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Willing Convert

Can converting commercial buildings to homes really help the housing shortage? Andrea Kirkby investigates.

The Negotiator
knitwear factory image

A sad building in East London, once a knitwear factory, maybe soon to be stunning homes.

 

It’s no news to anyone that we have a housing shortage. What’s less clear is what can be done about it. The government’s intended relaxation of planning law is obviously intended to help, but how useful is it likely to be? What’s currently proposed is that B1, office and light industrial, should have residential (C3) as a permitted development, in other words that no planning application would be needed for that change of use. That doesn’t include B2 (general industrial) and B8 (storage and distribution), and it also excludes retail space.

Office space lends itself to conversion to apartments, and it’s family houses that we need.’

commercial property image

Bull Inn Court, Covent Garden, a dingy unused building now converted to apartments.

Take a look at the statistics. The Government’s consultation paper suggests that the conversion of half the empty B1, B2 and B8 space could create 260,000 homes over the next ten years. (Some cynics have pointed out that this does little more than replace 215,000 homes taken out of the construction pipeline last year by councils after the abolition of Regional Spatial Strategies.)

The Institute for Public Policy Research estimates there will be a shortfall of 750,000 new homes by 2025. According to Nick Pearce, IPPR Director, fewer than 100,000 homes are being built every year, while at least 250,000 new homes a year are needed. In that context, 250,000 extra homes is a help, but it doesn’t solve the problem. There would be a good argument for adding retail space (A1 to A3) to the mix, as well.

commercial property interior image

Bull Inn Court, Covent Garden, a dingy unused building now converted to apartments.

Meanwhile Alex Morton, a researcher at the think-tank Policy Exchange, says vacancy rates for commercial property are running at 17 per cent even in the South- East, while only three per cent of residential housing is unoccupied. Landlords faced with the cost of rates and insurance on empty buildings have preferred to demolish them, even though that represents a major one-off cost, with nearly 9,000 buildings pulled down in not quite two years from March 2007 to the end of 2009.

UNLOVED BUILDINGS

The disparity in vacancy rates is at least partly explained not by recent changes in the housing market, but by changes in the structure of the economy. Technological progress and changes in the structure of British industry have led to changes in demand for commercial property. High-tech manufacturing needs different types of space from old smoke-stack industries, while heavier internet use has shrunk demand for offices as filing cabinets are replaced by slim-line servers and hot-desking becomes more common. Meanwhile, the high street has its own challenges as online retail has replaced the trip into town with one-click shopping.

Many commercial buildings are obsolescent. Some office property simply is not capable of being wired for the density of internet access now required by business, and many smaller high street shops don’t have parking space or loading bays, fine for boutiques but not for a supermarket.

THE ATTRACTION OF CONVERSION

At the same time, household formation continues to grow, partly a result of immigration, but also of smaller household sizes. That varies from region to region; Guy Passey, of agent E A Shaw, says, “In prime London there’s a massive shortage of residential space,” and the same is true of most of the south-east.

In central London you could look at £650 a square foot value – £1250 for residential.’ Guy Passey, EA Shaw

Guy Passey, EA Shaw image

Guy Passey, EA Shaw image

So does it seem likely that the proposed changes will help increase the amount of housing development?

There are obviously key attractions to developers in converting commercial space to residential, and several developers have already identified this area as a good one to work in. Philip Stewardson of Stewardson Developments, which works in the West Midlands, says “The attraction to us has been large sites in good locations where the buildings have had enormous floor spaces. That lends itself to so many uses.”

He points out that a high percentage of the cost of new-build is ground work; any conversion, even with a high percentage of structural changes, saves that cost. Conversions also have a much quicker turnaround time, so capital is tied up for a shorter period. In the current environment, that can be important.

But the biggest attraction for developers is financial. Quite simply, land with planning permission for residential use is worth a lot more than commercially zoned land, and a residential building will sell for much more than an office block. Alex Morton’s report for Policy Exchange quotes prices per hectare of land for building at £600,000 for B2 and £710,000 for B1 use, but £1.85m for residential.

Guy Passey says that in central London, “you could probably look at £650 a square foot capital value for an office, whereas if you go to residential use, the value is £1250 a square foot, so there’s a big difference.” Out of that figure, he guesses conversion costs would run to about £350 a square foot. That would still leave a gross profit margin of 25 per cent.

In other markets the difference is even more marked. Philip Stewardson says he expects to get three to ten times as much from residential as commercial use, depending on the density of development.

For instance, a half an acre might have an industrial value of £150,000 to £200,000. A high density residential development could create as many as 30 flats on that space, which would have generated £800,000 to £1m at pre-crunch prices, and probably a bit short of that now.

Guy Passey points out that commercial to residential is already a well trodden path. “The trend has already gained momentum over the past couple of years,” he says, “and EA Shaw has been successful in helping developers convert offices that they can’t let. Some of our commercial clients who have never thought about residential before are now looking at it quite seriously.” For example, at Bull Inn Court, Covent Garden, former office space was converted into 14 residential units, all of which were sold off plan. At 16 Stukeley Street, an adult educational college was converted into ten apartments, unusually, half for rent and half for sale.

THE CONCERNS

So if conversion from commercial to residential space is already possible, why bother with the change of regulations?

Guy Passey says one reason is that different councils have very different policies on change of use. Westminster, for instance, tends to favour commercial to residential conversions, while Camden sees them as less desirable, which makes the planning process in that borough more difficult and lengthier. So far, conversions have tended to cluster in the ‘easier’ boroughs; a change in legislation would make development more even across the capital.

But most conversions would require changes to the exterior of the building, which would require planning permission even if change of use were permitted. Peter Bolton King of the NAEA says that the devil is in the detail; external works such as shop fronts and fascias, for instance. Philip Stewardson’s experience has been that new windows are often needed, again requiring permission.

He is also skeptical about developing flats above shops; though they sound like a good idea, the fact is that it’s nearly impossible for individuals to source mortgage finance on them. “Where we develop this type, it’s purely as an investment” for rental income, he says.

Another concern is that office space generally lends itself to conversion to apartments, not houses. The market for apartments is fairly well supplied (in 2008-9, half the total housing supply was in the form of 1 and 2 bedroom flats, according to Policy Exchange), while it’s single family houses which form the biggest area of shortage. And Philip Stewardson says the apartment market is dead – “Our lender is telling us that no one will be funding apartment schemes for the next five years, except in London.”

He believes a much more radical approach needs to be taken to the definition of land for employment use. For instance, the Austin Rover site in Birmingham is currently defined as for employment use, but he says “Many years after the car factory closed, the vast majority of the site remains unused. I’d be surprised if 5 percent of it is occupied, I drive past it quite regularly. Policy dictates that it’s land for employment use, but businesses now simply don’t employ 10,000 people or need that kind of space.” Redeveloping it for housing, in his view, would be eminently sensible, but the
proposed changes wouldn’t achieve this.

Environmental issues also need to be considered. What about parking, or the availability of services such as retail, schools, and health centres? Guy Passey points out that this isn’t an issue in central London, even parking is no longer an issue, since many residential developments now exclude any right to parking spaces as a condition of the planning permission. (On the other hand, he says, a bike store on the ground floor is becoming a standard requirement.) And of course the services are all there already.

development case study imageBut moving to suburban locations, such as ring road business parks, conversions might find this more of a problem. Philip Stewardson warns that in some locations, noisy loading bays and heavy HGV traffic nearby might preclude residential development, while decontamination can also be a problem. Worse still, decontamination costs are extremely difficult to predict. “You have no idea at all till you get some ground investigations done,” he says.

Perhaps the strongest argument against the changes, though, is that they are an overreaction to a temporary blip in the market. Peter Rees, planning officer for the City of London, warns that easier conversion could exacerbate the cyclicality of the market.

“The cyclical nature of the property industry means that if developers were to turn offices into residential blocks when times were tough, the City’s ability to attract and house new firms when market conditions improved would be seriously diminished,” he says. This could dilute the concentration of offices, particularly the types of units favoured by smaller and medium sized firms, and could damage the ‘clustering’ effect that makes the City and similar business districts so successful.

Guy Passey says, “That’s a fair point to make. Once the building has been converted, that building has effectively gone from commercial use”, selling off individual leasehold flats within a larger building partitions its ownership and makes it impossible to reunify it.

Philip Stewardson also raises the spectre of businesses being priced out of the market for premises. “Change of use possibilities would push the value of land up,” he says, and asks “would you then get owners of commercial sites forcing businesses out to get a vacant site that can be flattened and redeveloped?”

Some of these issues could be overcome by safeguards such as property having to be vacant for at least a year before change of use became automatic, as Alex Morton suggests. He also believes conditions could be imposed where commercial property is scarce, a “last shop in the village” style provision.

But Guy Passey points out that councils currently often attach conditions to change of use permissions, which give them a great deal of leeway in controlling the standard and even the look of conversions. They would lose this ability under the proposed regulations, so there may be unintended negative consequences from a relaxation of policy. “Councils will have to revisit their planning policy,” he warns, “otherwise it will be uncontrollable.”

Impact on agents

The proposed change may not be all good news for residential agents, either. If the supply of residential land is expanded, economic theory would naturally expect prices to fall. Alex Morton says, “At present, we create higher housing costs and lower costs for offices and industrial property because our planning system is reluctant to allow change of use.” That could unwind if the system changes, and might well involve lower house prices over the medium term.

The government hasn’t just missed the boat, it’s missed the point.’ Mark & Philip Stewardson

Mark and Philip Stewardson

Mark & Philip Stewardson

The government may actually have missed the boat. Philip Stewardson feels commercial property prices have further to fall, so he’s looking mainly at buying residential space in need of  redevelopment. One particularly nice deal was buying a house that had been used as a cannabis factory. That needed a lot of work, the wiring and much of the fabric had been almost destroyed by the high humidity, but was a profitable project for his firm.

And he says the government hasn’t just missed the boat, it’s missed the point. It’s not planning laws that stop developers from building houses; it’s finance.

“There are so many building plots that have got consent and could start tomorrow,” he says. “Even housing associations aren’t building now, and if as ‘non-profits’ they can’t make the numbers add up, how can anyone else?”

April 17, 2012

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