Presented By: Stroock & Stroock & Lavan LLP
The Legalities of Office-to-Residential Conversions: What You Need to Know
Given the tenuous state of the office market plus the nationwide housing shortage, it’s no surprise that office-to-residential conversions have become a hot topic of late.
But while such conversions offer many potential benefits to owners and communities alike, the legalities involved in such conversions can seem overwhelming, especially since few developers have extensive experience in this area.
Fortunately, the current mood toward conversions favors development in New York City.
“It all starts with Article One, Chapter Five of New York’s zoning laws,” said John Egnatios-Beene, special counsel at Stroock & Stroock & Lavan LLP. “Current regulations allow for conversions of everything in Community Boards 1 through 6 in Manhattan, and several Community Boards in Brooklyn. Right now, zoning is not necessarily the major impediment.”
According to Egnatios-Beene, developers looking toward conversions are more likely to face issues related to New York State’s Multiple Dwelling Law, which lays out requirements for the physical aspects of the conversion.
“The issue with these old offices — let’s call them mid-century and beyond — is that they have these great big floor plates,” said Egnatios-Beene. “And between those and the windows around the perimeter, you’re not going to be able to easily convert them because you’re not going to get enough light and air. But there are lots of solutions to that, and the current regulatory environment allows for it.”
The law, however, which gives developers flexibility in how they handle these factors, currently applies in only some parts of the city.
“There is a proposal to allow all nonresidential buildings in the city to enjoy the benefits of this section of the Multiple Dwelling Law. That would make this easier for developers,” said Egnatios-Beene.
Another move Egnatios-Beene believes would ease the road to conversion for developers involves changing New York’s building code, which currently allows only three unrelated people to live in one dwelling.
“That’s a real problem in creating affordable housing and co-living, which has been very successful in other jurisdictions,” said Egnatios-Beene. “Co-living companies can’t get funding in New York because they can’t create this housing stock. If you were to change the code to allow more unrelated people to live together, you could make roommate situations more affordable, which frees up housing stock for people who already live here.”
Developers exploring conversion opportunities also need to be concerned about various environmental considerations, including adhering to New York City’s Local Law 97, which places limits on greenhouse gas emissions starting in 2024.
“If you’re doing an office-to-residential conversion, you’re basically looking at a gut renovation,” said Rusty Pomeroy, special counsel at Stroock. “You’re generally looking at older Class B or C building stock, and you’re probably going to be facing some significant asbestos abatement issues. But it’s pretty well established how to deal with that. The climate issues will be more significant.”
To comply with Local Law 97, developers need an accurate assessment of their building’s emissions.
“There’s an interesting dynamic in how the city has set the emissions limits for the various property types,” said Pomeroy. “For 2024 to 2029, the first five-year compliance period under the law, office space has a higher emissions limit than multifamily by about 10 percent. But that flips dramatically from 2030 to 2034, when the office occupancy type has around a 65 percent reduction in the allowable emissions limit. So when you get to 2030, a multifamily building will have an emissions limit about 25 percent higher than an office building, and that grows to 63 percent from 2035 to 2039. And in the last compliance period, 2040 to 2050, multifamily has about a 350 percent higher emissions limit than an office occupancy would have.”
This will have a significant impact on any developer now planning an office-to-residential conversion.
“The city and the state are both really pushing for greater electrification of buildings, and rapidly moving away from on-site burning of fossil fuels. New York City passed a gas ban law at the end of 2021, and that applies to new buildings,” said Pomeroy. “So building owners will have to think long and hard about using large-capacity heat pumps and electric ranges in tenant spaces as opposed to gas ranges.”
While Pomeroy notes that this will leave developers with larger upfront expenses for the more expensive systems, the cost has potential to be offset in several ways.
“If you have the opportunity to gut renovate a building, you can make that building a very high energy performing building,” said Pomeroy, “and that’s going to reduce your expenses down the road with respect to energy use and potential Local Law 97 penalties.”
Another consideration for developers contemplating conversions is whether to stick with rental apartments, choose a condo or co-op structure, or perhaps assemble some combination, such as a condo with retail units downstairs, a rental unit with rental or co-op apartments in the middle, and residential condo units on top. The condo structure allows for flexibility if the developer wants to sell off some or all of the property down the road.
“Developers should consider a condo regime, because it could help to maximize value,” said Leslie Byrd, special counsel at Stroock. “If a developer wants to get out of the building, the value of the parts could exceed the value of the whole.”
The process of establishing a condo regime would take longer than a straight office-to-apartments conversion, as it involves steps required under New York’s Martin Act (Article 23-A of the General Business Law) and Condominium Act (Article 9-B of the Real Property Law), including obtaining a “no action letter” from the attorney general’s office and recording a condo declaration and floor plans. The sale of individual residential condo (or co-op) units would also require an offering plan.
But while a condo or co-op move adds to the bureaucracy early in the process, Byrd said that it could lead to easier times down the road.
Many office-to-apartment conversions require some form of government subsidy, which in turn requires that the development have an affordable housing component.
“The affordable units will need to be rent-stabilized,” said Byrd. “You can create the rental structure more quickly, but you’re going to have ongoing compliance issues with respect to those apartments.”
Byrd also points out two other considerations for such conversions. For one, if a developer has a retail tenant, they’ll need to be part of the initial negotiations. And two, conversion developers should prepare to have extensive conversations with their lenders.
“You’re going to have to negotiate with the lender to permit the imposition of a condo regime on the property,” said Byrd. “The mortgage will have to be spread to cover the newly formed condo units.”