Here's How Developers Are Trying To Reduce The Cost Of Conversions

Office-to-residential conversions have become one of the trendiest real estate plays across the D.C. area.

While very few ground-up multifamily projects pencil in today’s capital markets and construction cost environment, buying office buildings for pennies on the dollar and repositioning them into residential is a strategy that often still works. 

These projects benefit from developers being able to secure prime locations at a low basis, as well as government incentives that help fill holes in the capital stack.

But capitalizing them is still a delicate dance, and keeping costs as low as possible is crucial to their success.

At Bisnow’s DMV Office Repositioning event Thursday, developers of office-to-residential conversions in the region spoke about solutions they’ve found to trim capex and, in turn, put less stress on their capital stack. 

“Developers still need to find office buildings that work economically and understand that those incentives are helpful, but they are not the end all, be all,” Foulger Pratt Director of Development Kofi Meroe said onstage at The Westin Washington, D.C. City Center.

“You're still having to come back and battle with the main drivers of our industry right now, which are construction costs, interest rates, things that we don't control.” 

Foulger Pratt in August completed an office-to-residential conversion near the White House, transforming a former Department of Justice office building at 1425 New York Ave. NW into a 243-unit apartment building called Accolade. 

The 287K SF building came with a four-level underground parking garage, Meroe said, allowing the developer to mitigate the extremely expensive costs of building underground parking in the city. 

“You can wrestle back some of that control by being creative in the acquisition of the asset that you make and finding ways to reduce and mitigate the effects of those costs you don't control by [incorporating] some of the existing infrastructures,” Meroe said.

In Crystal City, where JBG Smith has plans to convert multiple office buildings to apartments, the developer is mitigating construction costs by creating larger units instead of fitting in as many as possible, JBG Smith co-Head of Development Matt Ginivan told the audience. 

“Whereas 10 years ago we could improve our basis, and it was accretive to squeeze in that incremental unit, squeeze in that extra net rentable foot, now we have to be much more judicious about the cost that we're adding because trying to add in that extra square foot of that extra unit, you're just adding cost now,” he said. 

Meanwhile, as people stay renters for longer — with homebuying increasingly out of reach — they’re preferring larger units with more storage, anyway. Ginivan said that in JBG’s three pipeline projects, the average unit is over 1,000 SF. 

“That's not something that's costing us more money, and in a lot of cases, those are actually savings because that's less space that we're finishing, but it's giving those residents something more,” he said. 

National Real Estate Development also opted for the fewer-unit play when evaluating how to convert the downtown D.C. office building formerly home to the Air Line Pilots Association, said Katie Hartley, the firm’s managing director of development. 

The 1970s-era building at 1625 Massachusetts is nearly finished transforming into 157 units. 

But in initial conversations, National Real Estate Development was weighing whether to convert or demolish the building, Hartley said. Demolition would mean the developer could add another floor of units and still be in line with D.C.’s Height Act. 

But in the end, the developer opted for a conversion with fewer units, reducing the amount of financing it needed to obtain. 

“Really, the deciding factor for us was the smaller project total capitalization at that time is what drove us,” Hartley said.

“We only needed a construction loan around $60M. The debt markets were not where they are today two and a half years ago. So we decided to go the conversion route. We have experience. We thought we could mitigate the construction risk well enough and have a better capitalization strategy given the product size.”