Midtown Owners Hedge on Costly Office-to-Home Conversions
Landlords need Albany action to turn Manhattan commercial buildings into apartments — and that’s just the start of their challenges.
The eighth floor at 218 W. 40th St. is ready for any office tenant that wants to move in. The 14,000-square-foot space has whitewashed columns, floor-to-ceiling windows letting in an enormous amount of natural light, and offices built on both sides of the elevator bank to take advantage of windows looking east.
The prebuilt space, as it is known in real estate jargon, is the showcase for the Garment Center office building, which needs lots of new tenants. The 12-story building will soon have four empty floors, as well as a ground floor space that has been vacant for years.
Owner Bob Savitt is well aware of the buzz around converting vacant office space into residential apartments, as the pandemic has had a lasting impact on office space rentals and occupancy. The mostly older office buildings in the Garment Center are ripe targets, according to real estate experts.
But Savitt says he is committed to keeping 218 West 40th as an office building.
“To convert it to residential we’d have to cut a core into the middle and that would be very expensive,” he said, referencing the air shaft that would be required under building codes. Since his firm has no experience with residential conversion, he’d said he would have to sell it to someone with that expertise.
Converting office buildings to apartments has emerged as one of the key strategies for Mayor Eric Adams’ effort to adapt the city’s business districts to the post-pandemic world. Conversions revitalized downtown after the Sept. 11 terrorist attacks, administration officials note.
But obstacles facing Midtown are many. They include the need for legislation from Albany to relax strict rules for residential housing, rezoning to allow apartments in what are now commercial districts, a tax break if affordable units are required, and generally daunting economics.
What’s more, even properties with many vacancies typically still have some office tenants in place. Ten-year leases are common.
“Most office buildings are encumbered by existing office tenant leases and typically have to be emptied before being converted,” said Max Herzog, a specialist in financing conversions at the real estate firm JLL. “Deeper, bigger floor plates and other structural elements are often problems, there is a need for changes in the zoning and increased floor area ratios, and then there is also the financing.”
Record Office Vacancy Levels
The appeal of the conversion concept is that it could solve two problems at once: New York now has too much office space, some of it functionally obsolete, and the city desperately needs more housing. Such a move would also preserve tax revenue that would otherwise be lost if the commercial space remains unfilled.
The real estate firm CBRE estimated early last year that remote work would shrink the amount of needed office space by 9% — then increased that figure to 15% at the end of last year. Reflecting that reduced demand, the vacancy rate for Manhattan’s 415 million square feet of office space at the end of last year soared to a record 22.2%, according to Cushman & Wakefield.
The vacancy rate could be headed higher. Some 13 million square feet of new office space is already under construction. And several multi-billion-dollar projects, including a new tower to replace the Hyatt at Grand Central, are on the drawing boards.
Meanwhile, rents for available Manhattan apartments are at a record-high average of $4,097, according to the real estate firms Douglas Elliman and Miller Samuel. The Adams administration wants to add 500,000 new housing units over the next decade to expand supply and lower rents.
The Adams administration projects that converting office buildings could create 20,000 new apartments housing 40,000 people. The Real Estate Board of New York last year estimated some 20 million square feet of office space below 60th Street is ripe for conversion and could be turned into about 14,000 apartments.
The conventional wisdom is that companies will want to occupy new, modern office space, even at high rents, while older, more cramped office buildings will struggle to find tenants and will become obsolete. Areas likely to see the most conversions are Third Avenue in Midtown, the Garment Center and Herald Square.
The office market on Third Avenue is among the weakest in Manhattan, with asking rents well below the boroughwide average annual figure of $78 per square foot.
“The further you are from the main transit hubs, the less appealing buildings are for office use,” said Nicole La Russo, senior research director for the real estate firm CBRE, describing Third Avenue’s problem. The Garment Center’s problem is that the building stock is older, La Russo said.
Herald Square buildings are prime candidates for conversion because they are more like the buildings successfully converted in recent decades in the Financial District: older, with smaller floorplates that are easier to redesign. Chelsea and Flatiron are already dotted with successful conversions under the city’s Loft Law.
In what might become a point of controversy, even advocates of adding residential to Midtown want to exclude parts of the business district. “I don’t think residential buildings should be on Park or Madison,” said Mary Ann Tighe, the influential CEO of CBRE’s Tri-State region. “Those are strong commercial thoroughfares and can support the kind of rental rates needed.”
Proposed Tax Break
The obstacles to conversions begin with the actions needed in Albany and at City Hall.
Albany will need to overhaul a state law that limits the density of residential apartment buildings, because many of the Midtown office buildings have been built with much more space per floor than is allowed for apartments. There could be opposition since Assembly Housing Chair Linda Rosenthal says she is not ready to support that provision. The state legislature may also need to relax restrictions including rules on natural light in residential units.
City Hall will have to revise the 2018 Garment Center zoning, which loosened restrictions on conversion of manufacturing space, but prohibited any residential use. The local business improvement district is strongly in favor of the move, but advocates for the few remaining garment companies have opposed past efforts to change the zoning. Only 3,000 garment workers remain in the neighborhood, and their shops occupy only about 730,000 square feet, according to the BID.
Especially controversial will be a tax break Gov. Kathy Hochul has proposed to make sure new housing contains lower-cost units. Her proposal would grant a 19-year property-tax exemption for making 20% of units permanently affordable to households at or below 70% of the New York City area median income — about $93,000 for a family of four — and 5% at less than 40% of AMI.
“You are trading permanently affordable apartments for a temporary tax break, but developers have gotten used to that,” with other tax breaks like the expired 421-a abatement, said Daniel M. Bernstein, a lawyer at Rosenberg & Estis.
He and other experts said the proposed tax break was the bare minimum needed. But Assemblymember Rosenthal and state Senator Brian Kavanagh, who chairs the Senate’s housing committee, recently told THE CITY that they were unconvinced any tax abatement is needed.
The biggest problem is simply economics. Given that the specifics of each building are different, there is no broad guideline for what a conversion would cost.
The first step involves emptying buildings. The cost of buying out tenants is significant, said Jeffrey Schwartz, an attorney at Schwartz Sladkus Reich Greenberg Atlas.
Then there are structural impediments. Most office buildings in Midtown were built in the 1960s with large floor plates, columns and windows along the exterior. Many would have to open a new core in the center of the building to provide windows and light, a very costly undertaking that also drastically reduces the amount of space available for apartments.
Higher interest rates are a new complication, said Herzog, with the cost of construction financing at 9% or 10%, double the figure a year ago.
Owners of office buildings are rarely experts in conversions, so most would sell to specialists in order to carry out the process. Given the costs involved, converters will want to take on only buildings they can acquire cheaply.
All those reasons are why Savitt has decided to try to lease 218 W. 40th St. to office tenants, with annual per-square-foot rents in the $40s, rather than convert it. He says he is talking to firms in law and accounting as well as health care and tech. Yet he thinks the conversion of other buildings in the neighborhood will be crucial to his success.
“What we need is to make the Garment Center a 24/7 neighborhood, which will bring in more amenities, which will attract more tenants,” he said.