'A Million Things Can Go Wrong': City, Developers Outline Challenges In Office-To-Resi Conversions

Office-to-residential conversion has become the hottest topic in New York development in recent months — but without legislative changes, real estate players say nearly all hoped-for transformations of languishing properties will be dead in the water.

Mayor Eric Adams wants to form a partnership with the industry to make these conversions realistic, but he is also trying to balance the future fiscal health of the city, Lucy Joffe, New York City Department of Housing Preservation and Development's assistant commissioner for housing policy, said at Bisnow’s New York Construction and Development event last week.

“We want more rental housing and all of those things. But we also want to still have strong, vibrant business districts. We recognize that not all buildings are well set up,” Joffe said. “We want to keep working with partners in the industry to understand what regulations, what zoning issues are getting in the way and what incentives are important.”

Pressure on office landlords in the city is now intensifying, and many owners are looking at what to do with properties that no longer command top rents and strong leasing velocity.

The financing environment is not kind for a large swath of the city's office buildings —  older product with high vacancy rates in what are now considered less attractive districts.

The answer, in some cases, could be converting them to badly needed housing, but a host of policy changes must take place first, panelists said. Even then, the high cost of building, occupancy levels and design of a property can kill a conversion.

For its part, the city is committed to making it easier, Joffe said. Developers on stage said the floor-area ratio cap of 12 on residential buildings, set in a 1961 zoning code, is a major issue holding back developments.

“There's pending legislation to address the [floor-area ratio] cap and give New York City the ability to build larger, which would address an imbalance between residential and commercial," Joffe said. "That's also part of the governor's recent proposal, and that will we think make a difference for some of these buildings." 

Adams last month announced his plans to push to rezone Midtown Manhattan to allow for residential after a city-run task force charged with examining conversions released a report with recommendations that could open up an additional 136M SF eligible for conversion. 

The task force recommended allowing conversions of buildings built before 1990, which would open up 120M SF of office space to conversion. Another 16M SF of conversion space could be found, the task force said, by allowing conversions in all high-intensity office districts.

Tom Ortinau, who runs acquisitions for GFP Real Estate, said the Inflation Reduction Act is providing some support already.

"There's a number of credits that help offset the costs," he said. "I'm trying to figure out how we can draft off of those incentives to try and do better than the standard."

His firm has partnered with Nathan Berman’s Metro Loft Management and Rockwood Capital to turn 25 Water St., a 1.1M SF 1960s office building formerly known as 4 New York Plaza, into 1,300 apartments. In December, the team scored a $536M loan from MSD Partners and Apollo for the purchase and redevelopment of the building, the largest transaction of its kind in U.S. history.

However, that particular property allows as-of right housing development and its lone tenant has agreed to vacate. He said in many cases, the land under an old Manhattan office building is worth more than the structure.

“We’re buying 25 Water for $175 per SF, a massive discount to what it costs to build these things,” he said. "There's a lot of complexity here. I think the ground-up construction world is going to continue to be the primary source of housing for this community. But I think office conversions will be a part of it as well."

Those building prices can be prohibitive.

“There's a million things that can go wrong, not to be the naysayer here … The only way to really make it work is to get the building really cheap,” said Placemakr CEO Jason Fudin, who previously worked at Vornado. “That's a hard thing for people to swallow.”

The city’s task force recommended creating a tax incentive to provide support for mixed-income housing. Many proponents have pointed to 421-g, an incentive that sunsetted in 2006 that was used to convert nearly 13M SF of office space in Lower Manhattan, according to analysis from the Citizens Budget Commission.

Beyond addressing the housing crisis, some have argued incentives are worth it for the city, mainly because an empty office building produces far less in tax revenue than a full residential building, even a subsidized one.

“Over time, if we can convert those Class-B and C [offices] to residential, they're going to start paying more in taxes,” Real Estate Board of New York Senior Vice President of Planning Basha Gerhards said on Bisnow’s podcast last month. “Because it's a residential use, and that's considered a higher use and a higher assessed value as compared to the obsolete office building … even with the provision of the incentive.”

Gov. Kathy Hochul has proposed bringing in a tax break, called Affordable Housing from Commercial Conversions, which would offer a 19-year abatement for conversions that set 20% of the new units for households earning less than 70% of the area media income.

Joffe said the proposal is subject to legislative approval, but noted if lawmakers approve Hochul’s ideas, the implementation would be relatively swift.

“The regulatory and zoning changes would be pretty immediate. The tax incentive process, there might be some rulemaking required,” she said. “I think the effect would be pretty quick on the two proposals that are on the table ... Obviously, two months is a lot of time [in Albany], so anything can happen.”

In regards to the Midtown rezoning Adams is pursuing, she said planning a rezoning “takes a couple of years.”

Even amid these challenges, plenty of companies are gearing up to put money behind these kinds of conversions. Silverstein Properties, for example, is seeking to raise $1.5B to fund office conversions, targeting these kinds of obsolete properties in U.S. cities.

The company has already partnered with Metro Loft with the view of turning 55 Broad St. in the Financial District from a mostly vacant office building into more than 500 apartments. Metro Loft has so far built 5M SF of residential property out of old commercial buildings, establishing itself as the leader on this kind of work in the city.

Silverstein Vice President of Construction and Development Malcolm Williams said at the event that aging office stock in central business districts with strong live-work fundamentals are where the company is searching for conversion plays. He said a focus on data is going to be part of the company’s search for properties for conversion.

“How are we going to find the ones that are these unicorns, these gems that will allow you to enter the market at that low basis?” he said. “I think tech is going to be a big part of that.”