Office-to-housing conversions could save downtowns, but at high cost

There’s one buzzword everyone — politicians, developers and boosters alike — are using when talking about how to revive downtown Minneapolis and St. Paul: conversions.

Easy to say, but not so easy to do, as pretty much all of those Twin Cities factions are discovering.

Office-to-residential conversions have become the darlings of local leaders looking to reinvent downtowns emptied and dulled from the post-pandemic decline of commuters. But such projects, promising for their ability to solve housing shortages and office vacancies in one go, have proven difficult and expensive, forcing developers, real estate brokers and civic leaders to re-double efforts to encourage them.

“It’s a beautiful solution in that it positively impacts several things at once,” Minneapolis Mayor Jacob Frey said of conversions, which add much-needed housing, reduce the glut of vacant office space and foster foot traffic. “Every city in the country recognizes that this is an important transition, so we want to set up an environment that’s more conducive to making it.”

For years, developers have relied on public assistance for notoriously challenging conversions, often in the form of historic tax credits. Once interest rates and construction costs increased during the pandemic, however, those dollars were often no longer enough to make projects financially feasible. So private and public sector leaders started collaborating on ways to bridge budget gaps.

As some struggling office buildings begin selling at steep discounts, the urgency of their work is intensifying.

“Our vision for the downtowns is occurring. The question is: How fast can we deliver it?” said Chris Sherman, whose firm is redeveloping the Northstar Center’s east building and downtown St. Paul’s Landmark Towers into 400 combined units. “It’s whether we can go 30 miles per hour or 100 miles per hour.”

So far, office-to-residential conversions have barely put a dent in the amount of vacant office space haunting both downtowns, in part because not every building is a good conversion candidate.

More than half of downtown office space in Minneapolis is from the 1980s or later, according to Pew Charitable Trust and national planning firm Gensler. Newer buildings like those can be difficult — and expensive — to convert into apartments, in part because of windows: They often don’t have operable ones and have larger floor plans that make it difficult to install enough windows to meet residential code.

Generally, older office buildings that aren’t as wide are easier to convert: A boon for downtown St. Paul.

In fact, finding properties that are historic can be key. Though the 17-story former Ecolab tower in downtown St. Paul might not look architecturally significant, it was the Twin Cities’ first curtain-walled building, meaning its the outer walls are not structurally important, developer Carl Kaeding said. That allowed him to secure federal and state historic tax credits for its $70 million conversion.

Even that might not have been enough, though.

“This is one of the lowest-return projects I will have probably quarterbacked in the last two decades,” Kaeding said, adding costs piled up fast between the heating and cooling systems, plumbing for individual units and other equipment needed to meet residential code.

“Would we do this one again knowing everything we know now, uncovering all the skeletons?” Kaeding said. “Probably not.”

Erin Hanafin Berg, policy director at Rethos, hopes answers like that will change after the upcoming legislative session. The nonprofit, which supports historic redevelopment, is gearing up to again advocate for a five-year tax credit for converting underutilized and vacant buildings, which would cover 30% of qualified project costs. The proposal failed last legislative session but is already gaining support in advance of the next one in January.

“It’s a little more urgent now,” Hanafin Berg said. “We’ve seen the impacts [of empty office space] and are starting to see concerns about the property tax valuation in the cities.”

Meghan Elliott, founding principal of New History, a historic building reuse consulting firm based in Minneapolis, said market forces are another obstacle. Developers are leery of flooding the market with hundreds of market-rate rentals at a time when the apartment vacancy rate in both downtowns is already hovering near the highest in the metro.

“While there’s an unlimited need to develop housing downtown, it takes time for the market to absorb new units coming online,” she said. “That’s a real challenge for these developers.”

That’s why some are focused on providing rentals more affordable to service workers, students and retirees on limited budgets.

“Deeply affordable housing for individuals and families makes a lot of sense for downtown because it’s connected to all transit corridors,” said Jessie Hendel, executive director of Alliance Housing.

The group recently bought a downtown Minneapolis office building constructed in 1921, originally the Swedish Hospital, for conversion into 59 apartments. Units at Kyle Garden Square will primarily be for people who have experienced homelessness and will have around-the-clock supportive services on site for residents.

Financing the $25 million project was time consuming and complicated, Hendel said. After more than 100 years of various uses, architects and contractors are now dealing with how to transform a building that has a former swimming pool under the lower-level flooring and defunct skyway and tunnel connections to the hospital across the street into living spaces.

Like those wrestling with the complexity of the physical conversion, Alliance had to finance creatively, especially facing what Hendel calls an “inflation gap” from construction costs that rose to record highs during the pandemic.

She credited the city with helping fill that and has no regrets about the effort, given the location’s rare access to amenities and services.

“It took a lot of time to navigate all those hurdles,” Hendel said. “This was really opportunistic.”

Officials in both Twin Cities are looking for more ways to support projects like Alliance’s. Though experts say the proposed state tax credit is the biggest difference-maker, city officials have also been working to streamline review and permitting processes for conversion projects to reduce time and risk for developers.

Minneapolis, for instance, passed a law earlier this fall waiving the city’s inclusionary zoning requirement for conversions. St. Paul Mayor Melvin Carter’s proposed budget for 2025 includes $1 million to waive the costs of permitting, parkland dedication and right-of-way obstruction fees for two conversion projects. He also said he thinks the city should scale back its rent control policy.

Cities can provide direct assistance in the form of tax-increment financing (TIF), something both Minneapolis and St. Paul did for Sherman’s conversion projects. It’s a worthwhile investment, the developer argued, since it helps reduce the property tax burden shifting to homeowners as office buildings lose value.

“These projects can be a tremendous stabilizer of the tax base,” Sherman said.

Advocates are also planning to again ask the state to make temporary changes to the statute governing TIF, to give cities more flexibility to allocate dollars to conversions. That’s one of several public incentives on the Minneapolis Renaissance Coalition’s wish-list. The group of more than 150 organizations brainstorms ways to revitalize the city’s downtown. It also floated the idea of a demolition incentive program for buildings unsuitable for conversions.

“Housing is needed, but that’s not all we need,” said Minneapolis Renaissance Coalition founder Erin Fitzgerald. “The healthiest ecosystems need built-in diversity.”

Without significant subsidies, John Breitinger — a practice leader for commercial brokerage firm Cushman & Wakefield — worries cities might resort to tearing down lots of buildings.

“It is not an easy problem to solve,” he said.

To ward that off, a broad range of behind-the-scenes efforts are underway to help investors understand the opportunities vacant office buildings present. The nonprofit St. Paul Downtown Alliance commissioned Gensler to study 20 downtown buildings for their suitability for conversion.

And a newly formed group of local architects, financial consultants and other experts called CityShift is offering itself as a one-stop shop for brokers and property owners considering conversion. That group is under a $50,000 contract with the Minneapolis Foundation to study some downtown buildings and provide a blueprint for what’s possible.

“My view is: Downtown Minneapolis and St. Paul are poised for a reinvention and an opportunity to become more vital than they’ve been in 75 years. No question,” said Jon Commers, whose data analytics and market analysis firm, Visible City, is working with CityShift. “The kinds of infrastructure that you have — the location assets, the cultural power, the destinations — the downtowns are packed with those things.”

The challenge, Commers said, is cities designed their downtowns years ago to separate those uses: an entertainment district, retail district, central business district. Since the start of the year, he said he’s noticed more energy focused on blending those.

Both cities have examples of what success looks like. In the past decade, Minneapolis’ North Loop and St. Paul’s Lowertown drew restaurants, retail and thousands of new residents through the repurposing of old warehouses into residences.

Transforming the heart of both downtowns, which have much larger buildings than old warehouses, is going to take a lot more money, creativity and time. Josh Talberg, managing director at downtown Minneapolis brokerage JLL, said with no major apartment buildings on the drawing board in either downtown, the fleet of empty office buildings present a golden opportunity to create more housing and lead both cities in a new direction.

“You can can certainly see the fundamentals improving, and you can feel that vibrancy, and that’s ultimately the foundation that’s needed to get investors to reinvest in the city,” he said. “But it’s not as if these 18-wheelers can turn on a dime.”