Investment Analysis

Looking for a Redo

Adaptive reuse projects come with plenty of considerations, so when do such investments make sense?

As competition for developable land within certain asset classes increases, along with changing demographics and land use trends, opportunities to repurpose older and functionally obsolete properties are becoming increasingly attractive. Many developers are recognizing the value in reconfiguring obsolete properties for vastly different uses than originally designed - such as transitioning from hotel to office, retail to multifamily/mixed use, and industrial to live/work. 

Adaptive reuse is more than repositioning a tired retail center or re-tenanting office space; it's realizing a complete re-envisioning of a building without complete redevelopment.  

This process requires a creative eye and can offer many advantages for developers and investors. There may be less pricing pressure, because otherwise obsolete or underperforming assets have less competition than easily entitled development land or less complex value-add deals.  

The timeline for adaptive reuse projects can be shorter than ground-up projects; in some cases, it presents an opportunity to preserve and upgrade a historical property. This can unlock value in an asset that may otherwise be difficult to redevelop under restrictions from local government and residents for preservation.

That said, as with any real estate investment, critical factors must be considered when determining whether to tackle an adaptive reuse project and deciding what new use(s) may be appropriate. 

Evaluate Market Trends

Understanding market conditions - including macro trends in demographics, land use and zoning, and as-designed and proposed use - is critical to successful adaptive reuse. 

Shifting market dynamics have increased the viability of these projects, particularly in areas undergoing densification, losing manufacturing, and where retail assets are outdated and underutilized.  

For example, e-commerce has lessened the need for traditional regional malls and department stores, while increasing demand for industrial buildings of all sizes to address distribution, regional logistics, and last-mile concerns. 

In high-demand urban areas, underutilized industrial buildings may be suitable for live/work or experiential retail and mixed use. The San Francisco Ferry Building, shown above, is an example of an iconic property, obsolete for waterfront warehouse or commerce use, that was transformed into prime retail, dining, and community space.  

Changes in consumer habits have led to the continuing need to reinvent retail and reposition older shopping centers. Consumers expect malls to provide experiences - including entertainment, dining, and gathering spaces - rather than just places to shop. This trend creates opportunities for department, apparel, and big box stores to be converted into programmable spaces, food halls, movie theaters, and exercise studios. In recent years, prior manufacturing properties have been successfully converted into creative uses; former hotel space has been turned into unique offices; and obsolete retail locations have become office space. 

Recent opportunity zone legislation may spur additional adaptive reuse projects in areas that may not have received investor attention otherwise. The legislation helps communities seek investment in blighted or underserved areas of the country, increasing consideration of creative adaptive reuse investments. Because “substantial improvement” is required to realize opportunity zone tax benefits, repositioning obsolete buildings for new and better use could be on the rise

Determine Feasibility

Feasibility analysis is critical in determining viability of any real estate investment. Given the unique challenges of repurposing an existing site, the feasibility process needs to be more rigorous for adaptive reuse, examining factors such as location, demographics, community needs, and zoning. 

Beyond that of a typical building investment, attention is needed to assess whether general or specific plans govern uses and zoning of the property. Prospective investors must study the existing structure - its condition and foundation; mechanical, electrical and plumbing; and life-safety and accessibility.  

Constructability for the intended use should not be underestimated. Appropriate assessment will narrow possibilities for adaptive reuse projects. It also helps developers and investors rule out uses that are against regulations, too costly, or requiring too much remediation to pencil.

Stakeholders must also consider if a community will buy into the project. Support from community leaders and local groups are essential to success, ultimately delivering deeper benefits to investors and communities. This is particularly true if the intended-use changes require approval from a local planning commission, architectural review board, or city council. 

Many markets display a strong sense of “not in my backyard,” causing powerful community opposition to development of any kind. In some municipalities, projects can be taken to the ballot box and often killed at great expense to all involved. Town hall meetings and other public events that allow developers to illustrate how adaptive reuse projects will create benefits can go a long way toward achieving buy-in.

While the process of coordinating with municipalities may sound daunting, local consultants with expertise in these issues can help investors bring a competitive advantage to the project. 

Looking at Old Haunts

It's equally important to dig into potential ghosts of a property, including legacy environmental issues, boundary or easement challenges, or historical preservation ordinances. 

For example, shopping centers that previously housed dry cleaners, auto dealerships, or gas stations must be remediated to create spaces that are suitable for people to shop, live, and/or work. Long-term industrial use can also present more complex challenges in terms of environmental remediation.

At larger industrial properties, easements, boundaries, and rights of way all need to be assessed to ensure free and clear use when requesting zoning and construction approvals.  

Investors must develop a keen sense of trends affecting supply and demand in all properties within the market under consideration; these can be very local studies to regional and national trends. 

For more on this topic, check out CCIM Institute's 3Q18 Commercial Real Estate Insights report “Adaptive Reuse: Turning Blight into Bright."

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