News & Office to Residential Conversions
8 things to look at before buying into the hype-- and before buying a building that 'seems' to be 'on sale'.
The news: we updated our site!
The site now describes our development management services and our approach to NY real estate development, and I’m very excited to share it.
We also have an updated section highlighting our team leadership and a library of podcasts I have participated in.
Today's Newsletter: The 8 things I look at when first assessing an office to residential conversion.
A building that is underused because of economic conditions is obsolete. The market has clearly shown it no longer wants what the building offers. This can happen either because of the condition of the building or because of the condition of the market.
Often, it’s a combination of both.
I like to remind people that a conversion isn’t necessarily a slam dunk. It’s still a deal and it should be assessed like any other deal.
These are the 8 things I look at, in this order. And while this has an NYC emphasis, these steps can apply to any market.
The main purpose of going down this list is to establish whether the going-in basis + the carrying costs + the construction support the sellout or rents once you execute the business plan.
1 - The Market.
Do people want to live here? The best way to answer this is to ask yourself if you would like to build a new residential building here. Be honest. If the answer is no, then it’s a non-starter. For example— most suburban office parks are not places where people want to live. They are rarely good markets to convert buildings. Now, this tends to be different if you’re in a major metro area. However, neighborhoods and streets also matter and can have an impact on demand. That’s the first thing to think about.
2 - Zoning.
Can you convert the current use to residential? If that would require a rezoning, make sure you understand what that means. In NYC, rezoning efforts are rare because they are costly, time-consuming, and uncertain. I would not use rezoning as a business plan in NY. If the zoning doesn’t permit the change of use, and there is no clear and certain avenue to obtain the needed change, then this is the moment to move on.
3 - Comps.
What will you be competing against (exactly) when you complete the project? Is there a ton of new supply with beautiful amenities, lots of sunlight, and high ceiling heights? If yes, can you compete with that? If you can’t compete, what’s a reasonable discount you can assume? If your plan is to undercut the market, can you do that profitably in the context of the asking price? If, at this point, you determine you can reasonably compete, it’s time to generally understand your rough order of magnitude costs. Hint: the main things here are ceiling heights and window sizes. If you can’t change the existing conditions, will the existing conditions allow you to compete?
4 - Building age.
This has several implications. In NYC, specifically, a portion of the code is dedicated to conversions. It favors buildings built before 1961. It essentially allows a conversion of the entire built area to residential regardless of the residential floor area ratio (FAR) maximum. It also allows for some building code exemptions so old buildings don’t require unreasonably major alterations to comply with some current egress requirements. If you’re thinking this is great— it is. But don’t get too excited because you still need sprinklers, and you still need to provide light and air per current code (as you should— more on light & air in item #8). The other implication is that buildings of a certain age may contain lead and/or asbestos. In my experience, every building I‘ve looked at in NY that was built between ~1900 and 1961 has required at least some abatement. This is the moment to make a note to yourself to check on this ASAP.
5 - Area.
This is one of the most exciting parts if you’re in NYC. If you’re in the somewhat unique situation where the building you’re assessing is bigger than what you could build today, especially under the current residential zoning FAR, you have a much more valuable building than you would otherwise. We refer to these buildings are “overbuilt.” In many markets, office leasing area is not calculated based on the actual size of the building but based on the spaces office tenants are allowed to use. This allows for some double counting in some instances, so be wary of the marketed “office leasing area” since that may be different than your project area.
6 - Lease runway.
Up until this point, all other data is publicly available. This means you can get this far without tipping anyone off that you’re looking at a certain building. Are current leases set to expire anytime soon? Will they expire before you’re done with entitlements? If not, then can you reasonably buy them out? If not, then the value of the building will be depressed until there is a clear path for tenants to move out. And before you think about it, no— you cannot convert an entire building from office to resi while it is occupied. Not only is it logistically impossible, but in NY, once you file for a change of use, you lose your certificate of occupancy. Barring zoning, this is the #1 reason I see conversion candidates not work out (at least not right now).
7 - Floor plate size.
This primarily affects efficiency & light and air. Rule of thumb (with the caveat that geometry also plays a part): up to 8,000SF it’s fairly straightforward. From there until ~15,000SF there is less efficiency, and then from there until ~20,000SF it can get weird (and a lot less efficient). If you’re above 20,000SF, start considering cutting a hole through the building. If doing that decreases the built area to the extent that you’re no longer getting the benefit of an overbuilt building, what you have in your hands is a tear-down, not a conversion. The way I assess light and air feasibility is by looking at a 50’ offset from the building perimeter. If that line allows for reasonable circulation and access to what would be dwelling units, then I move forward with the assessment. The main point of this step is to understand efficiency. This will help determine your sellable/rentable area, which is crucial in understanding whether the exit projections can reasonably support the basis + expenses. The biggest mistake I see people make is they start their assessment of a building on this step. Looking at a plan is useless without understanding all the other deal breakers. Once you’re past the previous steps, the plan is somewhat easier. I highly recommend working with someone who has experience laying out conversions and is familiar with the applicable codes.
8 - Asset.
I use “the three Es”. Environmental, Envelope, Elevators.
Envelope: The roof, the windows, the facade, the foundation. Every surface that encloses the building is prone to water intrusion. Understanding whether or not there are leaks in any of these surfaces is key to assessing costs. The building envelope is also exposed to other elements, such as sunlight, wind, or freeze/thaw conditions in certain climates, which can damage it over time. Additionally, it is key to assess whether the envelope is appropriate for a new intended use. Do the windows need to be operable for the new use? If they're not currently, re-skinning the building may be a deal-breaker.
Environmental: Asbestos, lead, mold. Asbestos can be found in sealants, adhesives, insulation, ceiling tiles, vinyl flooring, and other old building materials. It can be everywhere, which makes it one of the trickiest materials to abate. Asbestos was used between the late 1800s and the late 1970s. As a rule of thumb, I suspect asbestos for anything built before 1980. Before the 1930s, most building paint contained lead, but it wasn't until 1978 that the US banned its use. Any building built before 1980 should be suspected of having lead paint, and any building built before 1930 surely has it (unless it's been renovated since). For mold to grow, all you need is 40 degrees, some darkness (privacy, please), a source of food (e.g., drywall), and a source of moisture (e.g., steam from a shower). Abating any of these can be costly. The riskiest aspect of this item is that it is impossible to quantify without an environmental survey that includes lab testing, and even then, the extent is unknown until the demo begins. This means abatement costs may be $20k or $200k.
Elevators: How many stops, cabs, and banks do you have? How many do you need? Once you know how many, you'll need to gauge whether to modernize or replace. For new elevators, I budget $36k/stop/cab. A combination of these three +major MEP will likely encompass most of the capex required on any deal. Now, if the plan is to renovate or reposition the asset, construction costs will not only include these items but also the cost to build for the new use. (Don't forget that!)
This is not meant to be an all-inclusive guide. There are neighbors, utilities and other local considerations that may additionally affect the feasibility and cost of a conversion.
The best advice I give people is to work with someone who understands the process, who knows what questions to ask, and who knows how to work the jurisdiction. This is some of the work we do.
If you own a building and aren’t sure how to maximize its value via redevelopment, feel free to reach out. We work all over the US. Or, if you own a building in NY and are looking for a development partner, let me know.
In addition to our development work in NY, MADDPROJECT provides fee development and professional project management services across the US.
Need help and don’t know where to start?
Have a specific subject you want to see us tackle in a future Newsletter?
Drop us a note!
