Tax, economic incentives needed to spur New York office-to-multifamily conversions

Newmark’s Jimmy Kuhn and Fried Frank’s Jon Mechanic say developers need support to convert obsolete properties.

Office-to-multifamily conversions continue to be possible in New York, but most are unlikely to move without an increase in real economic incentives to make these complex transactions work, said Jon Mechanic, chair of the real estate department at New York-based law firm Fried, Frank.

Speaking at the NYU Schack Institute of Real Estate’s annual capital markets conference this week in a conversation with Jimmy Kuhn, president of New York-based advisory Newmark, Mechanic outlined the potential for these deals using the example of 25 Water Street in New York’s Financial District.

The 1.2 million-square-foot property, formerly occupied by JPMorgan, is being converted into 1,200 rental units by a partnership that includes local investors GFP Real Estate, MetroLoft Management and Rockwood Capital. The conversion was funded by MSD Capital Partners in a deal arranged by Newmark.

“It was one of the most terrible, most awful buildings I’ve ever seen in New York,” Kuhn said. “But [the sponsors] took that building, dropped in two lightwells and created an abundance of apartments.”

This conversion was done without tax or other incentives, which will be necessary given the need for housing and the amount of excess off space in the city, Kuhn said. The effective price per square foot was about $200, he added.

“What were the challenges the buyers had to get this to work without tax incentives and what is your take on converting office buildings to multifamily?” Kuhn asked. “What are the economic and financial liabilities going forward?”

Mechanic, who worked on the deal, cited a number of factors. In addition to strong relationships between the sponsors and the eventual lenders, the partners were able to negotiate an early exit for JPMorgan for its lease.

“JPMorgan was happy to exit the building early and there was a deal negotiated that allowed JPMorgan to terminate the lease and make discounted termination payment to the existing lender, which had a purchase price for its debt. That brought down the basis that allowed the project to go forward in a way that made the changes economical,” Mechanic said.

It will be hard to replicate deals like this in other parts of the market today.

“New York has 450 million square feet of office space, and we will need maybe 300 or 350 million square feet,” Kuhn said. “But because there are not currently any tax incentive programs, [Mayor Eric Adams] is trying to help this change happen through zoning.”

The city will need to address the affordable housing crisis, through a new tax abatement program and zoning changes. “In order to build the housing we need, we need help from our legislative bodies,” Mechanic said.