Big cities like New York have two real estate problems. Housing is scarce and office buildings are empty (or at least under-utilized.) So there would seem to be an obvious solution: turn the offices into homes. And indeed there has been a lot of talk lately about "office-to-resi" conversions. But it's very hard, for a wide variety of reasons. Zoning, financing, and then, of course, the operational aspects of the construction all need to be in place. So what does it take? On this episode, we speak with Joey Chilelli, managing director at the Vanbarton Group, a firm that's been involved with these projects for a decade and long before the pandemic upended both real estate markets. We discuss the challenges involved in actually pulling off these complex projects. This transcript has been lightly edited for clarity.
Key insights from the pod
:
How to tell if a building can even be converted? — 3:00
The challenge of floorplate depth — 5:00
Evaluating a potential conversion — 6:46
The importance of contractor relationships — 9:19
The cost of conversions — 10:56
Legal impediments to conversions — 14:36
Can this solve the CRE crisis? — 17:41
How does NYC compare to other cities in the recovery? — 18:49
How inflation makes the work more difficult — 21:34
Window requirements in residential units? — 25:12
Have higher rates been an impediment? — 26:37
Are CRE holders willing to sell? — 30:35
The future of NYC real estate — 34:30
Why some office space is booming — 35:12
Why many new buildings are harder to convert — 40:14
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Joe Weisenthal (00:10):
Hello and welcome to another episode of the Odd Lots podcast. I'm Joe Weisenthal.
Tracy Alloway (00:15):
And I'm Tracy Alloway.
Joe (00:16):
Tracy, I think everyone sort of knows that in many cities, but definitely in New York City there's sort of this weird, there's two simultaneous real estate problems.
Tracy (00:26):
Yes.
Joe (00:26):
And they sort of complement each other in a weird way.
Tracy (00:28):
Right, okay. So rents are too high.
Joe (00:29):
Yes.
Tracy (00:30):
There's a shortage of housing and we have a bunch of empty office buildings, and there's a sort of obvious solution, which would be take all the empty office buildings and convert them into preferably affordable housing. And yet it seems to be very difficult to do that.
Joe (00:45):
Yeah. I thought it sounds super easy. Just like “oh, we're going to turn these offices into homes now.” Just let everyone just...
Tracy (00:49):
Just live in like an open plan trading floor or something?
Joe (00:52):
Yeah, it sounds nice.
Tracy (00:53):
It sounds all right.
Joe (00:53):
You know, put up some walls so people have some privacy.
Tracy (00:56):
Okay. But actually this reminds me, when I was at university, I had a friend who lived in a warehouse in London, and they built their walls out of cardboard to segment it. Hopefully that's not what we're doing here. But on a serious note, there are a number of difficulties it seems in doing this, and there's sort of physical ones around the actual layout of these former office buildings, but there's also regulatory, financial. And I hear people talk about it in a sort of abstract manner. But today I think we're going to dive into them in a little bit more detail.
Joe (01:26):
Right. So, it is, you know, we joked around, but it is, everyone says it is very difficult to convert an office into a residential building. But again, you know, the opportunity is there, but we really want to understand like what are the constraints? What are the real physical constraints and how big is the opportunity? Because in theory, clearly more can be done, but how much are we like moving, can this move the dial? It's a really interesting question.
Tracy (01:50):
Yeah. And the other thing I kind of struggle to understand is New York itself is a city with a long history of carving up older buildings into new types of apartments. And so I wonder why it seems to be so much more of an issue this time around.
Joe (02:06):
Well, I'm very excited because today we do in fact have the perfect guest. You know, lots of people have been talking about this question really, you know, since the pandemic struck. But our current guest has been working on it for a long time, since well before it was trendy to talk about. So the perfect guest, we are going to be speaking with Joey Chilelli. He's the managing director of the Vanbarton Group, which has been involved in the office to residential conversions for about a decade. So Joey, thank you so much for coming on Odd Lots.
Joey Chilelli (02:33):
Thank you very much. Thank you for having me.
Joe (02:35):
What do you do at the Vanbarton Group?
Joey (02:38):
So I'm within the asset management group, and we oversee essentially the execution of the business plan once we acquire assets. Different buildings.
Tracy (02:47):
So I'm going to start very broad, but then hopefully we can sort of get more into each one of these difficulties or problems. But what are the constraints around converting office buildings to residential?
Joey (03:00):
Yeah, for starters, it's the zoning. So is the building that you're looking at within a zoning district that allows for it to be converted. That's number one. If that checks the box, there are essentially a whole list of things that you go through. And for me, and when I evaluate these, the structure and the light and air, and the possibility of light and air and bringing that in to create residential units. And ceiling heights. So on a kind of concrete floor to the underside of the structure above, what is that height? And if that height is less than a certain distance, say if it's less than nine foot six or if it's nine feet, then once you factor in all of the MEPs, the mechanical systems that need to go in above...
Joe (03:51):
Is this like plumbing, electric, plumbing?
Joey (03:53):
Plumbing, sprinkler, electric, all those things that need to go in the ceiling above, then you drop your ceiling down, and if that goes below eight feet, really, that makes it very difficult to do. Especially in New York where you're not going to be able to market units that have a finished ceiling less than eight feet. So the ceiling height after the zoning district is one of the most crucial.
Joe (04:17):
So let's say, okay, there's a building, it's in an area that can be zoned. Theoretically, the zoning allows for the conversion. Someone calls you up and says, “Joey, come check out this building.” How long does it take for you to size up whether it's even worth exploring further? You walk into the building and what are you looking for broadly and hoping to see on that first that first walkthrough?
Joey (04:40):
Very quickly.
Joe (04:40):
Really?
Joey (04:40):
Within hours, yeah. You can go through it and see the ceiling heights. The depth of the floor plate the actual, you know, floor plan and the depth of that. And then the structure. Because if the depth is great and it works out, then you wouldn't need to do any structural reconfigurations.
Joe (05:00):
And the depth just means, you know, like here we're in the Bloomberg offices and we have this huge newsroom, which is very nice, but space in the middle of that would not make for a good unit because it would not be exposed to any windows.
Joey (05:13):
Correct. Correct. You'd have to make structural modifications to the building to be able to make that happen.
Tracy (05:19):
So I think one of your famous conversions is downtown, 180 Water Street, and you solved that depth problem…
Joey (05:26):
Yep.
Tracy (05:26):
By basically creating a sort of inner atrium courtyard, is that right?
Joey (05:31):
Yeah. We ended up cutting a 30 foot by 40 foot hole in the center of the building.
Joe (05:36):
Wow.
Joey (05:36):
20-something stories went all the way and that created a courtyard essentially for light and air to come down on the inside. And then there were studios and two or three bedrooms that had their bedrooms up against that.
Joe (05:50):
What was it that made that plausible? So, okay, so you see — wait, it's called the floor plate? Is the term?
Joey (05:55):
Yes. Correct.
Joe (05:56):
And this is like sort of...
Joey (05:58):
So if we're on the sixth floor or seventh floor of a building, that's the floor plate.
Joe (06:03):
The horizontal slice of the building. So 180 Water Street?
Joey (06:07):
Correct.
Joe (06:08):
Okay. So 180 Water Street in its previous version did not have a suitable floor plate, but you understood that there was an opportunity to cut a hole in it.
Joey (06:17):
Correct. It had a suitable floor plate at one point in time for office use, right?
Joe (06:22):
Right.
Joey (06:22):
Yeah, sure. But for residential it did not. And in evaluating that, we came up with the plan of cutting that hole in the center.
Joe (06:30)
Can you just talk a little bit more about that hole cutting? How did you sort of recognize that, yes, it's currently only capable for offices, but actually we can make the math work if we cut a giant hole down the center of a building. Talk a little bit about that evaluation.
Joey (06:46):
So with a lot of things, just about everything is possible but it would cost a lot of money. So you have to evaluate the structural modifications that it would take to create that and ultimately what you're going to do with that building at the end of the day. Create the residences, how much money you're going to get on the rent, and then eventually, you know, sell that building one day.
And so when you evaluate that, especially in that courtyard area, what's the spacing of the column base from column to column? And does it allow for enough space to be able to cut that in without really cutting out any other structural steel structural columns or supports. When we cut that out, we still had to reinforce the rest of the structure and do quite a bit of that.
Tracy (07:35):
So when you're looking to convert an office building to apartments or something like that, how much of what you're looking to do is based on, I guess, people's preferences on where they live versus regulatory requirements about, well, you have to have so many fire exits and you have to have this number of windows and that sort of thing?
Joey (07:56):
So we look at it at Vanbarton much differently in terms of you have to obviously look at the code requirements and have to build that within your plan. But we take it much further in terms of, we have a little bit more of like a hospitality approach to our multifamily buildings, our residential buildings, in that we look at the entire life cycle of the day and the resident and really put ourselves in the shoes of the resident. Not just in 2023, but in 2033 and beyond. So we try and incorporate as much technology and components that set this building up so that it's very much marketable at every point in time.
Joe (08:40):
Can you talk a little bit about, you know, again, I'm thinking about finding the right contractor, the right construction company that even knows how to like cut a hole in the middle of a building, which seems tricky. I imagine that's not something that every construction company can do.
Joey (08:56):
Yes.
Joe (08:57):
But can you talk a little bit about how many entities out there that can do that? And then maybe, alright, the cost in 2023 for that I assume are really a lot higher than when you started on 180 Water Street both due to inflation and supply chain constraints. Can you talk a little bit about sort of operational constraints of, okay, theoretically, yeah, this is a cut-hole-able building, but actually getting someone to do that?
Joey (09:19):
Yeah. you have to find the right team members. And since we've been in this space for a while, we've kind of brought on board and continued to work with for the majority of it. I'd say probably 70% of our team members or repeat team members.
Joe (09:33):
So when you say team members, these are contractors?
Joey (09:35):
Yeah, contractors.
Joe (09:36):
And people you work with and somewhat. Got it.
Joey (09:38):
We have the vision and know how to execute. We bring on our consultants and our other team members to really evaluate those nuts and bolts pieces of cutting the holes and doing those things and be the experts in their field. And finding the experts is difficult and it takes years to create that team that you're comfortable with to cut a hole in a building and know that everything is going to go as planned.
Tracy (10:25):
I wanted to ask you a little bit more about the financing because all of this, you know, cutting holes in the middle of building sounds very expensive. And it does seem like a lot of the office conversions are often aimed at a sort of premium segment of residential, and this has been one of the criticisms.
Joey (10:42):
Yes.
Tracy (10:43):
So how does that fit in with the decisions on whether or not to go ahead for these projects? Is it just a fact of life that you have to create more expensive apartments that are going to pay for this? Or could you do this on a more affordable basis?
Joey (10:57):
You could do it both ways, right? Ultimately, it comes down to what your basis is in the building when you purchase it. And if you have a low enough basis when you buy that on a per square foot basis and knowing, you know, we've done this a while, we know what it'll take to convert a building. So if that basis is a certain amount, we layer in the amount that it takes to convert it, and we know at the end of the day where we're going to end up on a per square foot basis and our all-in basis.
And so you can determine based off of that initial basis, which way it really needs to go. So if the basis is a certain amount, say if it's, you know, $300, $400, $500 a foot, if you're buying a building at $500 a foot and it's going to cost you $500 to convert, you know, you're in $1,000 a foot, that's a pretty hefty price today.
And so you know that you would have to get very high rents, market rate rents to be able to make that pencil. If you're able to purchase the building at a much lower basis, it gives you much more flexibility and then, you know, layer into it the need, in my opinion, for legislation, to be able to make that easier. And so then you can target different segments of the market. So it's not all at the luxury end of the of the spectrum.
Tracy (12:18):
So just on that basis, you mentioned legislation and my understanding is there is, or maybe there was, some tax credit support for doing these kind of conversions. Can you lay out what would you expect to see in terms of government support for doing this at the moment?
Joey (12:34):
So as of now there isn't any incentive, but, you know, there were debates in New York State Legislature to incorporate some sort of a tax abatement as part of this. And for that tax abatement there would be a certain amount of units within that converted building that would be affordable. I think that's fantastic. We need that. That'll help the housing crisis and that'll target a market that that really needs that housing that is not there.
Another end of it is the date, and I don't know if you've heard about the date, within zoning, being able to kind of convert buildings as a right. So downtown in the financial district, south of Murray Street, it was in the early nineties, they changed that date to 1977. So buildings in specific districts south of Murray Street that were built prior to 1977, you could convert those as of right completely to residential and it could be market rate. Here in Midtown it's 1961.
Joe (13:42):
What is the basis of these dates? I don't quite understand, what is it about a building that...
Tracy (13:48):
What happened in 1961?
Joe (13:50):
It's like why a building in 1965 they're uncomfortable with offering the carte blanche. What's some of the intuition or logic behind some of these constraints?
Joey (14:00):
It's very much arbitrary. And at that point in time, yes, it worked to help alleviate some of the vacant office space in the financial district. But the way that that really needs to be, and the mayor's task force and others have been a proponent for, is changing that date to 1990 for instance.
Joe (14:23):
Why even have a date? Why not just say, alright, yeah, if the market says it's doable and if the market would value this particular plot of land more as housing than as office? What is the logic behind having a date?
Joey (14:36):
So, there are a couple things with that. One, they proposed in 1990 with a rolling date. So then, as you know, in 2050, we don't have the same problem and we're saying we need to change the date. Okay. So it always cycles out.
But one thing within zoning and changing some of the districts say in Chelsea, some of the manufacturing areas, they're only zoned for manufacturing right now. An issue of just changing that to residential is — and they need to study this, they really do — and they need to put the time in on this. And I don't think it's a good idea just to flip the switch and allow for residential to go immediately without studying: Do we have enough schools? And hospitals? And markets? All of those things are the components of why there is a date, in these areas.
Tracy (15:27):
Interesting. So just on the idea of maybe getting more government support, more tax credits, loosening of some of the restrictions, one of the criticisms that you hear in New York specifically is that property developers already make a lot of money and while this might help on the housing front, alleviate the housing shortage, we're basically giving them even more money. What would be your response to that? Or how could you alleviate some of those concerns?
Joey (15:55):
Yeah, I think it's easier to say that from the outside looking in, but ultimately the risk that we're taking on in converting these buildings and making these investments is our risk and we should get paid for that. It's not to say...
Tracy (16:11):
Is it a risk though in New York? If you make a bunch of really nice apartments? Surely...
Joey (16:15):
It is always, it is always a risk. No matter what. And yes, New York is a fantastic market and you know, the best market in my opinion to ever do this because not only that, you know, we feel strongly, many people feel strongly about the market here and residential and multifamily.
And so yes, it is a great market to do it, but there is still risk with it. There are cost overruns that could potentially happen in the conversion. There are numerous operational things that could happen after the fact and during lease up and things like that. New product could come online and compete with you. Recessions could hit, other things could hit that could bring the prices down from when you started the discussion of that project.
Joe (16:56):
Let's say you know, the legislator cooperated and changed the tax code and they moved up the dates and a bunch of other stuff happened that was sort of favorable from a policy perspective. Okay, how much do you think just office-to-resi in general could move the dial in both directions? Because that's sort of the big question here. And it sounds like, you know, you've done a handful of projects but, you know, it doesn't seem like it's a possibility everywhere. And there are lots of buildings that, as you say, you can walk in and say, “no, this is not going to work.” So how much is this in terms of when people talk about there being a crisis of, you know, people not going to the office, etc. like that. How much could it move the dial in your view?
Joey (17:41):
It's going to be one piece of the puzzle. It's not going to be the solving piece. This won't solve the housing crisis altogether, but not many things on a broad brush will. But doing these things will certainly help and will certainly get more units on the market.
Tracy (18:01):
How closely do you follow the return-to-office headlines? You know, if you see a news article that says “Jamie Dimon says everyone at JP Morgan should come in four days a week instead of three." Do you immediately start incorporating that into your forecasts and expectations for rent?
Joey (18:18):
No, but we follow it very closely. We also invest in commercial office. We have many office buildings in our portfolio. So we follow that very closely
Joe (18:28):
Here in New York City?
Joey (18:29):
Here in New York. Also in San Francisco, Seattle, Los Angeles. So, we follow it very closely.
Joe (18:36):
Can we take a minute to talk about some of those markets from just a pure office perspective? Because people are so gloomy on it. You know, if you look at the shares of the publicly traded proxies, I guess for some of these markets, pretty down in the dumps.
Joey (18:49):
Yeah. There are challenges. New York is well ahead of many of the markets that I just mentioned. And I think that it comes down to, you know, the city and the administrations within those cities and making sure that they drive that traffic to their central business districts.
You know, for instance San Francisco, it has seen better days. And we're looking at a lot of different opportunities there where we could potentially convert because you have people out eating at restaurants. There are places that are busy and packed and not all the offices are occupied though.
Here in New York, we've seen that return. We've seen a lot of people come back into the office. You know, we really saw the residential multifamily takeoff in, call it May of 2021. That's when we really saw that trajectory. And it's helped with all the return to office and with Jamie Dimon saying, you know, four days a week or, or five days a week for managing directors. And that's what we need.
Tracy (19:56):
This might be a slightly weird question, but I remember, you know, the other big crisis in commercial real estate was sort of post-2008 when you had the death of retail and the dead malls all over America. And there was a move then to try to convert some of that space to, you know, new community facilities — gyms and things like that — or in some cases residential. I know this isn't your area of expertise necessarily, but how successful were those efforts and what can they tell us about the current situation?
Joey (20:29):
Yeah, I think it's area-dependent because some of those areas where you're able to change a mall to more of an outdoor mall, put some multifamily on top of those retail shops and maybe some parking below it, that creates a whole new lifecycle in a whole new area with entertainment, living. And then you can bring in some office components too.
And so I think there are some clear distinctions that separate the two. But I think the whole idea of breathing life into these areas is the key. And what we're doing downtown in our conversions is really breathing life into these buildings and neighborhoods. And once you do that and you bring people into those areas, then it's just kickstarts everything else. It kickstarts the retailers. And then, you know, even offices want to be there.
Joe (21:23):
I lived in the financial district for I think four years from 2011 through 2015 and it was picking up, but now when I go down there, there's just so much more. Like around the seaport and stuff like that. I was like, oh man, yeah, it's really nice. And I was like, oh man, I kind of wish... I mean it was a good time.
Can you talk a little bit about business and the constraints in the pandemic high inflation period that we've experienced? Because again, as we talked about, you've been doing it a long time, but everyone who's done doing any sort of construction in 2022, 2023 has probably seen headaches. Can you talk about those headaches? And have they abated at all? Have they eased in any way?
Joey (22:03):
Yeah, I think we saw a run up of pricing certainly in 2022 and a lot of time trying to get people signed on with a contract. They were very busy, they didn't necessarily have the time for this or that. And that kind of also goes back to building that team. Making sure that you have the repeat contractors or vendors. But we certainly saw the increase in prices of things. You also saw the whole crisis with shipping containers.
Joe (22:32):
Yeah.
Joey (22:32):
And the price of those skyrocketed.
Joe (22:34):
How did that affect you?
Joey (22:36):
So we actually had, around that same time, is when we were purchasing our glass for 160 Water, the project that's currently being converted to residential. And we were looking to locally source as many products as possible, but we couldn't get this glass locally, so we needed to go to Spain. And during that time, you know shipping containers were extremely expensive. It was hard to get things going. We also saw a trucker strike in Spain. So we had to...
Joe (23:09):
Remember the perfect storm era for Odd Lots episodes? That's like that's it...
Joey (23:12):
You really have to go through every iteration and create backup plans. So we made sure that we had a private escort for our glass to the docks and to make sure that it got on the containers when it was supposed to and to us. Because you have to follow every piece that closely. Because if not, it could get lost in things.
The same thing with our generator. Even though it was made in the Midwest, here in the US, we had weekly calls with our contractors and the manufacturer because of parts being an issue and what goes into the generator. So we had to really press them and say, “Hey, we'll fly out there. We want to come out there, we want to visit the plant, make sure everything's on track.” And it was that pressure that it really made sure that they understood that this was a very high priority for us.
Tracy (24:03):
It's kind of crazy you have to go chasing generators in this day and age. But since you mentioned glass, I have to ask, what's the deal with windows in New York? Sorry, that went very Seinfeld all of a sudden. “What's the deal with windows in New York apartments?” No, but this is one of my pet peeves about New York real estate, which is, and I sort of alluded to this before, but you have a lot of tenement buildings that have been cut up into smaller apartments, into these traditional railroad apartments. And the window is always at the end in the bedroom, which apparently is also required by legal statute. But my preference, certainly as a renter, would be: if I'm going to choose one room in the apartment to not have a window, it would probably be the bedroom. So why is that? And would loosening those type of requirements help these conversions?
Joey (24:54):
Yes, it would help, but I would say that, well, I guess depending upon who you ask, it could hurt the quality of life because the rules for light and air are there for a reason. And so that, you know, the general population and residents aren't necessarily taken advantage of.
Tracy (25:10):
I appreciate other people might have different opinions about bedroom windows.
Joey (25:12):
But yes. For instance, at 180 Water we noticed that, you know, some of the units that didn't have as much natural light as others went quicker because people have a preference for less light in their apartment or in their bedroom so that they could sleep better. And that a lot of times in New York, people were just there to sleep and go out and explore the city. But yes, ecause of the requirement for that.
Joe (25:42):
Yeah. I'm with you, I would...
Tracy (25:45):
I mean look, I would love windows in every room. I would like to make that clear. But if I'm going to choose, a lot of New York apartments have just one window.
Joey (25:51):
We do have the ability for like blackout shades, which we incorporate a lot of times in our units. We have the sun-drenched units. But we have the ability to have the blackout shades to help with that.
Joe (26:02):
Big fan of the blackout shades. Can we talk a little bit about financing? And obviously, you know, interest rates are a lot higher this year than they were you know, say a year ago or certainly two years ago or certainly pre-pandemic. Who is financing this and how much is, you know, it's sort of this perverse situation and we've talked about it just with residential real estate in general where we want more of it and maybe more of it would even be the key to easing inflation. And yet higher rates seem to be one constraint on the creation of new units. How does that play out in your world?
Joey (26:37):
Yes. That is, it's a deal killer. I mean, the environment that we've been in has put a massive constraint on commercial real estate. And there's just no mistaking that.
Joe (26:52):
What do you mean? So walk through specifically. What has changed or what does that constraint look like?
Joey (26:56):
So it could say that in terms of financing, you're spread over Libor, what it was, or now SOFR, which a lot of loans are, originally, call it 2021, going even back to 2020, I remember closing a loan February 23rd, 2020 and at that time Libor was 0.11. which is incredible. Now, you know, Libor is well over five. That, you know, 500 basis points difference is tacked on because you're going to have to pay whatever the Libor is plus your spread to the lender.
So instead of being in a, you know, call it a 4% range, now you're in a 9% range on your debt and that has massive impacts on the interest that you pay, on the money that you're being lent to do these projects. And it puts so much of a downward force on it that it really makes it so that a lot of these projects are not able to be done right now. And sure you could get interest rate caps on that, but those cost quite a bit of money because they're products that bring your risk down on the interest rate. But you have to pay for that privilege.
Joe (28:17):
Right.
Joey (28:18):
And the cost of that factored into everything else just makes a lot of these just not viable.
Tracy (28:25):
Can I just say I love that you brought up the benchmark lending rates because we're recording this on June 29th, tomorrow is the last ever day for Libor getting published. It's tomorrow. So moment of silence...
Joe (28:37):
Aren't you going to a party? Aren't you going to a Libor end of...
Tracy (28:41):
It's a wake. I'm going to a wake for Libor tonight.
Joey (28:43):
That's great.
Tracy (28:45):
But just on this note, I mean you've done conversions before rates got hiked so 180 Water Street and now you're doing 160 Water Street, I think you said. I take the point about financing in general is more expensive, but do you find when you're talking to investors, to lenders, that it's easier to make the argument for conversions nowadays than it was maybe several years ago?
Joey (29:09):
It is for us. If you have a track record, you have the experience, you have the know-how. Like I said, you could walk into a building within the first hour or two, we know. It is easier to communicate that now because this is much more of a headline, thanks to you and everyone else bringing this to the forefront. It allows us to really tell that story a little bit easier and give our investors a little bit of a glimpse of some of the expertise that we have so that they can be more rest assured that we have the know-how to do this and execute on this.
Joe (29:46):
You know, as you talked about, New York, for as much as there are problems here in New York still, it's done a lot better and no one really knows like what the final equilibrium is going to be. It is still to this day, improving little by little. You can look at MTA ridership and it's still ticking up modestly, etc. How much does the uncertainty of ultimate stable equilibrium sort of affect the willingness of building owners to even come to you for that first call?
Because they don't know. They might have some guess that it's like, well maybe we're going to be at 50, maybe we're going to be at 70, maybe it'll go back to 90 in two years. And how much is that sort of, those estimates for what that final destination going to be sort of impacting whether to even go down the road on a particular site?
Joey (30:32):
I think it's different for different building owners.
Joe (30:35):
Okay.
Joey (30:35):
You have some of these family offices that have been investing in real estate for generations and they hold various buildings. And they can hold, continue to hold without doing anything because they're going to hold through this cycle and the next cycle and so on and so forth. So they're not necessarily feeling the pressures as other building owners who really have a certain exit date that they have in mind. And if they're not creating that value or if their value has gone away from that investment, they need to figure that plan out and do it quickly. So I'd say it's different depending upon the investor.
Tracy (31:32):
Here's a question we probably should have asked at the beginning. A really basic one, but who makes the decision to actually convert an office building to residential? Is it developers will approach a building owner with a plan? Or the building owner will tap people like you to explore those options? How does that process actually work?
Joey (31:52):
A little bit of both. So the buildings that we own, even prior to acquisition, we're always evaluating the various scenarios. 160 Water, for instance, we bought in 2014. We knew we had the ability to convert it, but that wasn't necessarily Plan A. And so we're always evaluating it, especially with our own assets. Other owners call us because they know we're in the space and they know we have a certain expertise. But, you know, there are developers that also go out to different building owners and saying “Look, I think your building is a prime candidate for this.”
We've had numerous discussions with other building owners just like ourselves, but they don't necessarily have our expertise. And so we go to them and say, "Hey look, this is this is a prime candidate for this. Here are the potentials." And we look at whether or not we could do a deal with them where we come in on the equity side or if we just are there to assist on the conversion.
Joe (32:55):
It does sound like that know-how is really difficult. Like from day one, if Tracy and I were to say, "oh, I want to get into this," replicating that would be one of the challenging parts — building up that network of contractors and architects and people whose job it is to escort glass across the Spanish countryside
Tracy (33:14):
Or look for generator parts.
Joe (33:16):
Yeah, generator parts.
Joey (33:17):
Yes, exactly. It is, it really is. And you get down into the kind of nuts and bolts of it in terms of the building and how you do these things. And especially office buildings where you have like a structural steel, call it a structural steel, and metal deck. Metal deck with concrete on top where you're carving out residences, but you know, you're also reinforcing the structure with more steel.
And you have to make sure that plumbing risers or ductwork or electrical risers miss that steel and you can't hit that. But then you also have to have certain dimensions that are held within the apartment itself for code. And so putting all those together is like one big puzzle and at the end of the day, needing to have a unit that is desirable and marketable. So it's a pretty big challenge overall.
Tracy (34:08):
You know, to Joe's question about uncertainty over the outlook, I gather there are a lot of different moving parts here, but what's your base case for say, in 10 or 20 years? What is New York going to look like? Are we going to be walking down, you know, Lexington Avenue, are we going to have lots more large apartment buildings versus empty office buildings?
Joey (34:30):
I think that it's unmistakable that there will be more residential. People still obviously want to be here and they love this city. It's incredible. And so I think there will be a more residential component to it. But it's also a cycle. I think we'll add a lot more residential in this time period. But in a certain outlook, whether that's five years from now or 10 years from now, the office space will not necessarily come back in the exact way, but it'll be here and it'll be back. There is a large demand for Class A office space right now.
Joe (35:09):
Where's that coming from? That demand?
Joey (35:12):
The existing tenant base wants brand new space, state-of-the-art space and you know, whether it's brand new buildings at One Vanderbilt or Hudson Yards, these buildings are leasing up. So people want that office space. It's this Class B, Class C, potentially mid-block office building that doesn't necessarily have a future right now you can convert some of those, but it would have to be acquired for really pennies on the dollar. But that could be the case or it could be raised to the ground and then a Class A office building built. So we're kind of going through that now and how that all shakes out. But make no mistake. I think that New York in general with office will be here.
Tracy (35:57):
Yeah. I imagine the return-to-office argument is a lot easier to make if you're bringing people back to shiny new buildings versus this decrepit Midtown tower.
Joe (36:06):
I always have this conversation. I'm like, "Oh, a lot of people are back to the office," and people are like, "Well, you work at a really nice office, Joe." We do work at a really nice office here. Sorry, this might be a really naive question: Class A, Class B, Class C, are these objective things? Or are these like you sort of know a Class A office when you see it or a Class B office when you see it?
Joey (36:23):
You very much know.
Joe (36:25):
But it's not like there's some very bright set of things that...
Tracy (36:29):
It's not like the 1961 delineation.
Joey (36:32):
No, no.
Joe (36:32):
Okay.
Tracy (36:34):
I wanted to ask, you know, just going back to support for these conversions and possible tax credits or other measures. You were talking about how the cost base is really important in doing these. If New York woke up tomorrow and I guess the mayor or the governor announced some big support measure, would that immediately get factored into office building valuations in such a way that maybe it made conversions less attractive? Like, would everything suddenly be ratcheted up?
Joey (37:07):
No, I don't believe so. No. it would help. It would help maybe stabilize. The word I would use would be stabilize. It would help stabilize, as opposed to increase.
Tracy (37:18):
Right.
Joey (37:19):
There's still a lot of office buildings that are going to see decreases in value. There's Class Bs and Class Cs that people are holding onto and they're still thinking they're going to get a 2021 price for that. That has to work its way through the system of sorts.
Joe (37:37):
Yeah. This seems like a story that multiple guests have told us, which is that there is this sort of mental gap between what we can see on the screen when we look at, say the ticker of an entity like, you know, like a Vornado or something like that versus where markets are pricing, or private markets. In which case it sounds like there's still a pretty huge bid-ask spread in many of these cases. Has that narrowed at all? Do you see some movement? Have sellers, I don't know, what do you see on that spread?
Joey (38:09):
We're certainly starting to see some more movement. And granted, I thought that we would've seen more movement previously whether it's six months ago or so, but we are starting to see that movement. I think a lot of building owners have already come to that realization. They're at that place where they understand that value has decreased.
Joe (38:30):
Yeah.
Joey (38:31):
Now it's more of the lenders are needing to step in. And they're seeing the landscape and also understanding where they kind of stack up. And then that's kind of part of the flushing out, if you will. Whether it's the owner understanding it and then the lender and then it kind of starts to get out into the market.
Joe (38:51):
Just speaking of lending, and I guess, you know, on the office-to-resi, who is lending? I mean we talked about the price, but do you go to banks?
Tracy (38:59):
And has the mix changed?
Joey (39:01):
We do. The mix has changed. There are more people in the space. We've had a great relationship with Brookfield. Brookfield is our lender on 160 Water. They did 180 Water with us. They've done other deals where it's been a kind of a heavier redevelopment aspect to it. And so they've been a great partner in this space and they understand how it works.
Joe (39:23):
Are banks part of this or other private investors or private lending or any others? Just in terms of the broad opportunities out there for finding money?
Joey (39:30):
Yeah, I would say it's all ends of the spectrum for people to fill the full capital stack. It's going out and — whether you need to have a mezzanine piece come in, it might be more on the private side alongside a traditional bank.
Tracy (39:48):
I have a slightly weird question, but do you hate the inventor of open plan offices as much as some other people seem to? Like, when you walk into an office building and you just see a huge empty space, do you go, "Oh, why did this happen?"
Joey (40:01):
An empty space in terms of an open layout...
Tracy (40:03):
I guess an open space. One giant workspace, one giant room. Because my understanding is there are some office buildings that might be easier to convert if they're a little bit more segmented
Joe (40:13):
Halls and stuff.
Joey (40:14):
Oh, I see what you're saying. Yeah, s instead of just one floor plate that is complete as opposed to some cutouts and things like that. Not necessarily. It's all about the era that it was built in my opinion. And what they were going through during that time. In a more modern era, you have some of these deeper floor plates because they were able to bring in HVAC that they didn't have in 1910 or 1920. Whereas some of the buildings in the financial district, they have some more of these curves where it brings in that natural light and air.
Tracy (40:46):
I see.
Joey (40:47):
Because they didn't necessarily have AC at the time, and so you couldn't have a deep floor plate because people would be way too far away from a window.
Joe (40:55):
So really deep floor plates are in-part a function of the technology available to get people heating and cooling.
Joey (41:00):
Correct. And it would work much better for a trading floor, for instance to have that.
Joe (41:05):
Just real quickly, you know, we talked about some of the architectural issues, but from a sort of like safety and code issue, are there major distinctions between office and residential in terms of what needs to be changed?
Joey (41:16):
Yeah, I mean you have various requirements in terms of whether it's the sprinkler and fire alarm coverage systems to egress and making sure your stairwells are a certain width and certain means of egress in and out, your elevator systems. There are definitely distinctions. I wouldn't say one is necessarily much more, you know, cumbersome than the other. It's just a part of the overall process.
Joe (41:44):
Joey Chilelli, Vanbarton Group. Thank you so much for coming on Odd Lots.
Joey (41:47):
Thank you for having me.
Tracy (41:49):
Yeah, that was really interesting.
Joe (41:50):
That was super interesting.
Joey (42:04):
Tracy, I really enjoyed that conversation. I sort of obviously had an intuitive sense that it's pretty complex and I found that was like really helpful in understanding like so many different dimensions of what it takes.
Tracy (42:14):
Yeah. And it does sort of crystallize this idea of almost a double whammy for doing these at the moment. Because they're expensive to do. It certainly seems like, and at the same time, the cost of financing them seems to have gone up quite significantly — getting back to that capacity point
Joe (42:30):
And the uncertainty and the fact that different types of buyers, it's really interesting to think about the owners of buildings that have some sort of like strict lending commitments where at some point the owner can no longer say, "Oh we're in it for this cycle. We're long-term investors." And the lender steps in is like, "Yeah, that's nice. You have to sell the building because we don't want to end up with zero here."
Tracy (42:50):
Well, the other thing is, thinking back to previous cycles, I know I brought up the shopping mall analogy. But I remember people talking, you know, back in like 2013 or something like that about how some shopping malls are doomed, you can't do much with them. But there were a lot of luxury shopping malls that were doing fantastically well at that same point. So it does seem like you are getting these different performances within the sector.
Joe (43:15):
I wish I could remember the name of the guest that we had on, but it was — and I feel bad that I don't — it was a previous CRE episode and the guest made the point that after 2008-2009, the money was made by like spreadsheet people. And they’re like “Well here's the cash flow of X or Y.” And it was all those people buying like, you know, single family houses out in the deserts of Nevada. And you didn't really need to know that much about Nevada or anything. You just know that, yeah, this looks good on paper.
Tracy (43:46):
Here's how much it costs. Here's what I can get for it.
Joe (43:47):
Here's what I can borrow at right now. I'm going to buy a thousand houses. I think I could rent them out here, etc. And then hearing Joey talk about the team and it's just intuitive, the team of contractors and architects and people who would know how to cut a hole in a building, etc. It's very different skills it seems, than like spreadsheet skills.
Tracy (44:09):
Yes. But I would say like the spreadsheet portion of it still seems extremely important. And there's also a huge wild card factor in there which is, is New York or the US government on a federal level going to do something on like a tax credit basis to help get more of these done?
Joe (44:27):
I think it was Jim Costello was the guest that we had on to talk about it.
Tracy (44:30):
Oh, that sounds familiar.
Joe (44:31):
That was a really good episode. But yeah, I do think the spreadsheet stuff still seems really tricky. And then it's like, okay, well if you cut a hole, how much are we going to get for the square footage for the units that have a little less natural light because they're looking into the courtyard? And so it does seem like there's a lot of uncertainty and you asked that question, can you lose money? I feel confident that if I went into New York real estate I would find a way to lose money. I know it's supposed to be really good market.
Tracy (44:56):
I wasn't sure which way you were going to go with that...
Joe (44:57):
No, I feel very confident in my skills, my ability to lose money in New York real estate. I think I could pull it off.
Tracy (45:03):
I bought my place like at the top of the market last year, so I'm doing the same. Alright. On that happy note. Shall we leave it there?
Joe (45:10):
Let's leave it there.