Nov. 9 (Bloomberg) -- Vijay Vankadari, who has renovated Frankfurt apartment buildings for more than a decade, used a cheap and plentiful resource for his latest residential project in the city: old office buildings that businesses won’t touch.
Office-to-apartment conversions like Vankadari’s Grand-Westend 24 in the city center are growing in Germany’s financial capital, providing opportunities for landlords hard pressed to find corporate tenants for outdated buildings. Such projects will account for more than a fifth of the homes coming onto the market this year, city government data shows.
“Office owners don’t have the interest or funds to renovate buildings from the 1970s, so they put their old properties on the market,” said Vankadari, 48, a founding partner at Frankfurt-based Mercer Street Capital GmbH. “We started focusing on buying office buildings when residential prices became too expensive.”
Owners of 60s- and 70s-era office buildings in Frankfurt are fighting for tenants as banks and law firms cut jobs and new developments add competition. The city’s vacancy rate stands at about 15 percent, according to Savills Plc. That’s almost double the level in the City of London financial district and more than Manhattan’s 10.3 percent.
Young couples have replaced a private-equity firm at the Grand-Westend 24, a seven-story building with floor-to-ceiling windows, balconies big enough to fit sun loungers and oak and bamboo floors. The ground level apartments come with lawns.
Demand for homes is rising as Frankfurt’s population grows, boosting residential property prices. The city’s residential vacancy rate stands at 2.4 percent, according to property broker Jones Lang LaSalle Inc.
Vankadari’s project is one of 10 Frankfurt office buildings that will be turned into homes this year, according to data compiled by Savills Plc, a London-based broker. That’s double the total for 2011, making Frankfurt the city with the most conversions in Germany.
Many of Frankfurt’s offices are empty after developers flooded the market during the Internet driven boom of the late 1990s, said Oliver Barth, head of the local office at BNP Paribas Real Estate. The vacancy rate soared to 18 percent in 2002 from 2 percent in 1999. Since then, the rate has rarely fallen below 13 percent.
That hasn’t stopped builders from adding more space to the market. About 492,000 square meters (5.3 million square feet) of offices are under construction, according to data compiled by BNP Paribas Real Estate, a unit of the Paris-based bank. That’s the most since 2008.
Part of that includes twin towers being built for the European Central Bank. The building will have about 185,000 square meters of gross space when it’s completed in 2014, about half of which will be offices, according to Andrea Juerges, a spokeswoman for the ECB. The bank will be the only tenant and workers will be moved there from three other Frankfurt sites, she said.
As the new offices take tenants from older ones, few companies are willing to lease the aging spaces, said Barth. The older towers often have ceilings that are too low to accommodate modern wiring for computers and air conditioners and their fire-safety features are no longer legal, he said.
“Tenants in Frankfurt are banks and law firms that have high standards and want modern spaces,” he said. “Much of the existing stock is of a quality that’s not marketable.”
Office parks in the city’s outskirts, such as Merton Viertel and Niederrad, have some of the highest vacancies, as companies bring employees into the center. Tenants can be picky in the main financial districts as well, and landlords are struggling to fill even iconic buildings, said Sven Carstensen, head of the Frankfurt office at research firm BulwienGesa AG.
The MesseTurm, Europe’s tallest building when it opened in 1991 and the headquarters for Goldman Sachs Group Inc. in Germany, has a vacancy rate of 35 percent, according to owner GLL Real Estate Partners GmbH. The company is partly owned by Italian insurer Assicurazioni Generali SpA.
Falling demand from businesses is also keeping the office vacancy rate high. Tenants in Frankfurt are reducing the amount of space they rent as the European sovereign-debt crisis prompts banks to cut jobs, said Michael Voigtlaender, senior economist at the Cologne Institute for Economic Research.
Deutsche Bank AG, Germany’s biggest lender, said in July it would cut its workforce by 1,900, or almost 2 percent. Commerzbank AG, the second-largest bank, may eliminate more than 1,000 retail jobs, two people with knowledge of the matter said.
“The time when a tenant would simply sign a lease to rent the top ten floors of a tower is over,” said Christian Lanfer, head of office leasing at Jones Lang in Frankfurt.
Some of the old skyscrapers still appeal to big tenants. The Silver Tower, the former Dresdner Bank headquarters built in 1978, is occupied by German railway company Deutsche Bahn, which moved in this year. The office building was Germany’s tallest tower until it was overtaken by the MesseTurm.
While the office market struggles, demand for homes is rising. The population of Frankfurt, Germany’s fifth-biggest city, increased by 3 percent in the past three years to 700,259, according to local government data. Apartment prices in jumped 13 percent in the first half from a year earlier, Jones Lang estimated.
This year’s 10 conversions will create about 1,158 apartments, according to Savills, which estimates that 16 projects will be built next year.
Residential sales are also being boosted by large investors buying real estate in German cities including Frankfurt as a safe place to put their money amid the European debt crisis.
Frankfurt’s government began subsidizing conversions in 2007 to help alleviate a housing shortage that was emerging. Investors who want to turn unused commercial space into homes can seek planning advice from city officials and receive subsidies if they create homes in designated areas, said Mark Gellert, a city spokesman.
“A lot of our work is about convincing owners,” Gellert said. “It doesn’t benefit anybody to have long-standing office vacancies with no rent coming in.”
Conversions didn’t take off initially because owners had little financial incentive to sell, said Radomir Vasilijevic, head of office leasing at consulting firm NAI Apollo Group. In some cases, they prefer to take a loss on the property to pay less tax, he said. Funds may hesitate to sell properties that lost value because it will hurt their returns, he said.
“Owners in Frankfurt had enough money, and it was sometimes better for them to keep an empty building than to sell it,” Vasilijevic said.
This year, the financial scales tipped in favor of conversions as home prices and rents rose while office values stagnated, according to data compiled by Jones Lang.
Apartment prices climbed 13 percent to 2,930 euros a square meter in the first half from a year earlier, Jones Lang said. Yields for prime offices, a combination of rental income and value growth, were unchanged at about 4.8 percent.
Office rents were 20 cents higher per square meter than residential rates in 2011, Savills said. The difference was 5.50 euros in 2002, when office rents peaked.
“It’s taken a few years, but people are finally beginning to understand that the demand is settling in at a lower level,” said Matthias Pink, head of research at Savills in Frankfurt.
The pace of conversions is tempered by a lack of bank financing, NAI Apollo’s Vasilijevic said. German banks, which are reducing their real estate investments to comply with new Basel III banking regulations, are reluctant to make loans on properties that have high vacancy or require expensive renovations.
“Some older buildings are so expensive to turn into apartments that banks are not playing along,” he said. “There are lots of buildings that have potential, but because of financing difficulties they just stand empty.”
The concerns are sometimes justified, said Stefan Forster, the architect who turned the former headquarters of the IG Metall union in Frankfurt into Germany’s first high-rise conversion.
“In most situations, you have to strip the building down to the concrete and start from the beginning,” he said.
Dealing with legal challenges by neighbors and finding attractive ways to build around existing beams is also costly, Forster said. “A conversion is almost always more expensive than building something new,” he said.
Vankadari said renovating residential buildings is only attractive now if the developer finds a property that is both inexpensive and empty. Such real estate is rare, he said.
“It’s much more difficult to renovate an apartment building if there are people living in it,” he said.
His firm has easier access to capital than some competitors because of its track record of turning unwanted buildings into homes, Vankadari said. Mercer Street Capital typically borrows from local savings banks and small mortgage banks, and has been dealing with the same lenders for years.
“We’re in close contact with the banks, they know our previous projects and they know our style,” he said. It helps that Mercer only develops luxury properties that can be sold at a profit more easily than middle-income housing, he said.
Banks also like Mercer’s access to cash, which allows the firm to put down 20 percent of equity in exchange for an 80 percent loan.
“We could have done full equity,” he said. “We basically bought the building with our own money, and before the settlement, we figure out the structure of the financing.”
Conversions are set to keep growing, narrowing the imbalances between Frankfurt’s office and residential markets, Savills’ Pink said.
“In the years to come, we’ll see more growth in conversions, probably not at the same pace we’re seeing now, but the criteria for developers are there,” said Pink. “It’s clear that this will continue to help reduce the structural vacancies in Frankfurt’s office market.”
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