The Imbalance of the New York City Real Estate Market
Converting office buildings to residential use is not a new concept in New York city real estate. However, the idea is re-emerging as a way to counter pandemic-related market shifts. There is an imbalance in the New York City real estate market. We have an oversupply of arguably obsolete office space and a drastic undersupply of reasonably priced residential real estate.
This situation has existed for some time now and the trend towards remote work resulting from the pandemic has had a significant negative impact on office fundamentals, making the imbalance worse.
For example, Yelp recently announced that it was leaving offices in 3 major US cities including two locations totaling 270,000 SF in Manhattan. In announcing the decision, Yelp’s CEO cited an employee survey that found that 86% of their workers preferred to work remotely. And explained that when they reopened these offices, utilization was less than 2%.
Kastle Systems, which measures office occupancy based on key card swipes, pegs current office attendance in NYC at approximately 40% of pre-pandemic levels.
From 1995 to 2006, a tax incentive program known as 421g enacted for Lower Manhattan enabled more than 15 million square feet of conversions from office to residential use. Under this program, the owner received several substantial property tax benefits.
Residential conversions have also been completed successfully in other markets. In 2021 alone, 151 commercial properties across the country were converted to apartment buildings.
So what are the prospects for future conversions in New York City?
Manhattan currently has 37 office buildings exceeding 100,000 SF where at least half the building is listed for lease and this only accounts for the publicly listed available space. Many of these distressed office buildings are encumbered with large mortgages. On the surface, there is no shortage of conversion candidates.
A well-executed residential conversion generally costs far less than new ground-up multifamily construction. However, there are some significant challenges to executing this strategy.
Possibly the biggest physical obstacle is that many office buildings have large floor plates that lack accessible light and air in the interior. One possible solution is to use the interior of the building for storage, home offices or other amenities that do not require windows.
Zoning is another big obstacle. Many of the city’s office buildings are located in areas zoned only for commercial uses. Earlier this year, NY State Governor Hochul proposed zoning changes that would make office-to-residential conversions much easier. However, these proposed changes were rejected by the State Legislature.
It was recently announced that 55 Broad Street, a landmarked 425,000 sf, 30 story building in the Financial District was sold and will be converted to 571 apartments. The sale price was $180 million, which equates to $425 PSF. This price is substantially lower than most other Manhattan office buildings that are currently listed for sale.
This imbalance is a big problem with no easy solution. To the extent that mortgages on these buildings are underwater, these loans may need to be sold. It will be interesting to see how this situation evolves over time.
Mission Capital is a subsidiary of Marcus & Millichap.