Legal Update
Dec 8, 2023
White House Implements Plans to Facilitate Office-to-Residential Conversions
Seyfarth Synopsis: With the cooperation of federal agencies such as the Department of Housing and Urban Development (HUD) and the Department of Transportation (DOT), the White House has established plans to use grants and below-market-rate financing to entice private parties to participate in the much needed redevelopment of office space into affordable housing.
In a speech last week, Federal Deposit Insurance Corp. Chairman Matin Gruenberg noted that past-due loans associated with CRE, especially office properties, represent a risk to the banking industry. This follows regular updates in the CRE industry regarding distressed real estate, particularly with regard to urban office buildings. This is the current reality for the urban office sector, in particular, while the nation grapples with a housing shortage, especially as it relates to affordable housing. With this backdrop, developers, lenders and other interested participants in the CRE sector have focused on what appears to be a simple sounding solution: conversion of unused and vacant office space to housing. In truth, conversion of office to residential is complex, time-consuming, and expensive. While likely not a panacea, the White House has stepped into the breach with an initiative that attempts to address the mutual goals of providing affordable housing, fostering the use of under-used or unused office space, and revitalizing urban environments.
Introduction
Office-to-residential (OTR) conversions have been on the minds of many urban planners and public officials with Los Angeles and Alexandria, Virginia leading the country in OTR conversions. Additionally, New York City announced its “Office Conversion Accelerator” program this past August to aid conversion projects via zoning changes and expedited permitting processes. In October, Boston launched a program to incentivize conversion projects through a long-term tax abatement program.
The OTR conversion trend has drawn the attention of the federal government as the White House released a guidebook outlining different federal programs that could be used to assist projects repurposing vacant office space for residential use.
HUD: Community Development Blocks Grants
In October, HUD released an updated notice regarding the allocation of Community Development Block Grants (CDBG) for the acquisition, rehabilitation, and conversion of commercial properties to residential and mixed use properties. CDBGs can be received as loans or grants. Funding is granted to state and local governments who in turn distribute funding. Projects pursuing CDBGs must comply with statutory requirements[1].
DOT: TIFIA Financing
The Transportation Infrastructure Finance and Innovation Act (TIFIA) provides advantageous financing for conversion projects that qualify as Transit-Oriented Development (TOD). TOD includes projects that increase the availability of residential housing and are located within walking distance of public transit. Funding is available for projects with a minimum cost of $10 million and may be used for a broad range of conversion costs. Up to 49% of eligible costs can be financed by a TIFIA loan, and the loan’s fixed rate is roughly equal to the yield on US Treasury securities with comparable maturity. TIFIA can lend directly to private entities with a public sponsor. TIFIA loans and any senior debt must be rated investment grade.
DOT: RRIF
Railroad Rehabilitation and Improvement Financing (RRIF) provides below-market financing for commercial-to-residential development near transportation centers. RRIF eligible costs are slightly more restricted than TIFIA eligible costs, but include similar activities[2]. Like TIFIA loans, RRIF only finances TOD projects. RRIF-specific TOD projects must also satisfy additional DOT requirements[3]. Loans can have up to a 35-year repayment period. There is no maximum or minimum project cost, and up to 75% of eligible costs can be financed by a RRIF loan.
Final Notes
As with all Federal and other governmental programs, there are conditions and restrictions which must be understood and mastered (see footnotes below for examples), but these programs should not be ignored and may offer resources that make the expensive proposition that is office to residential conversion viable.
[1] Section 570.202(a) of the Code of Federal Regulations states that (1) CDBG funding can only be allocated to projects that comply with “national objectives;” (2) CDBG funding is limited to certain renovation activities if the recipient is a for-profit entity and is converting commercial space to residential (as opposed to rehabilitation of existing residential); and (3) CDBG funds allocated to for-profit entities for commercial space conversion projects are limited to select activities such as (i) improvement of the exterior of the building, (ii) abatement of asbestos hazards, (iii) lead-based paint hazard evaluation and reduction, and (iv) the correction of code violations.
[2] Costs eligible for RRIF include: (a) construction, reconstruction, rehabilitation, replacement, and acquisition of real property, environmental mitigation, construction contingencies, and acquisition of equipment; and (b) capitalized interest necessary to meet market requirements, reasonably required reserve funds, capital issuance expenses, and other carrying costs during construction.
[3] RRIF projects must: (i) incorporate private investment of greater than 20 percent of total project costs; (ii) be physically connected to, or is within ½ a mile of, a fixed guideway transit station, an intercity bus station, a passenger rail station, or multimodal station, provided that the location includes service by a railroad; (iii) demonstrate the ability of the applicant to commence the contracting process for construction not later than 90 days after the date on which the direct loan or loan guarantee is obligated for the project; and (iv) demonstrate the ability to generate new revenue for the relevant passenger rail station or service by increasing ridership, increasing tenant lease payments, or carrying out other activities that generate revenue exceeding costs.