Melbourne unlikely to see office-to-apartment conversions

The Property Council (PCA) recently commissioned Hassell to identify buildings suitable for adaptive reuse from commercial office to residential in the Melbourne CBD.

Hassell identified around 86 pre-1990s CBD buildings that it considered suitable for converting into as many as 12,000 apartments based on a criteria that identified buildings by age, grade and design, focusing on B-grade buildings and below.

The challenge is that JLL Research has found most of the vacant stock in the Melbourne CBD is in A-Grade buildings, typically more recently constructed and much more challenging to convert to residential.

This is unlike the market conditions that led to the last wave of adaptive reuse – the successful Postcode 3000 campaign in the mid-1990s, which saw more than 3000 apartments created from redundant offices.

The 1990s adaptive reuse program was driven by an economic recession that saw the cash rates peak at 17.50% in January 1990 and didn't drop below 10% until September 1991. The massive rise in interest rates triggered a crash in the value of commercial property assets, and unemployment reached a high of 11.20% in December 1992—the perfect storm for the CBD.

As a result, office vacancy peaked at 26% in 1992 and remained above 20% for four years, while office withdrawals peaked five years later in 1997.

While we are in a similar commercial office oversupply in 2024, employment is still robust, GDP growth is solid, and we have yet to see substantial withdrawals of office assets and although the return to office has been slower in Victoria the pendulum is steadily swinging back.

As a result of the robust economy owners are still being rewarded for reinvesting in their office stock as tenants flock towards better quality buildings – both refurbished and newly constructed assets and while pricing for office has shifted materially at the same time construction and refitting costs have increased 20-30%.

JLL Research recorded the Q4 2023 CBD vacancy rate as Prime grade at 18.8% and secondary grade at 16.8%. The older B grade (126,300 sqm vacant) and C & D grade ( 131,750 sqm empty) identified for adaptive reuse equates to 258,000 sqm of vacant floor space or just 5% of the total.

As tenants vacate buildings suitable for adaptive reuse, owners must decide whether to invest in upgrading the office space to modern standards or undergo the complicated and expensive process of converting them to apartments.

Many active developer clients have commented that the depth and configuration of office building floor plates don’t lend themselves to the requirements for residential dwellings. Planning and apartment design standards would need to drastically change to alleviate these issues, which is unlikely to occur in the short term.

As setback and density rules have also become extremely restrictive for CBD landholdings under 1,000sqm, there would need to be a revision of the planning scheme to provide for better outcomes on smaller sites which would allow for the delivery of more units. Unique and iconic residential buildings like Phoenix in Flinders Street and Collins House would not have been built under the current planning regime.

In summary, it may be too early in the cycle for the limited number of suitable buildings to be adapted for an alternate use, but if the economy keeps growing, unemployment stays low, and interest rates stabilise, conversion from existing office may only occur in very few buildings – if at all.