Downtown LA’s office-to-resi dilemma

A vacant building smack bang in the middle of a struggling office market is not ideal for any commercial investor. But for Starwood Property Trust, which ended up owning one at the end of 2022, it will have to do. 

The Barry Sternlicht-run REIT purchased the 1 million-square-foot Broadway Trade Center in Downtown L.A. through a foreclosure, winning an auction with a $200 million credit bid. Now it has to figure out how the building will make money.

Starwood, which did not respond to a request for comment, is looking at redevelopment opportunities, executives disclosed on its last earnings call. One thought is: Can it be converted into residential? 

As remote work has pushed office vacancies to all-time highs, developers and investors in L.A. are asking themselves whether converting their struggling office buildings into apartments or condos makes sense from a financial, architectural and logistical perspective. 

“Buildings, in a lot of instances, are now not financially viable as office buildings,” said Steven Paynter, an architect at Gensler. “The second that happens, people start to try and figure out what to do with them.” 

The answer is not clear-cut, according to attorneys, consultants and architects who have experience with this kind of  development. 

“It’s a convoluted process,” said Bobby Fijan, a Philadelphia-based developer who has successfully completed a few such projects. 

The factors that go into figuring out whether an office building in L.A. can be converted into residential are daunting and seemingly limitless. Developers must figure out floor plans, zoning, creative financing and more. 

In a study of more than 700 office buildings across the U.S. and Canada, Paynter has found that only about 30 percent are viable for residential conversions. 

“Most of the time,” he said, “we have to go back and tell clients, ‘This just isn’t going to happen. You need to think of a different approach here.’”

Location, location, location

Every developer knows — or should know — that location matters. 

With a residential conversion, the fastest way to rule out a project is if the zoning only allows for commercial uses. In L.A., and California at large, almost all plots are zoned for single-use, according to Chris Thornberg, who founded consulting and research firm Beacon Economics. 

“It’s amazing how hard it is in California to get a mixed-use permit,” Thornberg said. “We don’t adapt well to that.” 

But owners in Downtown L.A. have it slightly easier. 

In 1999, after a multi-decade exodus of workers left huge swaths of empty offices — not unlike the trends it’s facing now — the city of L.A. passed an adaptive reuse ordinance, which allowed developers to convert vacant and underutilized buildings into other uses by-right and without any need for formal rezoning applications.

Developers had to confront a “Kafkaesque nightmare of rules and regulations” without the ordinance, city planner Alan Bell told the L.A. Times in 1997. 

Shortly after the ordinance was passed, developer Tom Gilmore bit at the opportunity. He purchased four abandoned bank buildings near East 4th Street and South Main Street — the Hellman, the San Fernando, the Continental and Farmers & Merchants. 

Gilmore, who did not respond to a request for comment, refurbished the properties into apartments — the first developer to take advantage of the ordinance. 

Soon, other developers were following suit. In 2003, Kor Group converted the former Mobil Oil headquarters at 6th Street and Flower Street into 322 units. The same year, CIM built 274 units at the Gas Company’s 1924-built former headquarters. 

A development executive who has successfully converted a number of office buildings to residential properties called the ordinance “immensely helpful.” 

“It’s the only way these projects are possible,” the executive added. 

Before the ordinance passed, Downtown L.A. had about 11,600 housing units, most of which were classified as affordable, according to data from the Downtown L.A. Business Improvement District. 

By 2009, developers added 15,000 units — 86 percent of them market-rate. 

But L.A. never extended its adaptive reuse ordinance to the entire city. Today, it only applies to Downtown, about nine blocks of Hollywood and some parts of Koreatown. 

For office owners that fall outside, rezoning a property takes too long for a conversion to pencil out.

The city of Los Angeles has not released plans to formally broaden the ordinance to apply citywide. And no other cities in L.A. County have adopted similar laws. 

“A city who really wants to go ahead with these projects can change their zoning,” Thornberg said. “But NIMBYs typically lose their shit if the government tries to do that.” 

Structural hurdles

Say a developer is in Downtown L.A. and has the zoning by-right to do a conversion. Now what?

Some office buildings have really large floor plates, which make it difficult to physically divide into units people would want to live in.

“Say it’s 50 feet from the elevator to the glass, that starts to generate a really kind of long, thin residential unit,” Paynter said. 

There are a number of challenges from a design standpoint when it comes to residential conversions, including not only floor plate size but zoning, the emptiness of a building, financing, plumbing, air conditioning placement and whether the developer would end up with a bunch of windowless apartments, according to Shawn Gehle, an architect and co-founder of Culver City-based Office Untitled. 

In L.A., any sort of conversion in older buildings also requires seismic retrofitting, an expensive process, according to Kelly Farrell, another Gensler architect.

Attorneys and developers say the largest hurdle to these conversions is figuring out how to finance them.

Many developers also don’t realize that for a full conversion, the building has to be completely vacant, according to Fijan. Partial conversions can be done, but are even more complex.

“That requires a whole lot of risk and guts,” he said. “You have to watch it go all the way to zero.”

It’s difficult to persuade any lender to help a developer buy an office building and “make it worth less, so you can eventually make it worth more as a multifamily building,” Fijan added. 

The same developer who has worked on these conversions said having a big, long-time tenant in an office building can be a “deal killer for a conversion play,” adding that it’s sometimes hard to work with tenants on relocating them.

This poses an issue for some office owners, like Brookfield, that have large office vacancies but some long-term leases. 

Waiting for distress

Converting an office building to residential isn’t cheap. In fact, “renovations are as expensive as new construction,” Fijan said. 

Three ways these conversions can churn a profit are through federal tax credits, state incentives or if a developer can buy an office building for virtually nothing, according to attorneys, developers and architects familiar with office-to-residential conversions.

The National Park Service offers historic preservation tax credits that can be applied to adaptive reuse projects. However, to qualify, buildings typically have to be 50 to 60 years old. 

Many DTLA office towers were built in the 1980s and ’90s. Brookfield’s 777 South Figueroa Street and 555 West 5th Street — two properties it recently defaulted on — were both built in 1991. Neither would qualify for federal tax credits, barring an exception. 

The Park Service also has final say over what has to stay and what can be stripped away in an adaptive reuse project — the historic designation doesn’t apply to keeping the outside the same, but can apply to interior window panes or fixtures. 

In September, Gov. Gavin Newsom signed legislation to let adaptive reuse projects qualify for affordable-housing loan programs, though the state is still evaluating applications. 

The last way a conversion might make financial sense is if a developer buys a distressed property for “effectively zero,” said Gehle. “Then you can put the equity in on top of that.” 

But so far, Downtown L.A. hasn’t seen a massive wave of distress that would allow developers to swoop in and pick up properties for nothing.

“There’s a price point where conversion makes sense, but we have not hit it yet,” said Gregory Karns, a real estate attorney at Cox Castle. “Once we hit whatever that bottom is, I think people will see the opportunity.”

Starwood’s Broadway Trade Center does have some traits that would make a conversion easier. Starwood bought it at a discount. It’s vacant. And it has the zoning by-right, thanks to L.A.’s adaptive reuse ordinance.

None of that changes the fact that it’s essentially a giant rectangle with windows on the outside and average floor plates of 114,000 square feet, according to marketing materials. 

“It has the largest floor plates of any large office building in Downtown L.A., which will present some internal daylight and access-to-open-air challenges,” said Gehle. “But it’s certainly ripe for opportunity.”