After WeWork, Could Office-to-Residential Conversions Revive PropTech SPACs?
With what appears to be the impending bankruptcy of WeWork (NYSE:WE), it is beginning to feel like the end of an era, if not several eras.
Much of the focus has been the transition from WeWork’s eye-watering zenith at a $46 billion valuation and ambitions of irreversibly changing the world the way titans like Microsoft (NASDAQ:MSFT) or Google (NASDAQ:GOOG) did.
But, its rise and fall have taken place in a broader context of venture capital-propelled proptech firms seemingly having a disruptive answer for every inefficiency in the real estate market for a time. In the SPAC world, this expressed itself in 16 proptech companies announcing SPAC deals since September 2019, of which WeWork was just one.
WeWork’s struggles were unique due to its immense scale, ambition and debt load, but higher interest rates and a slow return of workers to the office have taken their toll on the entire sector. The 14 proptech companies that have completed SPAC deals are now valued at a median share price of $2.18 or $0.55, when adjusted for stock splits.
The most successful of these has been the oldest among them in Mosaic‘s target Vivint Smart Home, which was able to lock in a $12 per share valuation in its sale to NRG Energy (NYSE:NRG) last December.
Otherwise, the next four best performers (and the only now trading above $1) all came from serial SPAC sponsors that may have known how to pick the best from the trend – Social Capital II, Fifth Wall I, Gores VI, and Bridgetown 2.
Two more, TG Venture (NASDAQ:TGVG) and Nova Vision (NASDAQ:NOVV) have pending announced deals with Chinese co-working space operator Flexi Group and realty social media platform Real Messenger, respectively. Another, Crown Proptech (NYSE:CPTK), saw its combination with building management SaaS firm Brivo fall apart, and it has since sold its sponsor economics. So, it is not clear if any SPAC is still actively hunting specifically in this space.
But, perhaps there is an emerging angle SPACs should be considering.
Late last month, the Biden administration unveiled a multi-agency program to spur office-to-housing conversions to both ease housing shortages in urban areas and also provide support to real estate developers and owners struggling to generate revenues from office properties now sitting at low capacity.
As good as this sounds, there is a reason this shift has not happened already on its own.
Even putting aside zoning restrictions, transforming a building that is made up of several offices into several dozen apartments requires adding walls, plumbing and new HVAC work. This adds weight to each level and may require additional structural reinforcement. In the end, it is rarely cheaper to convert an office building to apartments than it is to build new apartments somewhere else.
As a result, firms with know-how in such conversions are something of a niche business, but the amount of federal state and local support coming down the pike to achieve this two-birds-with-one-stone effect could change that.
The new federal dollars are to come in the form of $35 billion in below-market rate loan availability for conversions near transit stations from the Department of Transportation and another $10 billion in block grants from the Department of Housing and Urban Development.
State and local governments have added perks of their own. In New York, the state has exempted office conversion projects from property tax if they include some affordable housing.
Existing regulations make thicker buildings without atria more difficult to convert as residential restrictions typically require every bedroom to have a window. But, there are ways around this, and NYC Eric Adams has supported easing such rules.
GFP Real estate and Metro Loft are currently building the country’s largest conversion in turning the 1.1 million-sq ft former headquarters of the NY Daily News into 1,300 apartments. These apartments will include windowless “home offices” at times in what may have normally been considered a bedroom.
So how can SPACs get in on the action?
Again, companies making specialist business models out of conversions are not currently numerous, but they are emerging. Ori Studio, whose designs maximize space with moveable furniture elements, raised $20 million in a 2019 series B from an investor group that included Khosla Ventures.
It has converted portions of 68 buildings in 34 cities and says its minimum targets for its designs are 10% higher rent per square meter and 35% higher IRR than the office had before.
Developers could also attempt to package together of group of properties undergoing a conversion that could be combined with a SPAC to allow retail investors to get in on the upside. Every conversion is also an opportunity to generate ESG benefits, which is something that Ernst & Young has encouraged investors to take advantage of.
If the ESG benefits and financial incentives can drop the cost basis for the property, there is also the potential for much faster speed to market and turnaround on deals for a conversion rather than full greenfield undertaking, EY notes.
How quickly this can all take off remains to be seen, but recent events at least suggest that there could soon be a great deal of WeWork spaces waiting for a redesign.