Matthew Pestronk, President & Co-Founder of Post Brothers, joined our institutional publication to discuss office-to-residential conversions. On the heels of the firm’s $228 million acquisition of Universal North and South in Washington DC, Pestronk explains the key elements for a successful adaptive reuse project.

Daily Beat: What’s your background?

Matthew Pestronk: I started my career around 23 years ago as a commercial office leasing broker at the Colliers’ affiliate in Philadelphia and thenjoined Ackman-Ziff as a mortgage broker.

I then decided that I wanted to own commercial real estate. My brother Michael and I bought our first building in 2006. He leads construction, development, and management, while I focus on acquisitions, financing, and raising capital.

Daily Beat: Which markets are you focused on?

Matthew Pestronk: We primarily focus on the East Coast cities of Philadelphia and Washington DC. Our team develops major urban multi-family and mixed-use projects. We have 2 billion square feet of active projects right now, in addition to our stabilized cash flowing properties under management.

Daily Beat: I gather that you’ll be converting Universal North and South, a 659,459–SF near Dupont Circle in Washington DC, into apartments. How long have you been doing projects like this?

Matthew Pestronk: We’ve been doing office building conversions and adaptive reuse for as long as we’ve been around. Our team has probably done more of it than anyone on the East Coast.

As office buildings have become more difficult to lease after COVID, the opportunity set that presents itself is basically how we formed our business.

Daily Beat: Is Philadelphia conducive to these types of conversions?

Matthew Pestronk: Yes. As a Philadelphia-based company, there are a lot of old structures in the area and adap- tive reuse was the preferred development business for a long time. It’s hard to take a commercial building – where everything inside is obsolete – rip it out and convert it to multi-family.

The less light & air, the less space you have. There’s three subsets of challenges – floor plates, light & air, and location. The depth of the floor plate is the key.

Daily Beat: Does the size of the floor plate matter?

Matthew Pestronk: No. The width is much less relevant than depth. To illustrate, if there’s a hallway going into an apartment, when you enter the front, the nearest window can’t be 60 feet from you. The ideal depths are not really much more than 40 feet. When building ground-up, depths are less than 30 feet.

Daily Beat: What type of cost savings do you gain when doing a conversion over an adaptive reuse? Having the foundation in place and all of the concrete and steel should help.

Matthew Pestronk: Yes. If you execute well, there’s 10 to 20% savings in the hard costs. You should be able to save some time, but there might be complications with the structure in terms of making it into a shell to start improving. It’s also advantageous not to have exposure to price swings of concrete and steel.

Daily Beat: So the cost savings aren’t as high as some might assume.

Matthew Pestronk: Yes. Generally, the market is pretty efficient. Cost savings will not be much greater when you pencil everything out because there’s a greater inefficiency of the structure of the building.

What’s happened after COVID is that there are now buildings in better locations available for a good basis because the owners don’t know what to do with them. If not for COVID, this build- ing would have remained as an office building. It would have never been priced appropriately enough to support a multi-family conversion.

Apartment conversions in this real estate cycle have been confined to outlying locations where there’s not an established market for commercial office. Investors would take a vacant building and renovate it, with the hope that tenants will live in an emerging location.

Five years ago, you would never find something in DuPont Circle that would be ripe for conversion. There’d be no chance.

Daily Beat: When you’re looking at these conversion opportunities, what are the ideal floor plates that you’re looking for? Light & air is obviously also key.

Matthew Pestronk: When you build a ground-up apartment development, you can make the floor plates a perfect rectangle, but it’s rare that an office building will work as perfectly as a ground-up residential floor plate.

A conversion almost ends up resulting in a bigger unit than you do ground up and therefore you wind up near the basis. The biggest advantage of conversion is twofold. There might not be land in a given location and there is not a lot of pricing exposure to concrete and steel because the structure is already built.

Daily Beat: Are there zoning challenges with conversions?

Matthew Pestronk: No. Most cities, other than New York, have moved to allow any office building or a hotel to be converted into an apartment building. The opposite is not true. We don’t have a lot of zoning risk in the cities we operate in.

Daily Beat: So there are clearly tradeoffs.

Matthew Pestronk: If you have always built ground-up, dealing with the confines of conversion presents a challenge; however, If you start doing conversions and you go to ground-up, you question why you ever did a conversion.

Sometimes, you’ll have an elevator shaft that someone filled in 15 years ago that wasn’t on the plans and then suddenly you have a hole the size of an elevator in 30 floors that must be filled.

You still have to do pretty elaborate construction drawings and design the unit layouts with the building mechanical systems around what’s there. It’s not that hard, but it’s just different.

Daily Beat: I remember when Nathan Berman did one at 20 Broad Street in Manhattan’s Financial District.

Matthew Pestronk: Yes. He’s the only person who’s done more than us in the whole country in the last 20 years.

Daily Beat: When you got started in the business, you chose the conversion path. Do you view this as less speculative than ground-up?

Matthew Pestronk: It’s all speculative. We started this way because over 20 years ago, buildings were inexpensive relative to their replacement cost by a large margin and rents weren’t particularly high.

Rents could not support new construction in many markets and there was not a lot of ground up apartment development. Fast forward to today, your basis is fairly comparable for either a conversion in a prime location or ground-up.

That used to not be the case. Ground-up costs were higher on a total basis because residential rents were low and buildings were relatively cheap to buy on a per foot basis.

Now, we’re at an inflection point where the market’s never seen. People see conversion potential and might be fine with the same basis as a ground-up project because they have less exposure to commodity prices and it might go faster.

Daily Beat: Are there any other factors to bear in mind when doing a conversion?

Matthew Pestronk: The office building needs a path to vacancy. Tenants can’t just abandon their lease obligations and move out of their office buildings. When leases start rolling over, opportunities will continue to increase.

Daily Beat: Do you raise individual funds or is it open ended. What’s the typical deal structure at Post Brothers?

Matthew Pestronk: No. We invest our own capital and have private investors that are typically high-net-worth individuals and family offices. The company doesn’t raise funds for discretionary investment.

*The interview has been edited and condensed for clarity.