Israel is stuck with huge amounts of office space – Government plans to convert some of it into residential real estate

Vast construction of huge office towers in central Israel over the past few years has resulted in excess supply in areas that, currently, no one needs. The government is initiating a move to convert large-scale office space into apartments; however, the plan has received widespread criticism by local municipalities.

The Corona crisis caught the Israeli commercial real estate sector during a thriving and prosperous period that many people thought would last forever. In recent years, a huge number of office towers were built in Tel Aviv and the surrounding cities – Bnei Brak, Ramat Gan, and Rishon LeZion, with experts warning of unwarranted supply.  While numerous towers have been completed and are already inhabited, many more are still under construction.

Record numbers of office space currently under construction

In 2018, a record 1.63 million square meters of office and retail space began construction, and 2019 saw the second-highest figure of 1.36 million square meters. This follows an average annual amount of between 700,000 and 800,000 square meters of office and retail space. The Corona crisis, therefore, found the Israeli office market with over 3 million square meters under construction that should be populated soon.

With this sharp increase in supply, the future for the office real estate sector, particularly as the pandemic lingers, is gloomy. Today in Israel, more than half a million people are unemployed, while hundreds of thousands have transferred their workplace to their homes to reduce unnecessary encounters and gatherings, thereby preventing the spread of infection. This means that not only is the 3 million square meters of space currently under construction less desirable, but much of the millions of meters of existing office space has also become redundant.

High supply, low demand and difficult to financing

The drop in demand is reflected in the level of rental prices of the firms, which are estimated to have dropped by 10% to 15% in Tel Aviv and the surrounding area.  But another effect is the difficulty that office developers are currently facing in sourcing financing for such projects.

Against the backdrop of the crisis in the office industry, a number of initiatives have emerged in recent months that have sought to turn the challenge into an opportunity – and to convert the many areas that are now being built into residential units.  This comes at a time when, unlike the office industry, the residential sector suffers from a severe supply shortage, which has been reflected in sharp price increases since late 2007.

Convert office-zoned areas to residential units

In early July, it was announced that under the “Arrangements Law” – a law that determines various economic changes and is approved annually in the Knesset along with the budget – the Ministry of Finance initiated the option of conversion of up to 50% of office-zoned areas in existing construction plans into residential areas with small apartments of up to 80 square meters. However, because of a political crisis in Israel that has prevented the transfer of the 2020 budget so far, the Law of Arrangements has not yet been approved, and this initiative remains, for the time being, on paper.

Initiative will harm municipalities financially

The delay in the legislation has pleased many mayors and local authorities, who oppose the initiative. According to the local authorities’ funding system in Israel, a large portion of their income is derived from taxes on commercial and office space, which requires minimal municipal services. While taxes on residential areas are relatively low, the services the authorities must provide to residents – education, culture, welfare, etc.– are much more expensive. Massive reassessment of residential office space is therefore seen by the municipalities as a significant financial threat.

However, this position is not unilateral. In some cities, the authorities have taken the ingenuity into their own hands and have begun promoting initiatives that would allow offices to be converted into residential units. For example, the Ramat Gan Municipality, adjacent to Tel Aviv, is currently advancing a decision that in the “Borsa” area –  one of the largest employment areas in Israel (named after the Diamond Exchange that operates there) – some of the office space can be converted into residences by granting an exceptional permit, which will be valid for ten years.

In Kfar Saba, another city in central Israel located northeast of Tel Aviv, the municipality has already allowed two office building developers in the city center area to withdraw their plans that had already been submitted and approved by the planning committee, and to redesign and reconfigure them as residential projects, significantly reducing the total built-up area. Despite the impact on the scale of construction, the developers prefer to build housing rather than offices, given the current market conditions.