$22M Office Teardown Makes Way for Multifamily

You might ask, "what sane investor would offer above-asking price for a 33-year-old, 150,000-square-foot, low-rise suburban class B office with a few dwindling leases, right at the onset of an office-fueled commercial real estate downturn?"

Well, any of the 12 suitors of 615 The City Dr. in Orange, California, would qualify not just as sane, but sharp, according to the listing brokers at Newmark who sold the property for $22.5 million in April.

That’s because they’re developers who know a smart multifamily conversion play when they see one.

And they were a captive audience, Newmark senior managing director Christopher Benton told LoopNet. The pitch to get the listing was geared toward multifamily conversion from day one. And it seems like everyone these days is talking about office conversions.

But although everyone is talking about it, it doesn't mean they are talking about the same thing. There’s a big difference between a building that can be adapted for a new use through a partial or full gutting, and one that requires a “land play,” which entails razing the existing building to the ground and starting anew, Benton said.

Offices are notoriously indisposed to the former. Most modern offices simply cannot be adapted to residential uses due to their wide and deep floorplates that restrict natural lighting to only the perimeters, and because of the overhauls required to run mechanical, electrical and plumbing to individual residential units. In the rare office building where conversions are possible, it’s wildly encouraged by developers, brokers and governmental bodies.

But that’s not the case for this behemoth in City Centre. Even though it provides access to lighting on all sides from the inside and out of each of its two adjoining octagons via courtyards, the four-story 625 The City wasn’t a good candidate for adaptive reuse, Benton said.

So why, in this case, as a proxy for myriad similar deals taking place across the country, did it “make all the sense in the world,” as Benton put it, to invest in a large, expensive and obsolete office building just to demolish it?

Because the 6.8 acres of land under it offered much more potential than its three-decade-old improvements. The market dictated a lot of that. “First off, it’s about the strong multifamily fundamentals in Orange County and specifically in the city of Orange,” Benton explained.

At the same time, drooping demand for offices in the Los Angeles-area suburbs of Orange County doesn’t help. Vacancy in the market is 13.3%, according to CoStar, the publisher of LoopNet. Net absorption was negative by about 2.2 million square feet in the past 12 months, and there’s plenty more new construction in the pipeline.

“Multi-tenant office is clearly out of favor, and the liquidity on the debt front is very poor,” Kevin Shannon, Newmark’s co-head of U.S. capital markets, explained to LoopNet. “Office nonbelievers are converting to sectors they have conviction in — which is both industrial and multifamily and there is capital flowing to those sectors.”

But an even more significant factor in the decision to focus on redevelopment, Benton continued, was the site’s flexible zoning allowances. Existing designations for the site, which has housed a large office since 1990, include up to 60 residential units per acre by-right. “And there’s no requirement to include affordable housing, which is incredibly attractive to developers,” Benton continued. “It just screams multifamily.”

Additionally, a wood-frame building can accommodate that density. This makes it possible to build a Type 5 (meaning wood-frame) “wrap” product, which entails residential units “wrapping” around above-ground parking structures in a donut shape. That kind of property “is the most preferred product to build in all of Southern California,” Benton said. “It’s all wood, and you don’t need to build a concrete podium.”

Lastly, having a few, but not many, remaining two- and three-year leases created a cushion for buyers to bring in rental income during the construction entitlement process, without having to worry about “buying out” tenants, which is the last thing multifamily developers want to do, according to Benton. “It was easy for the buying community to see how they’d be able to clear the building out.”

Private developer Watermarke Properties, based in Corona, California, closed on the property on April 28, 2023 for $22.5 million. Brokers Shannon and Benton worked on a team representing the seller, a private equity firm The Realty Associates Fund XI Portfolio, along with Newmark executive managing directors Paul Jones and Ken White, managing director Anthony Muhlstein and director Brandon White.