A tidal wave has swept through Manhattan’s commercial real estate market, as conversions to residential space carry away many aging prewar office buildings and pull down larger, more modern structures.
If the first adage of real estate is location, location, location, the second is revenue, revenue, revenue.
A residential building can sell for twice as much as an office building, and in a market where demand remains high, that’s ample motivation to switch.
While a significant increase in office rents – some say 20 percent – could reverse that trend, it doesn’t look likely soon. Among neighborhoods, Downtown, hit by sagging rents, has been particularly affected – losing 25 percent of its office inventory since 1995; a surprising portion of that total came before Sept. 11, despite a recent surge in the number of highly touted residential projects.
Conversions of office buildings are also happening in Midtown and Midtown South – as well as the boroughs.
The trend has been fostered by a robust residential real estate market and a generally flat office market.
“The residential market is so strong, and it way exceeds the profitability of office use,” said Eric Anton, a specialist in office property sales and senior managing director at Eastern Consolidated Properties. “If the office rents were higher, you’d have people who’d be less likely to sell their buildings.”
The majority of the buildings taken out by the wave of residential conversions is smaller Class B and C office buildings from the 1920s and 1930s, which typically trade at $200 or $300 a foot as fully leased office buildings. Those buildings – if located in a prime area and able to be vacated – can trade for $350 to $500 a foot as a residential conversion, Anton said.
“It could be even more, possibly, if it’s a tremendously good location, like a really goodécorner on the Upper East Side or a good neighborhood,” he said.
A case in point, Anton said, was a contract he signed in late May on a garden variety 50,000-square-foot office building in the 20s between Madison and Park avenues where there were still commercial tenants in the building.
“The owner wasn’t thinking of selling it as a residential conversion, but we brought in a buyer so fast and aggressive. There are actually still a couple of tenants the buyer has to deal with,” he said. “The market is so strong, he’s going to take the risk.”
The buyer purchased the building at $400 a foot; as an office building, it would be worth about $250 a foot. The sale should close in October. Other buildings Anton has sold for conversion include 121 West 19th Street, 650 Sixth Avenue, 655 Sixth Avenue, 49 East 21st Street and 21 Astor Place, among others.
He points to the emergence of investors focused on the quick conversion, a breed apart from the traditional well-established office property buyer in Manhattan.
“When you have an office building, you keep it and collect rents and make cash flow,” he said. “When you vacate your building and sell it as a conversion, you make one big profitable hit. It’s a different mentality.”
An increase in rents of possibly 20 percent from their current level could make an office building owner think twice about selling to a converter, Anton speculated. And that could happen with so many commercial buildings being taken out of inventory, especially in an area like Downtown.
The terrorist attacks of Sept. 11, 2001 drove many large financial services companies to leave Downtown, and also drove out the smaller companies that fed off of them. That left many smaller office buildings bereft of tenants or struggling, making residential conversion more attractive, said Joe Harkins, principal of Staubach, who heads Downtown operations for the firm.
Liberty Bond financing, which could be used for residential rental development, also fueled the conversion trend, with developers taking advantage of the tax-free benefits.
“You got all this money devoted by the federal government to Liberty Bonds, but no developer could justify using it for a commercial project,” said Harkins.
But in actuality, Downtown Manhattan was a hotbed of conversions well before Sept. 11, 2001. According to a Colliers ABR analysis, 55 office buildings were converted to residential from 1995 to 2001. Only 14 have been converted since then, with another 10 proposed for conversion.
During the 1995 to 2001 period, 6.3 percent of inventory was lost to conversion (and 13.3 percent to Sept. 11), and so far from 2002 through spring 2005, only about 4 percent of inventory had been lost to conversion.
The numbers point to two trends Downtown: the recent conversions have taken place in larger buildings – on average, 289,000-square-foot buildings post-Sept. 11 versus 147,000-square-foot buildings before – and developers now have preference for conversion to condominiums versus rentals.
“One building Downtown – 25 Broad Street – that was originally converted to rental is now potentially switching to condo,” said Robert Sammons, director of research at Colliers.
Some larger buildings, even some Class As, being converted Downtown now include 2 Chase Manhattan Plaza, 15 Broad Street, 233 Broadway and 90 West Street (taken out of inventory after Sept. 11), Sammons said.
Overall, with the proposed conversions, Downtown stands to lose a total of 24.4 percent of the office inventory it had in 1995, due to the terrorist attacks and conversions. That doesn’t take into account any office inventory created.
Those numbers have helped to reduce Downtown’s commercial vacancy rate, which hit a high of 15.3 percent in March 2003 and was at 13.7 percent in April.
“Residential conversions certainly help stabilize the Downtown market,” Sammons said. Some developers are ahead of the curve, recognizing that a thriving Downtown community with less office inventory will eventually need more office space. Kent Swig, principal and co-chair of Terra Holdings, raised eyebrows in 2000 when he delivered 48 Wall Street not as a residential conversion, as originally planned, but as a redevelopment of boutique office space. He is now the fifth-largest commercial landlord Downtown, according to CoStar Group.
“He’s ahead of the curve,” said Paul J. Massey Jr., founding partner of Massey Knakal Realty Services, which specializes in sales of investment and user properties. “I think he’ll probably be very happy he was.”
But for those developers still looking to convert commercial space to residential, the best opportunities are in the boroughs, Massey said.
“We just sold a fabulous old warehouse structure at 220 Water Street [in Brooklyn’s Vinegar Hill] for $23 million,” he said. “It was perfectly configured for residential use.”
Though it is zoned for manufacturing, Massey said he doubts the new owners will have problems getting it rezoned.
“Because of what it was, a warehouse that could barely command $10 [per square foot] rents, you could achieve three times that as a rental conversion, and sales is even an increment higher,” Massey said. “I think the boroughs are where the biggest scores have been made by smart developers.”