Rezoning Could 'Breathe New Life' Into Midtown South, But Only If Developers Can Justify The Costs

In 2019, Manhattan’s Midtown South was teeming with tech workers eating at Sweetgreen and bonding over beers. The 12-story office building at 29 W. 35th St, appraised at $73.5M at the time, was no different.

Now, four years later, its two largest tenants, flexible office firm Knotel and tech company Sprinklr, have departed, and the building has been foreclosed on. It headed to auction in August with its lender asking for $23M and received no bids, according to city records. 

But a rezoning proposal could give new life — and new value — to the plethora of Class-B and C office buildings that sit bleeding in the center of the city's core. Under the city's recently updated Midtown South Mixed-Use Plan, large swaths of the neighborhood could be converted into residential — a use that is presently not allowed.

The zones span 42 blocks around Penn Station, the Port Authority Bus Terminal, Herald Square and Bryant Park. The proposal applies to most of the area between 23rd and 40th streets and Fifth and Eighth avenues.

Since late October, when the latest version of the rezoning plan was released, buyers have begun sniffing around the neighborhood looking for opportunity.

“We're getting a lot of interest, questions and inquiries,” said Ashley Doukas, who chairs Adler & Stachenfeld’s Land Use & Zoning Practice. “It's currently all manufacturing around the largest transportation area in the city, with Penn Station right in the middle of the rezoning area.”

Despite its unparalleled transportation access, the area has not rebounded compared to other workforce hubs. As of the third quarter, office vacancy in Midtown South is 26.3%, above Manhattan's overall vacancy rate of 23.5%, according to a report by Cushman & Wakefield. 

Even Downtown Manhattan, where the Financial District sits, has a slightly lower vacancy rate of 24.4%. Its supply of unused office space has shrunk and is expected to keep shrinking as a wave of residential conversions comes to the area.

Buildings in chunks of Midtown South, however, have been unable to be reused due to restrictions that the Department of City Planning seeks to overturn. The mapped zones would have a floor area ratio of up to 18 with the potential to create approximately 9,700 units of housing, 2,800 of which would be permanently affordable.

That’s up from 4,000 units, with a quarter being income-restricted, that a previous draft allowed for. The updated proposal follows the lifting of the longstanding 12 FAR cap that Gov. Kathy Hochul signed into law as part of the state budget deal earlier this year. 

Ariel Property Advisors’ Howard Raber, who specializes in investment sales in Midtown Manhattan, recently brokered the sale of two buildings — at 250 W. 30th St and 236 W. 54th St. — to Hiwin Group USA. The Flushing-based developer also recently bought 245 W. 34th St, another site near Penn Station. 

Raber said those sites are ready-made development lots that work for Hiwin’s plans even in current-day zoning but give the developer a way to implement a business plan as soon as any new regulation goes into effect. 

“Whatever happens tomorrow, that's a bonus for that developer,” Raber said. “Those are developers that have the wherewithal to seize the opportunity. I’m not really seeing sites trade today that will only be usable with the rezoning.”

Both the Midtown South Mixed-Use Plan and the greater City of Yes citywide rezoning are meant to solve an ongoing housing crisis and create 24/7 communities in areas that were reliant on office work. Brokers and developers say that more development in the outlined area will further rejuvenate the Manhattan ecosystem beyond the boundaries of the rezoning.

MAG Partners has two multifamily projects close to the boundaries of the rezoning, at 243 W. 28th St. and 300 E. 50th St. Though the projects have been successful in leasing, “tenants yearn for more retail and lively streetscapes,” founder and CEO MaryAnne Gilmartin said.

“Residential uses and a [increased] FAR will breathe new life into the district,” Gilmartin said in an email.

For the areas of Manhattan caught in limbo, brokers and developers say that there is an increased perception of crime that, despite the crime rates consistently falling, is offputting to both tenants and investors.

“It's just good for business to have residential and a 24/7 neighborhood where businesses can come back in and people are walking the streets again. Once you have that public safety, that raises all ships,” said Craig Waggner, a managing director in the Private Capital Investment Sales Group at Cushman & Wakefield. “Values will come up. It's hard to tell when and how much, but for certain, values should increase over time.”

Still, a rezoning is no panacea. 

Under the draft proposal, the city's mandatory inclusionary requirement will apply to the new zones, meaning at least 20% to 30% of new residential units must be affordable for low and moderate-income residents. In addition, the projects would be built under the new 485-x tax incentive, which developers say actually makes building affordable housing more difficult given requirements for union labor and lower rent caps than its predecessor, 421-a.

Pile that on top of the costs to convert or raze buildings in Midtown South, the numbers don't add up to a boom waiting to happen, brokers and developers say. 

HKS Real Estate Advisors principal and Senior Managing Director Peter Carillo said he’s worked with developers on conversions in different neighborhoods of the city. Due to the costs of making an office livable, such as improving ventilation and creating window access, the economics only make sense to create luxury apartments. 

“Is it a great idea? Absolutely. Is it going to improve the city? 100%,” Carillo said. “But if the city doesn't realize that major component, it’s going to be very difficult to spark interest.”

Alchemy-ABR Investment Partners is among the developers who, under the proposed circumstances, are not interested. Nine out of 10 times, a conversion in Midtown is not possible, co-founder and Managing Partner Brian Ray said. 

In the instances when it is, the issue becomes the fact that a property must be vacant before a conversion can take place, forcing the developer to pay to buy out tenants or be encumbered by taxes before any construction can begin. 

“I think one of the easier solutions is to change some of the zoning on having commercial and [residential] in the same buildings,” Ray said. “And that's really a Fire Department issue.”

Ray added that the hurdles around securing capital for any new project add additional challenges. With the stagnated capital market, there has been a shift in yield expectations, meaning it is harder to justify an investment in a risky redevelopment.

But compared to the previous version of the Midtown South Mixed-Use Plan that would have allowed for just 4,000 new units under a lower FAR cap, the rezoning is more attractive for lenders looking for a higher yield. 

“You can't take institutional capital and go to your investment committee with an office deal in New York City, especially a Class-B, C mid-block building,” Waggner said. “If you go to an investment committee with [plans to] knock down these three buildings and build 18 FAR residential, then that becomes more appealing as a value-add opportunity.”

However, for existing owners of Midtown South buildings who may be struggling to fend off debt servicers, the rezoning likely won’t come in time. For values to return to the properties, it will take even longer.

“These things move like glaciers,” Waggner said.

Meanwhile, several other neighborhood rezonings are taking place across the five boroughs. 

In August, the New York City Council voted to approve the Bronx Metro-North Stations rezoning, which allows developers to add 7,000 new housing units around existing and soon-to-be-built transit stations. 

The Long Island City Neighborhood Plan is currently making its way through the system with the potential to bring 14,000 new homes, including at least 4,000 units of affordable housing. In Jamaica, a plan to rezone more than 300 blocks is in the early stages of drafting.

Those rezonings will not be as ultra-dense as Midtown South, nor are they in the middle of Manhattan, a value-add in and of itself. However, the economics to build housing are far easier, Carillo said.

In the South Bronx, “those buildings were bought at about anywhere between $50 to $80 a foot. Long Island City, they were bought anywhere between $150 and $200, $250, but it makes sense,” Carillo said. “Once you go beyond those numbers, it becomes very complicated.”