How zoning affects value.
A look at two NYC buildings and their potential for office to residential conversion.
Something different.
We’re trying something a little different with this newsletter.
The first and most obvious— I didn’t write it alone. Adding another voice with a very different perspective has been extremely valuable to my work (as it tends to be). My hope is that sharing some of that perspective here will bring value to everyone reading.
Our two main objectives with this newsletter are to test out this format (let us know what you think) and to share a bit more about our approach to development.
That said, we’re not straying from what’s always been the newsletter’s main focus: providing practical insights you can apply to your projects and markets.
A tale of two buildings.
In this newsletter, we will look at two buildings. Neither can be legally converted to residential under the current zoning code (as of late November 2024).
To avoid being repetitive, we looked at each building from a different perspective.
In the first example, we aimed to generally lay out how to look at zoning and utilize it as a marker of value based on a specific business plan.
In the second, Adrian builds on the principles explained in the first and goes deeper into the (still general) economics of the deal.
This is by no means a substitute for the detailed underwriting these deals require. The main point is to highlight the fundamentals that must be clearly understood before pursuing a conversion deal.
29 West 35th Street
In early October, 29W 35th Street went to auction at a starting bid of $23mm. Unsurprisingly (to us), the building received no bids.
(This is the type of news story that makes a great subject for misinformed social media posts that point to the “outrage” of the situation without really considering the details.)
So here are the relevant details.
1 - The area
Most of the marketing materials and articles written about the building cite the existing area between 85-90,000 square feet.
At the starting bid price, that’s $255-270/SF.
But here’s the thing: the building isn’t actually that big.
Per the building department, the gross envelope is 71,180SF. This is public data.
That means the building was actually listed for ~$320/SF, which is high in the current market.
This is one of the first things to look at in assessing value, and we can’t expect people on social media (or journalists, apparently) to properly diligence the information they share.
For the "price per pound" crowd, understanding the actual size of a building they’re planning to buy is particularly important.
In NYC, specifically, this means that should a building be considered a conversion candidate, the stated "rentable office" area is meaningless.
Rentable office area is determined by a somewhat subjective standard that allows double and triple counting of common spaces. (This varies across the country, but most major metro areas have some version of this.)
Every time I've seen a NYC office building listing, the area far exceeds the size of the envelope. This means it's impossible for the building to be as large as marketed.
Remember, this means you're buying a whole lot less real estate than what is being marketed if you're buying for the purpose of using existing area.
In this case, that's almost 30% less.
2- The (obsolete) zoning.
The building is zoned M1-6. This means that a residential use is not permitted. The most prevalent uses for this zoning are hotel and office (self-storage is also permitted).
Thanks to the city council, new hotel development requires a special permit, and thanks to the hotel union, getting an agreement to open a new hotel is nearly impossible.
So, we're left with office, which is the building's current use. And guess what, it's not a profitable use. If it were, the building wouldn't be up for auction.
This is the case of a building that is obsolete.
And I'm not talking about the architecture or mechanical systems (although I'd guess those are obsolete, too). I'm talking about the use.
We no longer need this building in this specific location.
Unfortunately, there is no viable way to replace it or transform it into something the market needs. Therefore, the current value of the building is extremely low.
3 - So why not buy the building and rezone it?
Rezoning in NYC isn't simple, expeditious, straightforward, or guaranteed. (The details of what that process entails are for another post.)
For this reason, nearly all development in NYC is typically pursued “as of right.” This means developers rarely, if ever, include a rezoning as part of their business plan. It’s simply too risky.
However, the city has recognized this area is obsolete and has been working on a plan to rezone the "M" zoned areas of midtown south to allow residential uses. A draft of the plan is public, and there have been several public meetings about it— there’s definitely progress.
However, there is no certainty regarding the requirements (especially regarding mandatory inclusionary housing) or when exactly the change will go into effect. This means that the only possible value of 29W 35th Street is uncertain while the building continues to incur in costs.
Perhaps a low enough basis can make it an attractive investment if an investor is willing to take the risk of an uncertain timeframe and an uncertain set of requirements-- which may cap the asset's value to an unknown degree.
So far, it seems that the basis isn't yet low enough for anyone to accept those risks.
675 3rd Avenue
A few weeks ago, it hit the news that The Durst Organization was planning to sell their 32-story office tower at 675 Third Ave as a “potential” office-to-residential conversion candidate.
Some of the media mentioned the “340k gross square foot building” may seek a potential $100mm price tag.
Let’s take a general look and see if this is a viable conversion candidate or if a conversion business plan makes sense at the rumored price.
Remember: this is the first step before we move on to a more thorough review of the deal, as outlined in this previous newsletter.
1 - The zoning
Under the current NYC zoning law, only buildings from 1961 or earlier (in this community district) are eligible for conversion as of right.
This building was built in 1966, which means under the current law, its not eligible.
Now, this is likely to change when the “City of Yes” up-zoning plan (this is different than the Midtown Zoning Plan mentioned above) passes the city council later this year, but if the bill is delayed or significantly changed (unlikely as of this writing), this building will need to remain as office.
2 - The area
The actual building size is ~289k square feet - or about 15% less than the marketed size. (See #1 from the previous section.)
3 - The numbers
So lets take the 289k sft at $100mm, or $346/ft, and see if a condo conversion pencils.
We’ll assume $450/gross sft in hard cost, $5mm for building demo, $11mm for design and other consultant fees, $3mm in permit and other city fees, and a development fee of 5% of hard + soft costs.
With interest reserves on the construction loan and operating reserves (condo fees + taxes) on the newly converted units, the total cost comes out to $325mm.
There aren’t too many true condo comps in the area, but the location isn’t overly desirable, and you have to factor in a discount to new ground-up development, so let’s assume a blended $1920/ft in sellout prices.
Since this is a conversion, we’ll have to assume a (conservative) 25% loss factor to the gross floor area, so on 289k in gross area, we can sell about 217k sft. With a standard 6% sales cost, this gives us a net sellout value of $388mm.
$325mm cost, $388mm sell out = $63mm in profit, on $114mm in equity (35% of total cost).
Over an 8+ year project horizon (it takes a while to sell 200+ condo units), that results in a 5.5% IRR and a 1.5x equity multiple.
The obvious conclusion is that the $100mm listing price is too high to provide a projected return that would be attractive to investors.
If you take the price down to $250/gross ft ($72mm value) the math starts to look a little bit more attractive, with a 2x equity multiple and a ~10% IRR.
But still not quite good enough (for us).
If you are interested in investing with us, let us know via the investor interest form below.
OR
If you have a development site with at least 40,000 buildable square feet zoned for residential use as of right in Manhattan or a good candidate for an office-to-residential conversion, let us know!
In addition to our development work in NY, MADDPROJECT provides fee development and professional project management services across the US.
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