Twin Cities developers, city leaders bet big on converting office buildings to homes
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Twin Cities developer Chris Sherman feels like he has a built-in advantage in two big downtown projects underway in Minneapolis and St. Paul — he can create hundreds of new homes without ever having to put a shovel in the ground. The buildings are already there.
They once housed downtown offices but then emptied when the COVID-19 pandemic hit. The workers didn’t return. Sherman’s betting now that converting those office buildings to apartments will lure people looking for homes in a region struggling to meet the demand.
Between Landmark Towers in St. Paul and Northstar Center in Minneapolis, Sherman said it will cost about $185 million to retrofit 600,000 square feet of vacant office space into 400 units of housing. Northstar Center is set to open in October.
“Seventy-five percent of the cost of a conversion goes to labor and only 25 percent material, whereas on new construction, it's about the opposite,” he said. “So for both sustainability and job creation, conversions are highly impactful.”
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Sherman and the local leaders supporting his projects are bullish on office conversions. In the wake of the pandemic, they see a generational opportunity to transform empty offices into livable downtown spaces capable of making money for developers, replenishing tax revenues that anchored government budgets before the pandemic and drawing new life into the urban cores.
It’s not an easy path. Buildings that weren’t meant to be lived in must be rethought by architects and engineers, and there are no guarantees that people will come. Still, the potential to draw thousands of new residents downtown has leaders convinced it’s worth the risk.
The goal is “to make sure we're making the highest and best use of all of our spaces” and “to make sure that our tax base in our economy remains strong, both downtown and citywide,” said Rebecca Noecker, a St. Paul City Council member who represents downtown and chairs the city’s Housing and Redevelopment Authority.
She and other city representatives are in the process of advocating for these proposals with state legislators who have control over new tax credits. A bill introduced at the Legislature in March would create a new state credit for converting “underused” buildings.
‘A real hidden strength’
For policy makers hoping to restore downtown vibrancy, the need to do something with vacant office space is increasingly clear. The current vacancy rate for the Twin Cities is 22.6 percent, one of the country’s highest office vacancy rates, according to the firm Moody’s CRE.
Noecker has plans for a program she hopes will fuel more office-to-residential conversion projects. St. Paul’s City Council hopes to streamline the approval process for conversions, offer new kinds of tax credits to developers who take on conversion projects and potentially waive the developer permitting fees in St. Paul for conversion projects.
St. Paul has a unique advantage when it comes to office conversions. Buildings designed to be offices tend to have large, rectangular floor plates that are difficult to divide into units that all have windows. St. Paul’s downtown office buildings often have the small floor plates easiest to split up into new apartments.
“What’s been sort of a disadvantage in the past in terms of getting commercial tenants actually turns out to be a real hidden strength of downtown St. Paul when it comes to these conversions,” said Noecker.
The City Council, working with St. Paul’s Downtown Alliance, has based some of their proposals on the success of office-to-residential conversion incentive programs in Calgary in Alberta, Canada. Local leaders and developers in Duluth and St. Cloud, have also touted plans for more office conversions.
Sherman said his company, Sherman Associates, has carved out a niche in conversion projects with 20 completed since the late 1990s. To finance the two conversion projects currently in progress, Sherman Associates used a mix of construction loans, one-time money, historic tax credits aimed at renovating older buildings and city tax breaks that allow future property tax payments to pay for the development.
Conversion projects can generally secure both private financing and historic tax credits, but just those two sources are not enough. Early this year, Sherman’s project at Landmark Towers received nearly $22 million of tax increment financing (TIF), which diverts future property tax revenue that could normally be spent elsewhere, in order to cover high construction costs, rising interest rates, and to account for the complexity of the site.
According to Sherman, “with solely private financing, these projects are left with extraordinary gaps that cannot be filled.”
It is those financing gaps that Noecker and the others at the St. Paul City Council want to fill through their conversion program, which would create other financing avenues at the city and state level instead of pushing these projects over the finish line with TIF.
The goal is not only to help local developers accomplish conversion projects, but also to draw developers across the country to the Twin Cities region. “Part of the reason for the public investment is that we're trying to attract development, not just from all over the region, but from all over the country,” Noecker explained.
Once the projects are completed, Sherman is optimistic about filling apartments. He explained that with current high interest rates, it has been more expensive for developers to take on construction debt and the pace of real estate development has slowed significantly.
“Our expectation is that Landmark tower in St. Paul will be full by spring of 2026, due to a lack of new supply,” Sherman said.
Noecker said they expect demand from young professionals and older adults who are looking to trade large homes for apartments that are easier to maintain and closer to different kinds of community resources.
St. Paul’s Downtown Alliance, with whom she’s worked on downtown revitalization initiatives, has set a goal of 20,000 new residents in downtown St. Paul in the next 10 years.
The development of new housing can be what allows neighborhoods to thrive. As people move in, the hope is that their presence alone will attract businesses and other local amenities.
“The neighborhoods around Minneapolis and St. Paul market in particular that are thriving the most are the neighborhoods where we've seen a lot of these conversions occur,” Sherman said.
‘We need more housing of every type’
New units in downtown districts are part of a larger trend in recent years of apartment development throughout Minneapolis and St. Paul. Analysis of permits for residential construction shows the combined total permits for apartment buildings, duplexes, and town homes have recently outpaced total permits for single family detached housing.
Anne Mavity, executive director of the Minnesota Housing Partnership, has spent years advocating for more affordable housing across the state. A March report by her organization found that despite development in the Twin Cities, Minnesota as a whole is short 100,000 homes and Minnesotans are increasingly rent burdened.
“The housing conditions across Minnesota are tighter than they’ve ever been,” she said.
New affordable housing and new housing are not the same thing. Sherman Associates’ project at Northstar Center has units set aside for affordable housing, but Landmark Towers will be all market-rate. However, Mavity sees market-rate development downtown as a good thing.
“You can think about it as a game of musical chairs … When the music stops, everyone’s supposed to find a chair … [Individuals] can’t get into housing because they’re the ones who got pushed out of it and there’s not enough chairs for them,” Mavity said. “We need more housing of every type in every corner of the state … What we’re looking for are ways to creatively and innovatively leverage what's available to us to create that housing.”
A recent report from the Federal Reserve Bank of Minneapolis also found that new housing, no matter the price, makes housing easier to access for those at various income levels.
As office vacancies rise, both cities need to rebuild the downtown tax bases that existed pre-pandemic.
Although residential properties are taxed at a lower rate than commercial properties, Noecker said the property values of buildings make more of a difference, and that real estate development will bring up those values.
When it comes to St. Paul’s tax base, Noecker said, “we know that a full bustling residential building is far, far better than a mostly vacant office building.”
MPR News reporter Anika Besst contributed to this report.