Office Landlords Consider Demolitions As Conversion Challenges Mount

As Class-B and C offices empty out, owners are getting increasingly nervous. 

Most dream of giving their buildings a new life by converting them to apartments, especially in a city like New York, where residential vacancy is at a 50-year low. Others are wrestling with the wrecking ball.

“A pretty high percentage of those buildings won't have a future,” said Peter Bafitis, managing principal at architecture firm RKTB. “[Pre-World War II] buildings lend themselves better to residential, but you’re going to have quite a few of the massive floor plate buildings after World War II. What do you do with them?”

Approximately 20% of Manhattan office space was available at the end of last quarter, according to Avison Young. However, that percentage is less than other parts of the country like San Francisco, where vacancy has exceeded 30%. 

Leasing volume has increased in recent months as tenants fall into their newfound office routines, bringing hope to landlords and brokers. But the data indicates tenants are leaving old offices for newer amenity-filled buildings: 42% of New York City leasing activity by square footage is concentrated in Class-A space, despite only representing 15% of the market, according to Avison Young. 

So far, few demolitions have taken place in New York City, with most owners attempting to hold on until they know more about future demand, as well as future conversion incentives. 

Among the knockdowns that are moving forward is 5 West 13th St. where Victor Sigoura’s Legion Investment Group filed permits to tear down a 130K SF office building shortly after buying it for $57.5M. The group has been aggressively acquiring properties and piecing together assemblages across the city.

Property owners across the country have been pushing for local governments to incentivize conversions, and to do so quickly.

SL Green Realty Corp. CEO Marc Holliday estimated in April that 40M SF of New York City office space will be converted under a state housing bill that has since been passed. City Planning Commissioner Daniel Garodnick places that figure at 136M SF — more than a quarter of the city’s office stock — if the City of Yes rezoning proposal is passed.

Post Brothers co-founder Mike Pestronk has had conversations with the White House to further advocate for the policy. Though he acknowledges that reusing a building doesn't save much money compared to demolition, he said it has other benefits, such as saving time and improving sustainability.

“Certainly sometimes it can make sense because you can just make better use of a site,” Pestronk said. “Generally, demolition is going to happen in the most premium locations, where things could otherwise be converted, because the economics are going to be such that you get paid a substantial premium for the space efficiency of new construction and you can generate a lot more yield.”

Factors like layouts, plumbing, windows and ventilation can make conversions pricey or challenging. For architects, approaching the conversion of a large building can be like solving a puzzle.  

CetraRuddy principal and Director of Architecture Eugene Flotteron is involved in some of New York’s largest conversions. In doing so, he has explored repurposing areas in the middle of buildings — areas that cannot be used for housing due to ventilation and light restrictions — as vertical amenity space, tenant storage or other back-of-house functions, such as those that would typically be in the basement.

“There's always a way to it. It's just a matter of if it's the best way,“ Flotteron said. “If it was under-built, and you're wasting all this area, and you can't modify it in an easy way without it being more expensive and taking longer, then it's an easy knockdown category.”

The developers making headlines for exploring office-to-residential conversions are some of the biggest names in New York City real estate: SL Green, RXR Realty, Silverstein Properties, Nathan Berman’s Metro Loft Management and Jeff Gural’s GFP Real Estate.

However, small landlords who don’t have the capital or knowledge of how to take on a conversion may struggle to take such risks. Starting from scratch offers more clear timelines and results. 

“All of these projects, these conversions, are almost pilots. We're learning right now, and learning at $100M a pop is a really expensive way to learn,” HLW principal Lee Devore said. “The more people come to the table with these projects, and the more that skill set evolves to be able to take it on, we'll find more competition will make it cheaper and cheaper to do.”

But in the meantime, Karp Strategies Director of Real Estate and Economic Development Annie White — who previously worked for the Department of City Planning — said that city education efforts will be key to getting those owners up to speed with what may be possible for their portfolios.

As of May, 64 office landlords approached the city wondering if they could convert their buildings to apartments. 

“A lot of these property owners, they've just been long-time land owners and are not well equipped to make that kind of transition,” White said. “For the less ambitious or the less aggressive property owner, it certainly is going to take more incentive and more support to go through with [a conversion].”

Despite all the dense, mid-block, curtain wall buildings, New York does have one advantage compared to other cities: incentives and policy for conversions are making their way through the system.

In other areas of the country with less government support for conversions, the future for vacant offices seems bleak.

Commercial foreclosures are up 13% nationwide from the first quarter, the highest quarterly figure in nearly a decade. More than $20B worth of office, multifamily and other property has been seized, according to MSCI data. 

Though some opportunistic buyers have been successful in the market, blight in urban cores often means that most office owners won’t be able to sell without taking a huge loss. And many are looking for solutions fast, before their debt catches up to them. 

“The cities where you will see some knockdowns because they have more glass, modern, fatter and taller buildings are the cities where the office market is not coming back at all because they have really strong suburban office or people have bigger homes and are deciding to work from home, and the delta between the residential and the office rent isn't that great,” HR&A Advisors partner Kate Wittels said. “A place like Charlotte, they have a lot of new buildings, and the resi market isn't that much more valuable than the cost to create residential.”

In those cities, wrecking balls are already coming out.

In Wilmington, North Carolina, city officials have put out a request for proposals to demolish three downtown office buildings.

“Market analysis shows there was no interest in re-using the existing structure, which is old and would require substantial repair,” city spokesperson Dylan Lee told the Wilmington Business Journal. “The site, however, has great potential if built for today’s needs.”

Similarly, officials have given up on the dream of rehabilitating the Capital One Tower in Lake Charles, Louisiana. Since a hurricane damaged the city’s tallest building in August 2020, officials have attempted to find a developer to restore the tower. However, those efforts were fruitless. 

“It’s time to move on,” Lake Charles Mayor Nic Hunter told residents in May. “We’ve been looking at this tower for almost four years. I know that there’s a lot of us that wanted to see it saved, but four years is long enough for us to stare at this eyesore in our community.”

As all 850K SF of the Ameriprise Financial Center is expected to be vacant in less than two years, there has been talk of it becoming housing in downtown Minneapolis. But Axios reported that the owner has recently received a bid for potential demolition.

And in Santa Ana, California, excavators have already begun knocking down a two-building office campus with plans to build a warehouse in its place.

Still, full knockdowns come with their own challenges. Costs can rack up based on building size, accessibility, material disposal and condition of the structure, such as if it also requires asbestos removal. 

Demolition can also emit large amounts of carbon. Demolishing and replacing a 10K SF commercial building releases over 1,300 metric tons, or the equivalent of 484,000 gallons of gasoline burned, according to a study by ECONorthwest.

GMP Executive Partner Stephan Schütz said he has worked on several projects that have been complete demolitions except for the facade.

"More than half of the gray energy [embodied carbon] contained in our building stock is in the skeletal structure,” Schütz said in an email. 

Beyond that, architects — even those who say that demolitions could be near —  say they want to preserve as many office buildings as possible, in part because of the emotional component.

Karp Strategies’ White compares the reuse conundrum to when the manufacturing industry departed New York City. Then, warehouses were converted to housing, shaping neighborhoods like the Meatpacking District and SoHo. 

“Not rushing to demolish a property that is not as class-A as it once was has allowed for creative, interesting things to happen in the city,” White said. 

Belmont Freeman, the founding principal of an eponymous architecture firm, has worked on several preservation projects and taught courses on the subject at Columbia University and the University of Pennsylvania. During a recent visit to Detroit, he commented on Art Deco banking halls being repurposed as restaurants and office towers finding new lives as hotels and housing.

“We have to get beyond the bottom line, spreadsheet analysis and try to incorporate some of the other costs to a neighborhood and into a city,” Freeman said. “[In Detroit], it's an economic, social and cultural renaissance that is achieved through the reuse of existing buildings, preserving the soul of the city, with new uses, new populations, new functions.”