Fear of Skyscraper Collapse in New York Highlights Risks of Office-to-Apartment Conversions
The former Pfizer headquarters was recently at risk of partial collapse, leading developers and lenders to anticipate stricter safety inspections and rising insurance costs for future conversion projects.
A day after structural damage put the largest office-to-apartment conversion project ever planned in the U.S. at risk, investors and lenders said they are rethinking their future commitments to complex real estate projects of this type.
On Tuesday, Philadelphia real estate developer Michael Pestronk finished presenting a series of new conversion projects to investors when he suddenly noticed five missed calls. He learned that a high-profile office-to-apartment conversion project at the former Pfizer headquarters in Midtown Manhattan was at risk of partial collapse. Pestronk, whose company Post Brothers is leading one of the largest conversion projects of its kind in the U.S. in Washington, noted: "An event like this could certainly steer investors and lenders away from office-to-apartment conversion projects."
Over the past five years, the office-to-apartment conversion sector has experienced a significant boom. At the beginning of the year, there were about 90,300 housing units across the U.S. in the planning or execution stages as part of office-to-apartment conversion projects, an increase of 28% compared to the previous year, according to the apartment search site RentCafe. New York leads the trend, with 16,358 housing units in various stages of conversion, almost twice as many as last year.
Private developers see office-to-apartment conversion as a way to reduce the ballooning costs of building from scratch, while government officials view it as a solution to both housing shortages and the surplus of empty office space. Now, some lenders are beginning to recalculate the feasibility of these deals.
"It will make everyone a little more conservative," said Paul Rahimian, CEO of Parkview Financial. "Maybe we will choose the simpler projects, but we will pass on the particularly complex ones." New York City officials stated on Wednesday that the building is now stable, and the contractor is discussing long-term solutions.
Neil O'Sannato, founder of Persistence Analytics Group, said that future projects are expected to face more comprehensive engineering and safety inspections, more expensive contractor insurance, and less debt financing. "The incident at the Pfizer building should cause developers, investors, lenders, insurance companies, and government officials to reprice the risk involved in converting offices to residential," he said. "The economic feasibility of such projects may change."
Challenges of Architectural Adaptation
Office-to-residential conversion projects can be more complex than new construction, partly because developers are trying to make a building fulfill a purpose for which it was not originally designed. It is necessary to introduce natural light and air, add bathrooms and kitchens, and adjust weight loads.
The project to convert the Pfizer headquarters into 1,600 new housing units is particularly ambitious, involving the addition of floors. Nathan Berman, founder of MetroLoft, told The Wall Street Journal that some of this additional weight is what caused the steel beams to bend. Industry experts expect regulatory oversight to tighten, and attorneys anticipate that the risk premium on contractor insurance will rise in the short term.
Asher Luzzatto, a developer in Denver, suggests that developers should keep conversion projects as simple as possible: "If the existing architecture was not designed to carry a significantly larger structure, don't force it."
Nevertheless, some remain undeterred. Ran Eliasaf, managing partner of Northwind Group, which provided a $135 million loan for the purchase of the old Pfizer building, said the company will continue to be "very optimistic" regarding the financing of such projects. However, industry experts agree that the incident serves as a wake-up call for the entire sector.
This article was translated by Globes exclusively from The Wall Street Journal.
