New Uses for Old Skyscrapers: Solving the Urban Housing Crunch
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July 20, 2023
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On a typical midweek afternoon, one might think that midtown Manhattan — a forest of glass and masonry towers crowded with stores and eateries — is the most dynamic neighborhood in the world. Each day, the streetscape hums with hustle and bustle as thousands of workers and commuters scurry about. But an evening or weekend visit reveals a reality more akin to a ghost town: vacant office buildings, closed and shuttered stores and little foot traffic.
Like many business districts in large American cities, midtown Manhattan office occupancy is a casualty of the pandemic. The transition to a hybrid workforce drove down the demand for office space and took with it the dollars that support nearby businesses and the local tax base. Since then, recovery has been sluggish. Although employment across the United States nears pre-pandemic levels, office vacancy rates stood at 17.8% in the first quarter of 2023 — the highest rate in 30 years.1 According to a recent New York Times article, Manhattan has about 75 million square feet of empty office space, or enough to fill almost 27 Empire State Buildings.2
Already economically unsettling, the sheer number of office vacancies takes on a cruel irony when viewed in the context of the U.S. housing crisis. As commercial office space goes begging for tenants, residential renters are competing for a severely limited stock of available units and struggling with high costs stemming from low supply and the effects of inflation. Nearly half of all tenants spend more than 30 percent of their income on monthly rent.3
Opportunity Knocks
This is where opportunity knocks for commercial real estate investors. Over the past few decades, the growing trend of “adaptive reuse” has offered an alternative investment strategy for distressed assets that not only has revitalized neighborhoods but also generated market returns. The concept involves acquiring buildings that have outlived their original function (e.g., offices, hotels, warehouses, etc.) and repurposing them. Adaptive reuse is perhaps most common in major metropolitan areas such as New York, Los Angeles, Chicago, Washington, D.C. and Philadelphia. In these cities, the conversion of commercial office buildings into multifamily properties has infused value and vitality into local communities.
Office Conversions Reach an All-time High
Source: Rentcafe.com analysis of Yardi matrix
https://www.rentcafe.com/blog/rental-market/market-snapshots/adaptive-reuse-apartments/
Built-in Benefits
Adaptive reuse offers notable financial advantages and cost savings compared with conventional construction. One key advantage is the emphasis on labor over building materials, resulting in savings despite skyrocketing material costs coming out of the pandemic.4 Labor costs, in contrast, have risen more slowly. Adaptive reuse also forgoes demolition and the cost of creating a new foundation, which can account for a third or more of a project’s budget. It is also possible to ease budget concerns by accessing local public benefit incentives and federal historic tax credits depending on the structure type and use.
Several other compelling factors offer appeal. Rehabbing existing structures can be a quicker process compared to constructing a new building. In some cases, areas of old buildings may be habitable after only minor refurbishments. That means that owners have the opportunity to open parts of a building for business even as a project is ongoing.
Creative adaptive reuse slows urban sprawl, often making projects popular among neighborhood residents because they help preserve a community’s character and history. For commercial builders, reusing an older building can drive interest in their project among investors and tenants alike.
Top Building Types Converted to Apartments in 2020-2021
Source: Rentcafe.com analysis of Yardi matrix
https://www.rentcafe.com/blog/rental-market/market-snapshots/adaptive-reuse-apartments/
Issues With “Used Goods”
While adaptive reuse has much to offer, there are several factors investors should consider before committing. One is the condition of the structure itself. In some instances, a building may be more decrepit than anticipated or may contain hazardous materials that require extensive remediation. A building may not be up to code and fail to meet modern standards. Addressing these issues can be costly and lead to significant delays, which is why most lenders prefer the predictability of new construction.
It also may not be economically feasible to convert a building into residential space. Construction and financing costs may present barriers if the goal of a project is market-rate or affordable housing, even with tax credits and other governmental assistance — and assuming the existing improvements can be acquired for the right price.
Finally, it is important to note that adaptive reuse presents design and construction challenges. Many developers experienced in ground-up construction consider adaptive reuse more complex and difficult to manage and therefore less desirable than purpose-built ground-up construction. For instance, post-World War II office building floor plates are often far deeper than those found in residential buildings, making it more difficult to achieve the necessary light and air (window) requirements to accommodate residential use. As a result, investors often expect a higher return beyond a typical development project because of the risk and complexity of these projects.
What Does Success Look Like?
When weighing the pros and cons of adaptive reuse, it helps to understand the significant influences of setting and context on favorable outcomes. Some business districts may be dense with office buildings but short on amenities like supermarkets and schools — two neighborhood essentials that attract renters and buyers. For this reason, successful adaptive reuse projects tend to be in mixed-use neighborhoods.
This is not to say that investors should not consider all properties. However, the transition from a commercial to a mixed-use neighborhood takes time as community retail and amenities grow to support residential use. Look to New York City’s financial district, a.k.a. “Wall Street” as an example. Tax and zoning incentives encouraged property owners to convert functionally obsolete buildings to residential spaces more than 30 years ago. The result is an ongoing transition to a vibrant mixed-use community filled with people seeking to lay down roots and start families. More recently, New York’s 2004 rezoning of nearby “Downtown” Brooklyn has transformed the neighborhood from a business district to mixed-use with the construction of more than 14,000 new residential units since 2014.5
Here are three elements of adaptive reuse that developers should keep in mind:
- Location: The old real estate adage, “location, location, location,” applies. Investors should look first towards existing mixed-use neighborhoods or residential-adjacent office districts for opportunities. Buildings typically considered for reuse are generally large, recommending dense neighborhoods with signs of strong population growth.
- Design: Maintaining designs and materials from the original structure adds to the character and originality of a repurposed building. This method is both more sustainable and more cost-effective.
- Costs: To justify moving forward, a project’s cost basis needs to be competitive and support market rate revenue assumptions and investment returns. A “fit study” to determine the building’s suitability should include an understanding of its “loss factor” in relation to marketable square footage.
As more industries focus on meeting ESG and Leadership in Energy and Environmental Design (“LEED”) standards, adaptive reuse becomes more attractive to real estate investors seeking to partner with sustainability-focused developers. Giving green new life to old buildings while simultaneously easing the housing crunch? That’s a win for communities, tenants, investors and the planet alike.
Footnotes:
1: Maura Webber Sadovi. “Office vacancy rate hits 30-year high.” Construction Dive (May 10, 2023). https://www.constructiondive.com/news/subleases-offer-cfos-deep-discounts-office-vacancies-hit-30-year-high/649298/
2: Edward L. Glaeser, Carlo Ratti. “26 Empire State Buildings Could Fit Into New York’s Empty Office Space. That’s a Sign.” New York Times. https://www.nytimes.com/interactive/2023/05/10/opinion/nyc-office-vacancy-playground-city.html
3: Yuliya Panfil. “The First Step to Solving the Housing Crisis Might Be Simpler Than You Think.” Politico (May 4, 2023). https://www.politico.com/news/magazine/2023/05/04/solving-the-housing-crisis-00095075
4: NewMediaWire. “The Impact of Rising Costs in Construction: How to Stay Ahead of the Game.” Yahoo! Finance (March 14, 2023). https://finance.yahoo.com/news/impact-rising-costs-construction-stay-160355241.html?guccounter=2
5: Amy Plitt. “Downtown Brooklyn: A Neighborhood ‘in the Middle of Everything’.” New York Times (December 22, 2021). https://www.nytimes.com/2021/12/22/realestate/downtown-brooklyn.html
About The Journal
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Published
July 20, 2023
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