposed brick and (polished) concrete floors have a lot of appeal in some settings, but it will depend on the market. The same applies to the property’s “curb appeal” — you may have to redo the exterior to make it more attractive or add features such as landscaping or green space.
Utilities will be a significant hurdle in any commercial-to-residential renovations. From centralized bathrooms to commercial electrical systems, you’ll have to essentially rebuild these systems from the ground up, as each multifamily unit will need its own plumbing, electrical wiring, and meter.
Get community buy-in
Although a commercial-to-residential conversion may not seem controversial, some projects have run into community opposition. Citizens arguing against your project at the public zoning board meeting may not, by itself, sink your project’s chances, but it can make them request quality-of-life amendments to your plan. That will take time — and money.
If a community is firmly against your conversion, you could be facing an uphill battle.
Get a handle on your budget
As you can see from the list above, retrofitting a commercial property into multifamily units can be very expensive. That’s in addition to rezoning application costs and carrying costs that will add up while you apply for rezoning, amend your plan, line up contractors, and perform renovations.
With so many moving parts and different stages in the process, you must keep a close eye on your budget. The retrofitting can easily spiral out of control and become a money pit.
The pros and cons of converting a commercial property
It’s a lot of work to convert commercial property to a residential multifamily building. But it can also radically increase the value of your property.
Let’s look at the positives and negatives of a conversion project.
Many commercial properties are centrally located and will be very valuable as residences.
There’s a dire housing shortage in many cities, so local governments are often happy to ease the conversion process with zoning changes and tax breaks.
Commercial properties are big, which means the residences will have a lot of square footage: more square footage equals more value.
Increase in value
It can be incredibly lucrative to convert, for example, a warehouse into two dozen condos. Those residences can be even more lucrative if you pursue a path like short-term rentals on a platform like Airbnb.
A long, uncertain regulatory process
Your rezoning application may not be approved, and even if it is, it will take months to get the green light.
Renovations are uniquely expensive
Even investors who are used to flipping multifamily buildings with a 1031 exchange can be surprised by the challenges of a commercial-to-residential conversion. The renovations you’ll be overseeing are much more than cosmetic; they’re remaking the space on a fundamental level. That kind of deep work takes more time — and more money.
Residential is high-maintenance
Being a landlord can be a full-time job — and then some. Between finding and screening tenants, collecting rent, and doing repairs and standard maintenance, your tenants can keep you extremely busy. And hiring a management company will cost you, on average, 10% of all rents collected.
Ben Mizes is the Co-Founder and CEO at Clever Real Estate, the nation’s leading real estate education platform for home buyers, sellers, and investors.