KPG rolls dice on dated office buildings

You can’t call Greg Kraut risk-averse.

While doomsday predictions proliferate about dated office buildings, Kraut’s KPG Funds has jumped into that market head first — buying, renovating and ultimately hoping to sell workplace properties that other investors and mainstream lenders won’t touch.

KPG has turned to alternative “hard money” lenders such as Thorofare Capital, GDS Brightstar, Maxim Capital Group and Sabal Investment Holdings to fund its business model, leaving less room for error on KPG’s part.

The company launched its first fund in January 2018. Two years later, the pandemic ushered in broad adoption of work-from-home policies that turned many office buildings into ticking debt bombs.

“These are all man-made problems,” Kraut said of factors causing the dreary outlook for office buildings. “I mean, Covid was a man-made problem — somebody in China or wherever it was done, right? Interest rate hikes so quickly — man-made problem.”

When those diminish, the thinking goes, normalcy will return.

“Everybody wants to be in New York City,” Kraut said. “Everyone needs an office in New York City.”

Kraut was a founding principal of Avison Young and worked for the company until 2017, when he left to co-found KPG Funds with Rod Kritsberg. The two were introduced in 2014 by a mutual friend.

Kraut has been aggressive from the start. In 2018, their firm, then named K Property Group, purchased the independent Sunshine Cinema at 141 East Houston Street for $31.5 million. The company demolished the theater, a Lower East Side institution, to make way for an office and retail development.

Asked by the Commercial Observer whether he felt bad about it, Kraut responded, “No, not at all.”

Kraut’s gambles are not limited to real estate. In 2018 he ran as Republican for the Connecticut House of Representatives in a deep blue area. Describing himself as fiscally conservative and socially liberal, Kraut says he campaigned on common-sense fiscal issues. One idea was to add high-speed internet to commuter trains to New York City.

“When I ran, everybody was like, ‘Oh, you’re the next Donald Trump,’” Kraut said. ‘You’re a commercial developer in New York City. You’re Donald Trump.’ I’m like, ‘I am not Donald Trump.’”

It didn’t matter: In a Democratic-wave election, he lost by a wide margin.

His firm’s ventures have better odds. On the surface, KPG’s strategy is more or less standard fix-and-flip.

This has led KPG to some of Manhattan’s most storied neighborhoods — Soho, Greenwich Village, Tribeca and the Lower East Side. Most of Kraut’s properties are in Soho, where lush architecture and high foot traffic are ideal for small office buildings.

Much of the talk about obsolete office buildings has been about converting them to apartments, but New York City’s building code and zoning make that difficult or impossible with many properties. Kraut’s approach avoids those obstacles.

KPG’s purchases don’t stray from its stated criteria. The company bought a vacant, five-story building at 446 Broadway in SoHo — now called L’Aelier — for $45 million in 2018. It bought a retail condo leased to Spectrum at 30 Warren Street for $12 million in 2021. It signed a 99-year ground lease on the seven-story former Salvation Army building at 132 West 14th Street, now called Le Gallerie.

The renovations give workers all the amenities they could want, upgrades that KPG says bring the buildings up to Class A. It targets properties with cast iron columns, high ceilings and ample windows that shower the workspace in light. Technological updates include a phone app that can open the doors when workers walk up and automatically summon an elevator.

KPG claims an occupancy rate of 86 percent across its portfolio, a feat accomplished by targeting mid-sized tenants, particularly businesses owned and operated by women. According to Savills, the Class A occupancy rate in Manhattan in the first quarter of 2023 was 80.7 percent.

“They’ve been very selective about locations and what types of assets,” said James Nelson, an investment sales broker at Avison Young. “They have been able to attract tenants who are paying premium rents — triple-digit rents in some cases — because they’ve really tried to curate the best type of product in those submarkets.”

Kraut says KPG’s acquisition targets are too small for big REITs, yet too expensive for smaller players. By threading that needle, KPG says it’s found a niche with few competitors.

“What happens is we end up making the market,” Kraut said.

There are downsides. Because the opportunities in that niche are limited, the company has a modest eight properties, and an exit strategy may involve selling one at a time, instead of as a portfolio. Because the buildings are leased, it likely rules out a sale to an owner-occupier.

“I think Class B and C offices are in no man’s land,” said Polpo Capital’s Dan McNamara, who famously shorted mall indexes in 2018 and now says he’s betting against office stocks. “It’s almost in a bit of a death spiral because you’ve seen occupancy numbers kind of flatten out. It’s gonna lead to higher vacancies as people don’t renew or renew with less space. You’re gonna start to see these zombie buildings sprouting up in cities across the country.”

KPG has been able to find financing in an era of high rates and stingy lending. Last month it secured a $50 million construction loan from Sabal, Brightstar and Maxim for 40 Crosby Street, which it dubs “The Crosby.”

But Kraut believes companies are starting to push back on work-from-home now that layoffs have softened the job market for white-collar workers. Tech companies in particular have renewed their push for in-office work.

But Google and Meta generally aren’t leasing in boutique office buildings. The trend could roll down to smaller companies, or not.

The outcome could go a long way toward determining if KPG has created a template for success in New York City’s beleaguered Class B and C office market.