Lenders adapt to changing needs of downtown residential development.

The residential housing market in Lower Manhattan has been somewhat of an anomaly in New York City. Even when demand for housing in other parts of the city was (and still is) strong, financiers feared that the slightest jolt in the financial markets could leave Downtown projects in the lurch. When Wall Street did experience just such a jolt for a brief period during the fall of last year, the Lower Manhattan residential market showed its resiliency.

Several factors initially affected the office-to-apartment conversion process in Lower Manhattan. First, during the late 1980's and early 1990's, the office market in Downtown New York City suffered along with the rest of the national real estate economy. In addition, many older office buildings located in Lower Manhattan had become economically obsolete, suffering from antiquated systems that were inefficient or unable to handle the basic technology needs of today's businesses. Re-engineering these structures would have been cost prohibitive, or the return on the investment would not justify the capital infusion to be made by developers and their bankers.

But with high ceilings and large, open floorplates, these existing office buildings were considered strong candidates for apartment conversions, especially for professionals working in the Financial District. The concept of a 24-hour residential neighborhood in Lower Manhattan appeared more plausible after considering the area's extensive transportation infrastructure and the destination shopping within the World Trade Center and the World Financial Center.

The Downtown re-development for residential usage also seemed to be a natural extension of the continued growth and development of Battery Park City and its residential amenities.

As the idea of a residential marketplace in Lower Manhattan became more of a reality, strong public-private partnerships began to develop to ensure that the atmosphere and projects needed to create a full-time residential neighborhood would be completed. With the enactment of the Silver/Conner Bill (or more specifically, the 421-g Real Estate Tax Exemption and Abatement Program) in June 1995, developers were given further incentive to pursue these conversion projects.

Between 1996 and 1998, the office-to-apartment conversion trend took hold Downtown. In 1996, PNC Bank was the first lender in New York City to finance such an office building conversion in Lower Manhattan. The project, located at 200 Water Street, was sponsored by Rockrose Development Corp. and involved the rehabilitation and renovation of a 550,000 square-foot office structure into 475 luxury apartments, including approximately 14,000 square feet of retail space.

All together, PNC Bank has provided more than $200 million of financing for four office-to-apartment conversion projects, which produced more than 1,000 new apartment units in the Financial District.

Since then, there have been almost a dozen conversions started or completed in Lower Manhattan, adding some 3,000 residential units to the marketplace.

Despite the success of these conversion projects and the overall tight apartment market in New York City, some lenders still were not convinced of the renaissance taking place in Lower Manhattan, and perceived the investment risk as being too high. So when loan spreads dramatically rose last fall, affecting deals all across the country, Downtown office conversions were temporarily slowed. Financing options were unattractive and several of the prime locations had already been converted or were in the process of being converted. Also, the office market in Lower Manhattan was enjoying a resurgence, reducing the office inventory available for conversion to residential usage.

Accordingly, real estate professionals took a closer look at the roster of office buildings available for rehabilitation to reassess their plans for re-development. From this review, it was clear that for any one of several reasons - either risk associated with the construction, the sponsorship or the economic feasibility - some of these projects would be difficult to finance in any climate.

The fluctuations in the capital markets seemed to reinforce that the limited amount of capital available was being invested in apartment conversion projects with a well-defined development plan.

The question now is, what's next for Lower Manhattan? While Downtown conversions will continue, developers and lenders alike will remain very selective of the projects they undertake. Capital for Downtown projects may be less available than it was 12 months ago, but it is far from gone. A benefit to all concerns will be the addition of more ancillary businesses and services in the local area, both to fill the needs of an around-the-clock residential neighborhood and to augment the variety of businesses already in the area. The appearance of these local businesses will help to attract even more residents to the Downtown housing market.

It will be the charge of the strong public-private partnerships that have cooperated in the past to make housing in this area of the city a reality to continue to ensure that the needs of the residents are being met. Already, the demand of the existing housing market for more retail such as a grocery stores is being addressed by these public-private partnerships. As the result of this partnership's intervention, an "Amish Market" supermarket is now planning to open a store on Greenwich Street. Future plans also call for the development of a multiplex movie theater and new hotels in nearby Battery Park City.

Over time, the evolution of the Lower Manhattan housing market will be completed, but only if all parties - developers, residents, government, the business community and lenders - adapt to the changing demands and needs of the marketplace. As a lender who has remained active in real estate in New York City and nationwide, PNC Bank has learned first-hand that adapting to the changing marketplace without sacrificing quality is a sure sign of success.

Thomas Nastarowicz and Timothy Zietara, Vice Presidents, PNC Bank N.A., Real Estate Finance