423. The Office-to-Resi Conversion Boom is Just Getting Started with Joey Chilelli, Vanbarton Group

0:00So our goal is that a resident, when they come in to lease a unit, that they would actually never know that it was a former office building.

0:13Welcome to the TREP Wire podcast, the show where commercial real estate meets data and insights. This is a special guest podcast. I'm Haley Keen with TREP, a data modeling and analytics firm for the CMBS commercial real estate and CLO markets. I'm with Lonnie Hendry, Chief Product Officer. Today, we are joined by Joey Colelli, partner at Van Barton Group, a vertically integrated real estate investment manager with a 30-year track record investing in customized real estate strategies for institutional investors. Joey oversees the development and asset management of office, multifamily, and mixed-use assets.

0:52He also leads the firm's office-to-residential conversion platform, overseeing the acquisition and redevelopment of obsolete office buildings and has helped establish Van Barton as one of New York City's most active office to residential conversion developers. Joey, we're so excited to dig into all things commercial real estate with you today. Welcome to the show and thank you for joining us. Thank you. Thank you, Haley. And thank you, Ani, for having me on. I'm very excited. So I know I talked a little bit about your background, but we'd love to hear it from you. So you've spent your career across acquisitions, asset management, development, and redevelopment, and now are really one of the predominant office to residential conversion players.

1:34So we'll get into that later today. But why don't we talk about your start? How did you find yourself in commercial real estate and then ultimately end up with Van Barton? Yeah, well, thank you. And I think that it was interesting. Christine, I know that some of the guests on your podcast kind of fall into commercial real estate. I, on the other hand, have kind of always wanted to be in commercial real estate. Started off on the construction side, actually, understanding how buildings are built, how they operate. And then from there, kind of knew I always wanted to be on the investment side and took a few different paths through the education world, getting an MBA in finance, and then a master's in real estate development, and ultimately landing positions more on the kind of project management acquisitions, and then ultimately at Van Barton in 2016 on the asset management side.

2:34Joey Chilelli: Yeah, it's great. And I love having someone on the show that kind of knew they wanted to be in commercial real estate. It's great to hear the stories about how people fell into it. But it's also really cool to see that there are some of us that really, you know, grew up kind of fascinated by buildings. And I think for you, starting in construction is a great story. You know, we want to get into the office to resi discussion. I mean, that's what your primary focus is now. And it's a topic that I think is probably a little bit under discussed. There's a lot of headlines, but there's not really a lot of meat and potatoes discussion.

3:03Joey Chilelli: So we'll get to that point. But I think kind of as an entree to that, you know, it's important for us to maybe talk about just the general state of the office market, because I think some of these opportunities are being created because I would assume the general office market is not functioning as efficiently as it has in the past. We see it with our delinquency data, et cetera. But maybe from your perspective, like how would you characterize today's office market? I mean, what are you seeing today? And is this like a cyclical challenge or is this a structural disruption? Yeah, I think that it is a structural.

3:35And with that is that we have this class A premium office space that is going very strong. And so it's a bifurcation of that and the class Bs and class Cs that are underperforming. And so I think that it's great that there are some tailwinds that are kind of behind some of the office space in terms of having back to office in place and a lot of the stats of the return to office here. But you see tenants using space differently or you see them envisioning themselves in spaces much differently than they used to pre-pandemic. And what that has ushered in is the strong dynamic within that Class A office space that is well located.

4:26So it's central to, say, for instance, here in New York, the Grand Central Submarket performing very well. Then there are some other office buildings that might be Class C in the Garment District that are not performing well. And so it's not a tale of everyone is being lifted up here. But I think that goes back to how spaces are being used today. And so it's very promising and it's great to see a lot of the office kind of leasing and back to office. But there is still that issue and it goes to the structural components of the office market that is there and I think will be there for some of those other classes.

5:08Joey Chilelli: You know, it's really interesting on the Class A stuff. I mean, we've seen in New York in particular and several other, you know, what I would call high-functioning markets where they've been able to push rents, vacancies are at historic lows. And it's been, to your point, this tale of two markets with the haves and the have-nots. My question, and, you know, we can talk briefly on this and transition into the conversion stuff, but how much more road do you think they have ahead of them on that? I mean, like how much farther can these Class A highly amenitized buildings continue to push before some of that trickle down maybe starts to happen?

5:40Joey Chilelli: Because it feels like at this point, the tenants that want to be in the best buildings and the best locations are willing to pay the premium. But there has to be a breaking point at some level where they say, look, we're not going to spend that. And while we don't want to be in a lesser location or in a lesser building, the economics just make it to where that's the option that works best for us. Yeah, I do believe that we are starting to see some of that now. and where it might not be the top of the class A mark, but others that would fit within that kind of class A or even class B plus, if you will, where it's centered maybe not directly in the kind of bullseye of where the class A premium space is, but just on the peripheral.

6:26And we're starting to see that kind of trickle out a little bit, which is a great sign. and then it kind of backfills some of the other spaces. But those other spaces still need to be built to a certain degree of a level of finish that would be commensurate for that class A or B plus product. But we are seeing that where the top end of the market has been kind of taken. And now we're starting to see the tier right below that kind of fill in. And I think part of that is when we get into the next part of the conversation, part of that is also because of some of the space in some of those areas coming offline for conversions.

7:06And so it's helping kind of put a bottom in for those other properties.

7:10Joey Chilelli: Yes, that's a nice segue for us. I mean, when you look at the total office inventory today, you know, how much of today's inventory do you think is still an office building 10 years from now? And, you know, what percentage do you think is going to be something other than office? And what do you think generally that secondary use is going to be? Yeah, I like to think about it in terms of a sub-market specific, because say we're talking about New York City. New York City, in general, 700 million plus square feet of office space. But if you look at it where the Grand Central area is a, call it a 40, 45 million square foot sub-market.

7:49And within that, there's plus or minus about four, four and a half million square feet that's being taken offline for conversions. So give or take about 10 % of that. Now, I think as we look on into the years ahead, buildings are continuing to age just like all of us. And so we'll see how that dynamic plays out where I think that shift will naturally happen even outside of any other maturities, right? in terms of debt maturities and things where the amount of office space that is being used today will need to then be upgraded or will have new office buildings come online that will compete in a different way.

8:36And so the existing kind of stock will then look to be converted.

8:42Joey Chilelli: I don't disagree with you. I think this discussion has to be at a sub-market level, because if you look at the total of the office market, in any major office market, the amount of conversions on the sum total is going to be a very small number. Exactly. But in certain sub-markets, you might have a really proportion. I mean, like 10 % is still relatively small, but in practice, it's a lot. You know, if you get 4.5 million square feet or so that converts to residential, that's sizable, and that creates some market demand or meets maybe market demand on the housing side that is there. And so, you know, you guys at Van Barton, I mean, you've been pursuing office to residential conversions before it was cool, I think, before the remote work and before everything else.

9:25Joey Chilelli: You know, obviously, it's now become a national conversation, and there's been a lot of firms kind of pop up that are, you know, specializing in this. But you guys have been doing this even before that as identified opportunity for this aging office inventory. I mean, that's one thing for me, and I'd like to get your take on this, is the obsolete office building is not new. It's like we're just now finally recognizing it nationally, at least what I feel. What are your thoughts on that? No, I definitely agree. And we can look at that across the country in different cities, big and small, where certain office buildings that have become obsolete just never had a new purpose.

10:02And I think that now with the spotlight being much more so on a new way to convert them into residential, although, you know, Office to Residential has been around for decades, right? And something that we've been investing in going back to 2011. And I think that what has shifted is the ability with technology, so good and bad, but like with that is the dynamics of where people are able to live and work and where they want to entertain. And so I think that understanding that shift with the fact that you can now take an office building that may have been in a CBD, convert it to residential and create a new life and create a new kind of environment that allows that sub-market to take a whole new kind of trajectory.

10:57Where before, that may not have been in the kind of vision where the thought process may have been that, okay, that's CBD. That's just where all the office needs to be. And residential happens over here. And now the way that I think that people view this, certainly how I view it, is that mixture of office, residential, retail, hospitality, really mixing together is where all of the kind of creative juices flow. And that's what makes these cities great. And I think that We're just going to continue to see that. And I think that that will pick up in other cities. Again, big and small, it might be more challenging in a smaller city just because you need certain metrics to make that work.

11:45But I think to me, that's the biggest driver and why the view of obsolete office has changed over the past five or six years. Yeah.

11:57Joey Chilelli: I mean, we've seen this kind of live, work, play development theory pretty significantly across single-family residential development, where they build the houses and the schools and the medical office and all the stuff right there where someone can do all of that. But to your point, the same opportunity exists in these CBD markets where you have a bunch of people there all the time. They probably don't want to necessarily jump on the train or take a subway and go an hour and a half back home if they could live right there. and they're not too far from the necessities of groceries and other things.

12:28Right. And with the makeup of these CBDs, they're already in such locations where they're tied into mass transit, generally speaking, and they have the infrastructure that is in place that allows them to have that multi-use. Yeah.

12:43Joey Chilelli: This is one of those things where logically it makes sense. I think we haven't seen enough of this in practice for the mainstream mind to fully wrap themselves around this. But you guys obviously have been doing this, like you said, since 2011. So what were some of the signs that you guys saw as early as, you know, 10 years plus or minus before COVID that, you know, made this a bet you guys were willing to take in terms of an investment thesis? There were always these opportunities where in specific submarkets or areas that, and predominantly here in New York City, that was in the financial district, where the shift had focused more of the finance center to Midtown.

13:27And so it left a lot of office buildings with high vacancies. And so that was the predominant focal point of this. Then with the different debt maturities coming up, and we were able to look at different opportunities that would come up where it would work for the going in basis. And something else that has helped quite a bit in to be able to make the economics work is the rent levels, which we need to have. We need to be able to do that to be able to put the cost and CapEx into place to be able to convert them. But it was very much idiosyncratic strategy where it wasn't as bountiful in terms of the opportunities.

14:11There were always these one-off opportunities that will come up, very special situations where we might have a family that had owned this piece of real estate for generations that now has gone on to the children and they want to sell it. or debt maturity was coming up and the building could not end up working with the new debt levels. And so it was very strategic in that way. And since the pandemic, that has really increased the amount of opportunity here in New York, as well as across the country. And then you combine in all the different economics that have changed in terms of New York City, specifically with City of Yes, which has been a major driver, as well as the 467M tax incentive program that the state has passed.

15:02And there are these different programs in different cities that has really allowed the overall kind of pipeline to be able to grow. So it isn't as much of that one-off scenario where you might have one building every couple of years or so, and now you could that multiple in a single year.

15:23Joey Chilelli: Yeah, I mean, I think that's one thing I've seen. The cities where you're seeing more traction here, they've put in place expedited permitting, or they've done some sort of abatements, or there's some sort of public-private partnership that really incentivizes developers to try to take this on. And I think the cities that are struggling to kind of get traction here are the ones that are just not really incentivized developers to really make the push here. So New York has certainly put themselves front and center here with some of the the programs you mentioned, not to mention just the housing challenges that are faced in the city.

15:56Joey Chilelli: I mean, on the conventional side, you know, non-rent controlled or rent stabilized, there's not enough housing and prices continue to go up. And so those drivers from a developer perspective are great. Like every new unit you add, there's someone, you know, probably more than one person ready to take that unit down. So, you know, what are some of those underwriting components or what are some of the things that you guys have to look at to help make the determination of something pencils is, I would assume it's very market specific, but I mean, is the primary emphasis on the going in basis? Is it really on construction costs?

16:29Joey Chilelli: I mean, what are some of those things that move the needle, you know, make this a go no go decision? Yeah, overarching outside of the specific kind of sub market that we're in, the basis is one of the key components. And then another component is the existing. Is it fully vacant building or are there office tenants? And if they're office tenants, what's the vault? And then it kind of snowballs from there because even within that, it could say that the vault is eight years, but there are various termination options within each lease, whether it's for the landlord or tenant. So there's a lot that goes into kind of the next set of metrics, but very much does the initial acquisition basis make sense, given the capex that goes into it, the hard costs, all costs, and any of the carry costs.

17:24And that's the primary view. There's a whole host of other metrics that we look at from a diligence standpoint on whether or not a building and project is viable.

17:36Joey Chilelli: Are there any rules of thumb related to that? I mean, I know it's hard to say, like, we need to be able to acquire this at, you know, 30 cents on the dollar relative to the last trade, because sometimes, depending on when these assets traded, the last trade might have been inflated, interest rates have been considerably reduced relative to historical norms. Or is it like it needs to be land value effectively? I mean, like, what is the overarching view on what is satisfactory from an acquisition cost perspective? So the basis ultimately will matter with how much all the other factors come into play.

18:10So if it's a building that does not require very much in terms of hard cost to convert it, if the building already lays out very well, it's much more of an interior renovation, those costs are much lower. The acquisition basis could potentially be higher. But the way that we view it really is on the exit. At the end of the day, after the acquisition, everything that we put into it and the time factor, which on a conversion is drastically lower than if we were to do this on a ground up basis, anywhere from, call it in New York City at least, 50, 60 % less time. But on the exit, where we see it is the basis and on a per unit, whether or not the per unit, give or take if you're in all in for call it 650 ,000 a unit on up to maybe 900 ,000 a unit.

19:07It's a pretty big range, but it is very much sub-market dependent because even within New York City that each neighborhood is very different in terms of what rents they could command. But we follow that same guideline really in any city. And what we're looking at in Boston, we'll still have those same metrics and what has been recent sales comps and where historically units have traded so that we find ourselves in a situation where we're well below kind of any of the recent sales comps that have happened.

19:42Joey Chilelli: No, I think that all makes sense to me. The timing part of just the construction is really interesting, you know, 50 or 60 % less. I mean, it's obvious you're not doing the foundation and all the peers and everything else. But it's to hear that, it's that, like that's pretty compelling. It is. And essentially it really de-risks a lot of it. And when you compare that to ground up from the most part, from acquisition to the first time that we could have residents move in the building, it could be anywhere from 18 months to 24 months. On a ground up, that might be four years. It might be even longer.

20:20In some cases, It could be five or six if there's an initial parcel that has a building that needs to be raised and then do new foundations and the superstructure. So with this strategy, you have the existing superstructure to work with. And so it's really that adaptive reuse methodology that allows you to really press and get the units on the market that much quicker.

20:43Joey Chilelli: So on the financing side, I mean, like with this becoming more mainstream, has that helped? Does it hurt? I mean, has it created a better lending environment? Are there a small number of lenders that do this type of financing? Or you guys found that capital is available, you know, pretty readily for folks like you that are doing this? I think that what has changed, because prior to the pandemic, even in early 2020 to 2022, it wasn't as kind of mainstream. And prior to that, there were a handful of lenders that were in this space. And now, as we see it, there are dozens. And the breadth of the lender group has widened quite a bit, where we're seeing a very competitive landscape for lenders.

21:31Now, I think they have a much better understanding of what conversions are. And previously, for the most part, most of those lenders didn't have that understanding or had some misconceptions with it that kind of made them steer away from the space. And now that light has been kind of shining on this strategy, that has helped quite a bit in bringing more people to the table.

21:59Joey Chilelli: And what about the tenant experience? Do you have any data or any analysis from your guys' buildings? Do tenants enjoy living in an old office that's been converted because it maybe creates some eclectic components that you might not get in a, like, you know, build-a-suit ground-up multi-development? What has the takeaway been from the tenant experience? So our goal is that a resident, when they come in to lease a unit, that they would actually never know that it was a former office building. And what we do is create a product that is very much on the same level or exceeds a ground-up development.

22:37In terms of finish level, the programming, the amenities, we go down into the detail of finishes and how the fabrics look and feel. And each chair, for instance, in our developments gets tested out by someone in my office. before we purchase them. So we get extremely granular. And what I think that does is goes back to the resident experience. And when they come into the building, there's usually a wow moment of a wow. This is the residential building that I'm going to live in. And they do not know that it was a former office building. So if we're successful, that is the response that we get. And the way that we see it as well is that if we have a high renewal percentage, if we're able to achieve renewals of, call it 60 % or more, then we are achieving that.

23:37And by the tenant feedback in terms of their units themselves, how they utilize the amenity spaces, what we're putting into the building, and we're competing directly with other ground-up buildings that are purpose -built residential. And we're seeing that in our leasing data, saying that we're taking residents from X, Y, and Z building that was a purpose-built residential over to ours.

24:02Joey Chilelli: Yeah, that's really, it's great. I mean, I think for all developers, if you're not going to that level of testing the chairs and making sure that the experience is there, you're going to struggle because that's what's required today. I mean, consumers in all walks of commercial real estate, whether you're leasing office space or you're leasing industrial space or you're leasing multifamily, they're all more informed than they have been at any other time in history than my experience. I mean, I've been in this business 25 years and the consumer today is much more informed than they ever have been.

24:30Yes, totally agree. It is a very sophisticated renter. And we're seeing that more and more even where our average age is now ticking up. And people have been around various buildings, right? And they've moved around. And so they know. And they know if the developer owner fills a space just to fill a space or if there's purpose behind it, if there's a curative way of how you're to move through a space versus just putting a sofa in a corner just because the space needs to be filled. And so I agree. It definitely is one of those points that to be successful, the developer needs to go into that kind of detail.

25:15And it really shows, and it shows for the long-term stability of that asset.

25:20Joey Chilelli: I probably should have asked this a little bit earlier, but is there a particular floor plate size, like within a building? Is there like an ideal candidate or building where it makes it easier to get that seamless conversion? You know, because I know for some of these buildings, like the floor plates are just so massive that I have to imagine all of the work that has to go in, the architecture, the engineering, everything to make interior spaces feel like a traditional apartment are challenging. So is there kind of a sweet spot where you guys look at a building and you say, okay, if it's X number of square feet on the floor plate, that this is going to be a lot easier for us?

25:56Joey Chilelli: Or is that just something that you guys have learned to just navigate regardless of the size? We navigate regardless. And I'm a firm believer that just about any building could be converted. It just goes to that basis and what you can do with the asset. There are various ways to change the floor plate, whether that's peeling back the facade, creating balconies, limiting that distance of the apartment, doing different things with the back part of the floor plate. If they're creating different blind shafts and reallocating that square footage or utilizing courtyards, there are a whole host of ways to change that floor plate if the basis works.

26:38There are certainly some floor plates that work out much better from the onset. If it's a building with four sides light in the air and the floor plates 12 ,000 square feet, and depending upon where the elevator core is, if it's a side core or center core, there are certain things that would allow that to be much more conducive for a conversion. But I think that with a little bit of creativity and a lot of experience, that any floor plate really could be modified to make it into something that is closer to what a purpose-built residential would be.

27:24Joey Chilelli: I want to sound like, I mean, you guys have done this for so long now. I mean, for Van Barton, I mean, this is a component of your business. I mean, like how many people do you have working on this? And like, what does this look like in the construct of your overall business endeavors? Yeah, so it's another strategy. And granted, this strategy has grown much more so since the pandemic. But overall, we still invest in office, multifamily. Historically, we've invested in retail and hospitality. So it's another kind of prong of the overall kind of offering in which we invest in. And so our belief in office is still very much there.

28:07And there are office buildings that we're looking at, we're underwriting, we're bidding on. And with that, we've also been able to grow this side of the business and really have a dedicated development team. And our asset managers that also oversee office or multifamily also have a component where they are the asset manager on a conversion. Because it also brings in different components from all the other investments that we have. Because if we acquire an office building that's 50 % occupied, it still operates as an office building until the last day that that office tenant leaves. Then it goes under a development period.

28:49And then it starts to lease up as a multifamily building. So having that dynamic, well-rounded kind of asset manager or investment professional on these types of projects is key.

29:01Joey Chilelli: The reason I brought it up and you hit it out of the park with the answer, like your guys' perspective across the spectrum creates just more competitive advantage and that experience matters to lenders and it matters to tenants and it matters to everyone else, right? It does. The lenders and investors, of course, want to see that we have a deep bench, that we have that experience. And the tenure of our team members is quite significant where we've really promoted within and been able to take on these projects and also provide the level of detail that, for instance, a lender would look for in understanding that we've been through many different cycles.

29:45and different market conditions. It's more of a seasoned professional and we know how to come to the table with different solutions to get us through.

29:54Joey Chilelli: We work with a lot of academic clients and I hope some of them listening to this show will reach out because I think you probably have a really deep list of case studies for these adaptive reuse courses that are a lot of times hypothetical, theoretical. You guys have real life practical examples of how you've taken something and with a little bit of vision and hard work turned it into something completely different. I appreciate that. Yes, we definitely have some case studies and it's great to do that and also speak with different students and programs that kind of shines a little bit more of a deeper light into how these work and how we model them and underwrite them and the execution aspect of it.

30:35Yeah.

30:36Joey Chilelli: When I was in grad school, you know, we took a course on adaptive reuse, but it was nothing at this scale. I mean, nothing and nothing with as many commas and zeros attached to it. And, you know, you guys doing this for so long at this point now, I mean, this is an established part of your business. And it's pretty remarkable. Obviously, I've done some presentations and been in some of your office buildings, and you guys have very top notch. I'd love to come walk through one of these multifamily conversions because I think it It would be a great way just to see how you guys turn something in to a completely new being.

31:09Joey Chilelli: I mean, it's a new endeavor. It is. Thank you. I appreciate that. The invitation is always there. We have multiple projects going on. And I do believe that going out and touring the projects gives people another sense of the scale of them as well as how it all comes together. because it really is a remarkable thing and being able to breathe that new life into these assets that really were obsolete and didn't have another path forward. But it's being able to reuse them in a way and seeing how invigorating it is for the streetscape and the neighborhood and really what kind of life that it brings in.

31:49I'm a firm believer by doing this that then retail comes in and even office. Office wants to then be where that action is. And so I think it's a very good cycle to have.

32:00Joey Chilelli: You know, it's one of those things that we've seen through this latest disruption. It's just how interconnected all the property sectors are. So to your point, you bring in some nice looking high-end multifamily. It brings better retail options. It brings better restaurants. And to your point, eventually it's going to bring some additional redeveloped offices where maybe the adaptive reuse isn't an office to residential, but it's tearing down an old office and building a newer Class A office in its place. I think we're going to start seeing that play itself out. I agree. So maybe one last question for me, and then Haley will take us out here.

32:31Joey Chilelli: When you look out five years from now, is there a next wave of office to residential opportunities? Are we kind of riding the wave now? Is this just embedded in part of the CRE cycle? What does this look like for you, taking the current environment and maybe looking out five plus years? Where are we going to be sitting in that regard? I firmly believe that this trend of sorts that is seemingly a trend just isn't, and it's more becoming part of the fabric. Yes, I do believe that over the course of the next five years or so, that it will be robust in the pipeline and the amount of buildings that will be converted and the amount of residential units that will come online.

33:13But I do believe it's something that is going to be here for the long term and more so than it was pre-pandemic. Pre-pandemic, it was here. I think that people will see the good that comes out of this and how much housing can be produced. It's not going to be the end-all fix to the housing crisis in New York or Boston or other cities, but it'll certainly help. And I think that's here to stay. And people will be able to walk through these properties and not think that they were a former office building. And I think that that will only grow. So I think it's early and there's many years ahead where we're going to see a lot of this robust activity.

33:55That's great. And we're excited to follow along with your firm's journey and all that you do for the space. So thank you, Joey, for joining us today and really peeling back the curtain and showing us the practical use of all that your firm has done for the space and commercial real estate in general. It's been so great chatting with you today. Thank you both. Really appreciate it. Thanks for having me on. One last question here. I'm sure our listeners will want to chat with you or have follow-up questions. is there a way for them to get in touch with you or Van Barton Group in general? Yeah, I would say go right to our website, vanbartongroup.com, and then click on the contact us section where you could send in for any kind of general inquiries.

34:40Also happy to have any emails directly to me. It's at kaleli at vanbartongroup.com. and I know it's a little hard to say and thus I'll spell it C-H-I-L-E-L-L-I at bandmartengroup.com Thank you. This has been a great interview and we're excited to keep in touch. So with that, we'll close this special podcast. Thank you, Joey, for joining us today. Join us later this week as we look at what's happened during the week and how it may be impacting you. If you have a question or just a comment, send an email to podcast.trep.com. Until then, visit trip.com for more info and subscribe to the Tripwire podcast with your favorite provider.

35:23Thank you for listening and stay well.

35:25Joey Chilelli: All right.