To convert or not to convert?

More ask the question

Investor Steven Witkoff was working on plans to convert his new purchase at Ten Hanover Square to some form of residential usage when Goldman Sachs decided the office tower was perfect for its needs and took over the entire property. Witkoff says, "I love the conversion market. I just loved Goldman Sachs better."

Witkoff is not alone in his decision to keep his Downtown property a commercial office building. According to brokers and buyers, the pioneering residential conversions at 45 Wall, 25 Broad, 127 John and 71 Broadway have brought down the commercial vacancy rates at the same time growing companies are discovering a need for more and cheaper office space.

Some Downtown brokers are even advising clients not to convert so fast, but instead to hold on. Gil Robinov, a senior vice president of CB Commercial, says the office market certainly has improved and there is an optimism for an increase in rents for office space.

"The investors are looking at it as office buildings rather than residential," he said. "It's a different kind of office owner, and they are stretching and reaching, but they think the market will catch up to them."

Newmark's chairman, James D. Kuhn, worries that buyers are investing in Downtown at prices that assume there will be a major spike in office rents, similar to what has happened in Midtown. In Class B buildings, he says, Downtown rents have to go from $22 and $23 a square-foot to the $27 to $28 a square-foot range to support the investment.

"They are not buying on today's numbers," said Kuhn. "On pre-war, when prices approach $80 a foot, you are buying futures. That doesn't make sense."

Take 100 Wall Street. The 1969 building was owned by Hexalon and in April 1993, was showing 56.46 percent or 258,011 square feet of its total 457,000 square footage as vacant.

After a renovation in 1994, it won the Building Owners and Managers Association (BOMA) award for modernization and restoration, and slowly was able to bring up occupancy. It went on the market with an asking price of $45 million, but Witkoff purchased it for $34 million earlier this year, and recent reports have it now sold to a real estate investment trust for $58.5 million.

Because the buildings are selling at higher prices, Robinov agrees, "Buyers have to get higher rents to achieve the rents they told the mortgagee they were going to get. Buyers are chasing product and paying more, and that in itself will raise the rents and the renewal rents."

Rents in the recent past have been kept low, Robinov explained, because the owners or mortgagees owned the properties at a lower price. And many of them own at a lower price precisely because others paid too much in the late 1980's. When rents and failing tenants did not support the buildings, they lost them to mortgagees and new owners.

It is those who got in low or because of defaults that took advantage of the conversion market. Others who bought early and held are also catching the current price spikes to get out, selling higher and higher to the newest round of buyers.

Gedaliah Borvick, director of Eastern Consolidated Properties who is known as Gordon, says "First were the steals, then the bargains, and now the higher prices."

He defines the first pricing at $10 to $20 a foot, the second as the $40 to $50 a foot range, and now the third phase of $60 and up, even for the Class B buildings.

"I have been eyeing some deals which can be converted today or converted down the road," Borvick said. "Buyers are saying they have tenants left and they work around the expiration dates and fill them up. There are benefits to keeping it office, as long as you do various types of work."

If an office building has unique infrastructure, or it can be boosted to a Class A status, or tenants can be shifted to create a multi-hundred thousand square-foot block, the office spaces can compete with Midtown, asserted Joseph Farkas, managing officer of CB Commercial.

"You could snare one 100,000 square-foot tenant and break the $30 [a foot] mark that hasn't yet been seen," predicted Farkas.

One reason recent buyers don't mind keeping the buildings as offices is that it's easier. Wilkoff says an office deal is a simpler deal to put together. "Just do the TIs (tenant improvements) and they are ready to go," he added. "There is no major retrofitting."

But costs can be high when office tenants need complete fit-outs. One booster for residential conversion where the building doesn't work well for offices is William G. Cohen, executive vice president of Newmark.

A few years ago, he said, people were chasing the Downtown buildings strictly for the change of use, because the conversion benefits were available and those often-empty buildings were not suited to office use to begin with.

"What made them a bad office building - the shallow floorplates and many windows - makes them a good residential building. But the cost of conversion is double to triple the cost of building for a commercial tenant," explained Cohen. in a typical 10,000 square-foot office rental at $30 a foot, he noted, after 10 years, it could cost the owner $600,000 to basically buy back his space when you add up free rent, work, concessions, legal and brokerage.

"However, once you build a one-bedroom apartment, all you have to do is paint for the next guy. It's not a tenant specific installation," he said.

When Donald Trump bought the leasehold at 40 Wall for about $1 million in 1994, the Downtown plan had not yet passed. The 1.3 million square-foot property had seen its share of wide-eyed owners. Former Philippine President Ferdinand Marcos purchased the 70-story tower for $70 million in 1982, and it was sold at a Citibank auction to the Resnicks in the late 1980's for $77 million. They began a multi-million dollar renovation program just when the leasing market died. The Chinese group Kinson Properties bought the property at auction for $7 million in 1992 before finally selling it to Trump, after realizing they were not equipped to finance ambitious renovation plans.

"When Trump was looking at 40 Wall, he figured his cost of putting a tenant in was $35 or $40 a foot, but the conversion to residential was three times more," said Cohen.

Trump considered making elaborate condominiums in the tower, but ultimately decided to keep the building as offices, and is leasing up the building to mostly services tenants. He is also pursuing plans for a hotel in the base to take advantage of an exquisite but separate Pine Street banking lobby entrance.

The Rudin Organization originally was among those that encouraged the Giuliani administration to come up with a plan that would aid both current office buildings as well as residential conversions. But the Rudins have kept their Downtown properties an office product.

"Our buildings didn't warrant a conversion," noted William C. Rudin of the Rudin Organization. "They were basically occupied."

The building that was vacant at 55 Broad Street was turned into the Information Technology Center and marketed with city support as an Internet incubator which is now 100 percent occupied.

Now, Rudin says, any owner or bidder for a property would have to consider "the product, the building and the price," because "there's a demand for both."

That demand is finally showing up in vacancy numbers, as well as the success of the apartment rentals.

According to the third quarter Studley report, 7,492,149 square feet of space was leased in the Alliance area below Chambers Street this year, leaving 13.2 million square feet available out of a total or 91.46 million square feet. While the overall vacancy rate is 14.4 percent, only 8.1 percent is vacant in Class A and 16.3 percent vacant in Class B.

By comparison, Midtown vacancies number 7.9 percent overall, 4.5 percent in Class A, and 9.1 percent in Class B.

"The shrinking of the inventory has an impact, and you do have some interest from Uptown tenants," said Robinov.

Since the Class B market provides most of the currently available 4.6 million square feet. Robinov says rents on Broadway and Broad Street have recently gone from high teens to mid 20's on average.

"They have gone up $7 a foot since the beginning of the year," he said. "For the most part, office rents are not going up $5 a foot, but go up $1 a foot every two or three months."

Carl Weisbrod, president of the business improvement district the Alliance for Downtown New York, says buyers have to make the economic calculation, "but certain owners and buyers only work in commercial, and others are only residential developers."

When 30 Wall Street was purchased a year ago by CBC Properties, some of the other buyers had worked their numbers on a residential conversion. Cut the investor group led by Charles Bendit wanted to keep the property as an office building and bought it as such. For one thing, Bendit is not a converter, and he believes 30 Wall was never a good candidate to be converted.

"The floors were not ideal, nor was leasing status, and it would have taken a long time to get vacant possession," he said. "I also believe Wall Street is a great office address."

That 118,364 square-foot building was bought for $7.25 million from Tozai Real Estate Company in November 1996, which had purchased it in 1986 for $31 million.

The next building Bendit's group purchased was at 50 Broadway in June of this year for $14.4 million. He says it was conducive structurally to residential conversion, but "we had two-thirds rented to office tenants, and financially it would have worked, but I'm happy to keep it as office and bring it into the 21st Century with many improvements."

There are already 1,900 residential units underway or complete in about 15 buildings, said Weisbrod. He expects there will be roughly 7,000 apartments converted by the time the incentive program is scheduled to end in 2002.

Borvick says some building buyers feel there are a lot of units coming into the market, and instead of competing with them, expect to wait out the first phase of residential conversion and jump in after the market has settled.

"Hopefully there will be another round of demand [for apartments]," he said. "Now there are pioneering people. But once there is a real residential community with residential needs being taken care of and the school [at Battery Park City] is completed, than the second phase of either renters or buyers will move into that area."

According to Cushman & Wakefield, residential conversions have removed 15 buildings overall from office inventory, totalling 3,880,673 square feet. That number doesn't even include the towers of 60 Broad or 100 John, both of which are still in the renovation process, or the hotel planned for 17 Battery Place South.

More important for building buyers, however, is that these apartments are being occupied, pulling square footage off the office market and creating a neighborhood environment that is further fueling office occupancies and a stronger look from Midtown companies.

Because the office market is strong, however, owners that held properties back, such as Zar Realty's Two Broadway, are now adding them to the inventory. That former Olympia & York property alone, which was purchased for $20.5 million in September 1995 and is now being leased through Williams, means another 1.58 million square feet of competition. Still, there are already signed deals with McGraw Hill, and other girder-kickers abound.

"The office numbers have come up," agreed Weisbrod, "but so have the residential numbers, as the track record has shown a great enthusiasm for both apartments and offices."

The office spillover is not yet being felt in the adjacent areas of Tribeca, Soho and Chelsea because the impetus there is residential conversions. But there is some forewarning.

Michael Goldenberg, director of sales for the residential Halstead Group, says recently he has gotten a few phone calls from potential loft buyers asking whether he thought there would be a need for back office space in Tribeca.

"Since it was becoming so residential around Wall Street, they thought people might be looking for back offices," he said.

Richard Baxter, a senior managing director of Insignia Investment Group, says the office market has heated up to such a degree that it's almost a wash to keeping buildings as office.

But he agrees the decision is very property-specific, because older buildings don't lend themselves well to loss factors and make better residential properties.

"The Two Broadways and the 1950's and 1960's vintage will remain offices," he predicted, while the pre-war will be converted or have mixed residential and office use.

Downtown incentives provide residential conversions with up to 12 percent commercial space the ability to pay no real estate taxes for 12 years upon completion of the conversion. Those with 12 percent to under 25 percent commercial space have pro-rated benefits.

The recently enacted changes to the incentive program permit those buildings or portions of properties remaining commercial to have a straight $2.50 per foot exemption from property taxes. That comes off the tenant's bill and provides a direct incentive for them to rent Downtown.

At 90 John Street, developer Joseph Moinian is taking advantage of all the available Downtown programs. He is converting the top of the building to rental apartments, which will have a 100 John Street address, and has signed up a portion of the base office building into the city's Plug 'N Go program, which provides lower rents to office tenants seeking Internet-ready spaces.

Weisbrod said, "It's an individual choice with each building [whether or not to convert], and there's no question that since the commercial market has come back, there has been renewed interest in the office buildings. The programs work together and we always said the residential program would boost the commercial market."