There’s a paradox facing major cities in the US: office buildings are sitting empty while housing is in short-supply.
The obvious answer to this property puzzle— simply converting large offices into more apartments — is more difficult than it seems. While conversions are possible, real estate developers face a host of physical, regulatory and financial constraints that may slow them down.
In the latest episode of the Odd Lots podcast, Joey Chilelli, managing director of Vanbarton Group, an investment firm that specializes in New York City real estate, explains the limitations facing would-be office-to-residential developers. Even before the pandemic Vanbarton was transforming old offices into apartments, including the landmark 180 Water Street development that created a 573-unit apartment complex out of a 1960s office building. Now, he's working on another office-to-apartment conversion next door at 160 Water Street.
As Chilelli explains it, office-to-housing conversions face a number of hurdles:
In New York City, zoning regulations that restrict alterations are limiting the scope for office-to-residential conversions in the nation’s biggest office real estate market. For the downtown Financial District, buildings constructed prior to 1977 are eligible for conversion, Chilelli says. In Midtown, however, the cut-off date is set at 1961.
Such limits are needed in order to ensure public services like schools and transportation networks can support newly-converted residential neighborhoods, Chilelli explains. Yet inconsistent cut-off dates often frustrate developers, Chilelli notes. “It’s very abitrary.”
As part of a broader examination of the future of New York City and its economy, the Office of Adaptive Reuse Task Force was convened by Mayor Eric Adams’s administration in July 2022. The ensuing study, released in January, proposed 1990 as a uniform construction date for buildings to qualify for conversion. The change would allow an additional 136 million square feet of office space to be converted to residential use, which translates into new homes for up to 40,000 New Yorkers in the next 10 years, according to the city’s estimates.
Not all buildings are conducive for repurposing. Are ceiling heights above eight feet? Is there enough access to light? What about plumbing? These are all necessary considerations for whether or not a building could be a candidate for conversion.
“You're carving out the residences, but you're also reinforcing the structure with more steel,” Chilelli explains. “You have to make sure that plumbing risers or duct work or electrical risers miss that steel. 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.”
According to Chilelli, it takes only a few hours to make the initial judgment on a building’s suitability. That said, creative workarounds are possible. The conversion at 180 Water Street involved cutting an atrium into the core of the building to create more windows and air flow. But making major structural changes is tough and requires skilled contractors who may be in short-supply.
“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,” Chilelli says. He estimated that 70% of their contractors had worked with the company before.
Just because a building already exists on a plot of land doesn’t mean you’re saving money by reusing it. Repurposing is often an expensive process that comes on top of initial acquisition costs, or what's known as the “basis” in commercial real estate.
“We've done this a while, we know what it'll take to convert a building,” he says. “So if that basis is … $500 a [square] foot and it’s going to cost you $500 to convert, you know, you're looking at $1,000 a foot. That’s a pretty hefty price today.”
Since high costs require high rents to offset, most office conversions tend to cater to the luxury segment of the market, which means they have historically done little to alleviate a shortage of affordable housing in the city.
New legislation that supports cheaper acquisitions could help make the market for property conversions viable for less pricey apartments. In New York, Governor Kathy Hochul’s $227 billion February budget proposal included property-tax exemptions for landlords who agree to include affordable housing in their office conversion projects.
But the biggest hurdle facing developers may be uncertainty over the future trajectory of both the broader economy and work-from-home itself.
Pandemic-era inflation and disrupted supply chains sent manufacturing and shipping costs soaring, such that Chilelli at one point found himself hiring contractors to escort custom window glass as it was shipped from Spain, and making in-person visits to factories in the Midwest to ensure supply could continue.
And as the status of remote work continues to fluctuate, there’s a big question mark over the desirability of these projects in the first place. Return-to-office policies are of particular importance to the Vanbarton Group, which also has office buildings across the country in its investment portfolio.
“I think there will be a more residential component to [New York City,] but it’s also a cycle,” Chilelli says. “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.”