'We're A Business, Not A Charity': Denver Developers Want More Conversion Options

Denver developers want to expand the scope of potential office conversion projects beyond residential adaptations, saying that allowing more potential alternatives could help alleviate some of the concerns around completing such projects.

On a panel at Bisnow’s Denver State of the Market event on Oct. 25 at Mile High Station, Gresham Smith Project Executive T.J. Carvis spoke about the financial challenges inherent in adaptive reuse projects in today’s market.

Adaptive reuse projects can be cost-prohibitive because the market value of offices hasn’t decreased enough to make a pro forma work, he said. He pointed to Brookfield’s Republic Plaza office tower as an example. Even though the building has seen its market value plummet because of its high vacancy rate, it could still cost a developer in the ballpark of $300M to acquire the building, Carvis said. 

After that, there are construction and maintenance costs that need to be factored into the equation, which make the transaction altogether unattractive, he said. 

“There’s a big push for adaptive reuse here in Denver and that’s great,” Carvis said. “But we need to expand our thinking about it into other uses.” 

Carvis said Denver should look at doing office-to-lab conversions to support its life sciences industry, or office-to-industrial conversions since the industrial sector is still one of the city’s hottest submarkets. The city could also build schools, daycares or medical facilities through adaptive reuse, he said. 

In August, Denver partnered with national architecture firm Gensler to identify 22 office buildings in downtown that could be turned into roughly 5,000 housing units.

“This is a great goal to have, and Denver’s idea has a lot of potential, but it also presents a lot of challenges,” Jeremy Atcheson, business manager at Turner Construction, said during the event. 

One of the primary challenges developers face when trying to convert offices to residential units are the buildings themselves, Atcheson said. Some old buildings don’t have the appropriate electrical or mechanical systems, which can be two of the most costly components to upgrade. There can also be a lot of unknowns hidden in old office buildings because their architectural drawings are not always up to date, he said. 

Denver’s adaptive reuse goals would be tough to meet in a good market, according to Eric Rymarz, director of development for Urban Villages. Given the industry is facing high interest rates, supply chain issues and a host of regulatory constraints, Rymarz said it is difficult to get these kinds of projects to pencil out. 

The Federal Reserve has increased interest rates 11 different times over the last two years, bringing the federal fund rate to 5.25% to 5.5%. This has pushed interest rates for construction loans up to nearly 9% in some cases, which Rymarz described as a “real deal-killer” for a lot of projects. 

Banks have also become more cautious of commercial real estate deals, according to Aimee Love, executive vice president at Independent Financial. Not only are banks being squeezed by high interest rates, but they are also facing increasing pressure from regulators concerning their liquidity following the collapse of Silicon Valley Bank earlier this year. This environment makes it hard for developers to forge new relationships with banks, Love said. 

“The transactional type of lending is something that banks are going to have to avoid for the foreseeable future, at least until we can get some clarity about interest rate hikes,” Love said. 

Developers also questioned whether Denver’s adaptive reuse goals make sense in combination with the city’s electrification requirements. According to panelists, almost all of the 22 buildings identified in Denver’s adaptive reuse study would need their electrical systems upgraded to become residential units and meet the standards in Energize Denver.

There is also an open question of whether the city’s power grid can handle that much more demand from building electrification. 

These are just a couple of reasons why some of Urban Village’s pro formas for small adaptive reuse projects have shown negative returns, Rymarz said. 

“We’re a business, not a charity,” Rymarz said. “So I think the city will need to play a big role in helping developers meet these adaptive reuse goals.”