NYC commercial-to-residential feasibility

By Richard J. DeMarco, AIA, MADGI Design

Commercial tenants currently only use approximately 50% of their offices. Companies are either shrinking their space or not renewing their leases. To make matters worse, prior to the pandemic, many owners of older, mortgage-free office buildings took out loans against the equity. This leaves many landlords struggling to afford their mortgages and desperate to either sell or find an alternative use.

Converting a commercial building to a multi-family residential use potentially increases the revenues by 150%, providing a solution. Our firm is currently reviewing $2 billion worth of potential conversions for both current owners and potential buyers.

The cost of converting large office towers ranges from $350 to $400 psf. In smaller buildings this might increase to $450 psf. Considering the current residential rents, this means the buildings acquired for between $190/sf and $445/sf are viable for conversions.

Commercial buildings constructed between the 1920s and 1950s are particularly feasible, since many of these properties are less than two-thirds as profitable as they could be as residential buildings.

Real estate tax abatements and the recent passage of NYC’s “City of Yes” law, also make this a good time to convert buildings. Currently, New York State real estate taxes are abated for 30 years, if a converted property contains at least 30% affordable housing units.

The “City of Yes” is a massive rezoning initiative that makes conversions easier by eliminating some of the burdens and restrictions in an effort to encourage the construction of affordable housing alongside market rate units. The initiative also rezoned Manhattan’s Midtown South section, opening it to conversions.

Developers are now permitted to build 20% more of a floor area and increase building heights to accommodate increased square footage of affordable units. Plus, zoning laws have been amended so that commercial properties that received a certificate of occupancy prior to 1991 can now be converted to residential use amounting to 12 times of their lot area. This change adds approximately 122 million s/f of commercial space eligible for conversions.

Pre-1991 commercial properties are usually overbuilt, meaning they are constructed to the sizes exceeding today’s zoning limits. Likewise, commercial buildings have a higher allowed floor area to height ratio than new multifamily buildings. That’s why the “City of Yes” makes these buildings attractive for conversions.

Feasibility Evaluation

These are the factors to consider when evaluating the feasibility of a conversion:

1. Loss factor, which is the amount of space a tenant has to rent but can’t actually use, such as the lobby, electrical closets and fire stairs. This metric depends on a floor plate size and design, and defines the prospective financial benefit of a conversion.

An average office building in NYC has a loss factor of around 27%, with a range of 20% to 37%. Per the industry’s standards, only 80 to 85% of a formerly commercial building can be rented once converted, so the income would need to be at least 30-40% higher than in the office use to make the conversion viable, unless office spaces are vacant.

With large office towers, the cost of conversion typically ranges from $350 to $400 psf. In smaller buildings that cost might increase to $450 psf.

2. Design feasibility. Buildings with a smaller footprint are easier to convert due to regulations. Light and air access laws dictate that in each occupied space in a residence the window size must amount to at least 10% of the size of the entire space, with half of them operable.

This is why a building’s Floor Area Ratio (FAR) – which measures the ratio of a zoning-allowed floor area to a total area of the lot – determines if/how a building can be converted. Typically, residential buildings have a maximum FAR of less than 12. While commercial buildings might have a FAR between 18 and 25.

Commercial buildings with large footprints with windows only on the exterior perimeter are more challenging to convert. Our firm has addressed this by removing core floor spaces on the lower levels to create light wells that extend to the roof. This solution creates an added benefit, as the square footage eliminated from the lower floors may be recovered elsewhere, typically through upward expansions. We have used the inner core spaces to create highly-desirable tenant amenities such as gyms, movie theaters and art studios, which don’t require windows.

3. Test fit. Once the initial analysis has been performed, the development team moves on to the test fit analysis, which focuses on fitting a high value-producing layout of residences within the existing building. This establishes the potential revenues from the converted building.

Forecast

While a significant number of conversion projects is being evaluated, additional factors will influence the market going forward. These include the new US administration’s housing policies, economy, local regulations, lending rates and return-to-the-office policies. Property-specific factors such as locations and local demand will continue impacting individual buildings.

Richard J. DeMarco, AIA is principal of MADGI Design.