Living at the Office

Converting Commercial Spaces Gives Developers and Residents an Attractive Housing Alternative

New York–With city living growing increasingly fashionable, finding urban sites where new housing can be developed has become quite a challenge for the multifamily industry. So converting commercial and industrial space has become a popular development play for those looking to recycle sites, preserve part of a city’s history and, of course, deliver residents with an attractive downtown housing option.
majestic_news1In fact, converting these often historic structures may give developers a marketing edge, as more and more of today’s renters are looking for buildings with a distinctive personality and uncommon features.

“The renter today is looking for something different than what they’ve seen before, and what we can do to give the renter something different is restore these historic buildings,” said Jonathan Holtzman, CEO of Village Green Co. “They have higher ceilings, bigger windows and better soundproofing because of the way they were built with concrete masonry. And a historic building generally will command higher rents because you have the historic charm, historic accents and often a better location.”

But while these renovations offer the potential for big financial rewards, the profits do not come easily. Converting office or industrial space can be a huge challenge, requiring the cooperative and dedicated effort of developers, architects, builders, lenders, engineers and government entities. And the costs for such an endeavor can often run quite high.

According to George Figliolia, president of Builders Group, such conversions require a disciplined, well-thought-out approach to maintain an efficient plan and budget. “We go by a cliche here: When you are building a building new out of the ground, the only person in your way is yourself. But when you are renovating an existing structure, the problem is what was put there by the team prior, and sometimes the mistakes they made become problems and headaches for [you],” said Figliolia, whose company has worked on a number of historic projects in the New York City area, including many of the first conversions in Manhattan’s red-hot Chelsea submarket.

Inherently, Figliolia explained, taking a facility built for one purpose and converting it to another creates a clash. “To some degree you are fitting a circle into a square. So a more diligent or more aggressive program prior to the start of construction is necessary whenever there is a change of use,” Figliolia said.

Experience & Expenses
Holtzman, whose Village Green has completed about a dozen such conversion projects since the early 1980s, believes it is imperative to hire architects, contractors and subcontractors who have all participated in such projects before.

Patrick Martin, executive vice president with Related Capital Co., agreed. “You want to make sure the architect is competent, the builder is competent and that people are aware of the [property’s] historic aspects.”

And lenders also want to feel confident that the developers themselves know what they are getting into. “The track record of the developer is important to see that they have done conversions before because these [projects] are usually a little trickier in terms of construction,” said Martin.

Holtzman further explained that while the tasks involved in new construction are quite clear, those associated with a conversion oftentimes are not, facilitating a need for trial and error and a bit of investigation.

“A historic building is generally inefficient. So we work closely with the architect, the construction company, the subcontractor and the suppliers in literally punching holes in the building, installing things and testing them, all while redeveloping the property,” Holtzman said. “It’s about not assuming things but verifying them. That makes the plans and specs clearer and gets better pricing from the subcontractor, suppliers and general contractor.”

What’s more, Holtzman cautioned that developers should have a higher cash reserve for a historic building than for new construction. “Even when you’ve done your homework. there are still surprises,” he said.

For Gary Gorman, president of Gorman Co., there is no doubt a conversion ultimately runs a higher price tag than conventional multifamily development. Among the most expensive aspects of a redevelopment? Retrofitting the building’s mechanicals and bringing the structure up to current building codes.

Marble Staircases, Vaudeville Stages
The Majestic Milwaukee Loft Apartments is Gorman Co.’s first conversion from office to multi-housing, although the company has transformed everything from toy factories, knitting mills, old school buildings, tractor factories and furniture stores to apartments throughout Wisconsin. The $17.2 million facelift of the 97-year old Majestic Building –listed on the National Register of Historic Places–is proving quite a feat for its developers and architects, who are confronting antiquated building systems and the obligation to abide by stringent rehabilitation guidelines.

From the onset, the project’s design architect, James McFadden, principal of McFadden & Co., explained the team incurred considerable demolition costs. “That includes the fact that we were not aware of the impact of asbestos and lead paints. So the deconstruction involved tremendous care to be given to the removal of materials that are detrimental to one’s health,” McFadden said.

Secondly, the landmark Majestic dealt the team an unusual floorplan, one designed for offices at a time when electricity was still quite young and building methods were not quite sophisticated. “[Developers then] were considerably dependent on daylight for lighting of the offices and they did not know how to span long distances very well, so there are columns scattered throughout that one has to deal with,” said McFadden. “And now we are both cursed with atypical and shallow floorplans but blessed with large windows.”

In addition, the structure houses a grand wrought iron and marble staircase that was required to remain in place under the historic rehabilitation guidelines. “It is not very efficient, however, and takes up a fair amount of space, but we needed and wanted to maintain certain interior features of which the staircase is most prominent,” McFadden shared.

Interestingly, the 14-story landmark was also once home to a 2,000-seat vaudeville theater, incorporated into the office project by the original developers to draw crowds to their beer garden located in an adjacent building. With no windows and soaring ceilings, Gorman and McFadden were left to determine a viable solution for the wide-open, barren space.

“We used that to our advantage by putting in many of our amenities in the space,” said McFadden. The property now boasts a 20-seat theater, business center, community room, fitness center, golf driving range and putting green, as well as a half-court basketball court which benefits most from the height of the space.

Credit for Conversions
Eighty percent of the 144-unit Majestic Milwaukee project will be marketed at affordable rents to those earning no more than 60 percent of the area median income; the remainder will rent at market-rate levels. And indeed, quite a number of historic conversions are targeting the affordable segment of the multi-housing marketplace.

In Gorman’s view, the affordable component unquestionably adds a degree of difficulty to such a project. “There is certainly an additional level of complexity financially because what you are doing is trading the ability to obtain debt through the higher incomes of a completely market-rate property,” he said. “And working through the tax-exempt bond process and the negotiation of a deal with a tax-credit motivated investor certainly adds significantly to the complexity of the process.”

Due to its affordable component, the Majestic Milwaukee is, in fact, a public/private partnership: the Wisconsin Housing and Economic Development Authority provided a $9.76 million construction loan; the City of Milwaukee funded a $439,010 Home Loan; and a $6.15 million equity investment from the sale of Section 42 housing credits and federal and state historic tax credits was made by Alliant Capital.

For Related Capital Co., such conversion transactions represent approximately 25 percent of the firm’s business, said Martin. The company is attracted to the character and historic appeal of the buildings, as well as the ability to provide more affordable housing in and around urban centers. “Such affordable projects are rare, so that’s why they are nice to do, and we really like doing them,” Martin said.

Of course, such transactions don’t work for every market. Trendy locations such as New York City’s Soho are prohibitive to developers and lenders looking to work together to convert commercial or industrial properties into affordable housing, as rents will not be high enough to cover their pricey acquisition and construction.

“Usually [affordable conversion projects] are developed by trendsetters because they are coming in before an area gets really trendy and the market-rate follows and drives up the pricing,” Martin explained. “So affordable sometimes is leading the pack.”

Proper Properties
So what types of commercial properties are best suited and most ill-suited for multi-housing conversions? Very large buildings tend to make poor candidates for conversion, especially for affordable projects. “Sometimes someone will come to us with a one million square foot building they want to convert into a lot of units, and that’s just too big,” Martin said. “The construction is too complicated and costly.”

According to Martin, the conversion of a hotel into multifamily is, not surprisingly, perhaps the least difficult rehabilitation project type, the reason being the structure’s more practical layout.

“If you take any type of commercial space, for example if you are looking at an industrial floorplate, it is very large and the problem there is what do you do with the excess space in the middle of the building,” Martin said. “A hotel is a nice use of space because usually the rooms are set up and you can just combine two or three to make an apartment.”

Putting its money where its belief is, Related Capital recently provided $5.3 million in equity for tax credits to Triad Development Inc., which is converting Seattle’s OK Hotel, built in 1915, into 44 affordable apartments.

Triad’s renovation plans call for over 11,000 square feet of commercial space, with the ground floor dedicated to retail space and the basement level reserved for 12 artists’ lofts. The upper four floors will be converted into studio and one-bedroom apartments and there will be a community room. Particular attention in the renovations will be focused on the hotel’s masonry and wood framing system in order to preserve its historic facade.