Difficult Office Conversions

The Real Estate Espresso Podcast

Difficult Office Conversions

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Difficult Office Conversions

Speaker 1: Welcome to the Real Estate Espresso Podcast, your morning shot of what’s new in the world of real estate investing. I’m your host, Victor Menasce.

Today we are talking about one of the more fascinating office-to-residential conversion stories in Washington, D.C. It’s a former General Services Administration office building that’s slated for conversion to apartments. Part of it includes a museum planned for the ground floor. It was featured in yesterday’s Wall Street Journal.

Speaker 1: This is the kind of project that gets my attention—not because it sounds glamorous, but it forces us to really think like developers and ask a simple question: can you take a building that was designed for an obsolete use, buy it at a deep discount, and create a product the market will actually pay for? That’s the question.

So, we’ll start with the obvious. The purchase price was remarkably low—at roughly twenty-four million dollars for a nine-hundred-and-forty-thousand square foot building. That works to twenty-five dollars and fifty-three cents a square foot. That’s far below replacement cost. In fact, it’s probably below the replacement value of the land and the shell before you even spend a dollar on demolition, reconstruction, mechanical, elevators, code compliance, and all the rest that comes with the conversion.

So, from a purchase price standpoint, this is exactly the kind of price that makes a difficult project worth studying. No question, buying well solves a lot of problems, but a low price doesn’t solve all problems.

This particular building has a massive floor plate. It’s almost two and three-quarter acres per floor. The shortest dimension of the building depth is 227 feet. That’s very deep for residential. Office buildings can tolerate deep floor plates because people can work far from the window under artificial light, but apartments can’t. Residential units need access to the building’s perimeter. They need light, they need air, they need livability.

Bedrooms and living rooms need to be on the perimeter of the building, and you can put things like bathrooms, closets, kitchens, laundry in the interior, but there’s only so much space that you can use for that purpose. When I look at the perimeter of the building, there are enough windows to do about 65 one-bedroom apartments on each floor, just based on the existing windows. That means the inner one-third of each floor plate would be unused, unless they cut a hole in the center of the building and try and use that space in some way.

So, there’ll be a large amount of unused space in the core, or it’s going to require carving out courtyards, light wells, or atriums into the middle of the structure. It would require subtracting rentable area in order to create usable rentable area. But overall, the good news is, the building has a lot of perimeter windows, and that helps. If you have enough perimeter you can create a very large number of units with decent natural light. The question is whether those units will be attractive enough and whether the common areas and the circulation can overcome the awkwardness of the original structure.

But that brings us to the real underwriting question: will the market pay respectable rent? Not maximum rent, but respectable rent? If the plan is to underwrite this project as a trophy luxury apartment building, that’s probably a mistake. It’s not going to work. The geometry of the building fights against that positioning. But if you underwrite it as well-located, distinctive urban housing with some institutional character, some generous windows, and strong access to employment, you might have a thesis.

But this is not a residential area. It’s in a tourist area. And it’s in an area that has a lot of other office buildings. And of course, location matters. This property has some strengths. It’s in central Washington. It’s near L’Enfant Plaza. It’s got proximity to the National Mall, the Wharf, employment centers, transit, all of these tourist amenities. That could be viewed as an advantage that suburban office conversions would never have. People can live there and participate in the city without a long commute.

But people don’t choose location because they are close to museums. They want access to other things that are part of your daily convenience, like access to groceries. There’s none of that in the area. So, the success of that project is not just about the building. It’s about whether the surrounding district has a hope of maturing into a real neighborhood.

The ground floor museum is an interesting move. In many projects, the first floor is the hardest place to activate. Retail is not really viable on such a large floor plate. A museum could create identity, destination traffic, and a public-facing use that gives the property some character and some reason for being. It could also preserve some of the building’s civic legacy.

But from an apartment investor standpoint, the museum is not an economic engine. There’s an amenity to the district, not a reason for the building itself. That deal is going to work or fail based on the apartments.

There’s some very real absorption risk. If we’re talking something north of 360 apartments, which is what I’m expecting, that’s a lot of units to absorb. Even in a strong market, you need leasing velocity to fill a building that large without crushing rents through concessions. So, a development team has to think carefully about the unit mix, the target tenant, any phasing strategy. Who is the end customer? Is it young professionals? Are they government workers, many of whom have been let go recently? Is it folks that are downsizing and want access to the urban lifestyle near the Mall and the Wharf? Families are less likely if access to groceries and schools is important.

At a conventional acquisition price I would say the building is far too awkward. At $25.53 a square foot, you’re being paid to solve a problem, and that might be a good place to start. Like with all real estate, real estate does not reward easy stories; it rewards disciplined execution. A cheap building isn’t a bargain unless the finished product matches real demand.

And if this team can convert a difficult shell into housing that people genuinely want to live in at rents the market can sustain, this could be an outstanding example of buying obsolete real estate below replacement cost and creating value through design.

As you think about that, have an awesome rest of your day. Go make some great things happen, and we’ll talk again tomorrow.

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