Distressed assets

Born-Again Buildings

Adaptive reuse revival transforms neglected properties into productive assets.

C all it the “Friends” effect: After a decade of watching the television show about six characters sharing funky urban digs, young adults in mid-size U.S. cities have decided that’s the life they want. But unlike previous generations who actually took off for the big city, today’s young adults often can find loft apartments with exposed brick walls right in their own hometowns.

To one degree or another, it’s happening in St. Louis, Kansas City, Mo., Albuquerque, N.M., Louisville, Ky., Columbus, Ohio, and Cleveland, among other secondary and tertiary cities. While earlier urban revitalization attempts focused on convention centers and sports stadiums, today’s city planners realize that attracting residents is crucial to attaining a 24/7 downtown.

That’s just one of the many factors creating adaptive reuse opportunities for commercial real estate professionals in markets of all sizes. And today’s investment real estate market provides further incentive. The convergence of low interest rates, plentiful capital, a ready supply of conversion product, and sky-high prices for new buildings has created an unprecedented opportunity for investors to buy low, add value, and build equity. Those who don’t relish the developer role can find opportunities in consulting and locating adaptive reuse properties for clients.

The Time Is Right

After years of fits and starts, adaptive reuse has come into its own as niche product, mostly as part of a larger urban redevelopment trend. For example, in St. Louis 20 properties have been rehabbed into rental and for-sale units and 31 more are in the process. By year-end 2006, conversions will account for more than 2,100 additional units of downtown housing, according to the Downtown St. Louis 2004 Housing Report. Occupancy rates last year averaged around 80 percent, with newer projects averaging 94 percent.

The outcome is a plus on several fronts. Urban residents earn higher than average area salaries — in Kansas City, $55,800 versus $35,000 — and spend 67 percent more in restaurants and about 50 percent more on cultural activities, according to Claritas research. What attracts them is what they can’t get in the suburbs: the character of older architecture and the “walkable” city experience.

To create the “experience” in secondary markets, city planners are focusing development in particular neighborhoods, encouraging reuse through tax credits, city streetscape and transit improvements, and economic development business districts.

As a result, developers are turning once-vacant buildings into investment properties, tapping into tax credits for equity and financing. In some cases they are taking class B and C office properties off the market, reducing some of those double-digit central business district office vacancy rates. Retail is chasing after new urban rooftops, providing services, restaurants, and night life. In cities where critical residential mass is met, mixed-use developments are on the planning boards, combining adaptive reuse and new construction, bringing hotels, national retailers, and entertainment venues.

In smaller markets, other cultural trends are promoting adaptive reuse. The National Trust for Historic Preservation’s successful Main Street program counts more than 96,000 rehabbed properties in communities of all sizes. Along with raising the profile of adaptive reuse, the Main Street program focuses on creating a self-sustaining mix of housing, retail, entertainment, and businesses.

Along the same lines is the Preserve America program, which has designated 220 towns as Preserve America communities, allowing them to tap into federal money for local historic and cultural site preservation, including adaptive reuse. As part of the cultural tourism trend, these towns focus on attracting visitors who plan vacations around historical and cultural offerings and spend almost $200 more than the average U.S. traveler, according to the National Travel Survey.

The redevelopment of under-used properties into multifamily, retail, and office space is occurring in first-tier, secondary, and tertiary markets nationwide. While these projects provide new opportunities for commercial real estate professionals, they largely depend on local market factors and a broker’s creativity.

Analyzing the Market


In the late 1990s, Todd D. Clarke, CCIM, president of NM Apartments/Cantera Consultants and Advisors in Albuquerque, N.M., was in on the ground floor of the city’s dramatic downtown turnaround. As the real estate consultant on one of the two final teams battling for the right to redevelop Albuquerque’s old high school, his market study determined “that apartments were the highest and best use.”

The two teams presented the city with different approaches. “The other team proposed a mix of uses that made all of the constituents happy: performing arts, retail, YMCA, nonprofit office space, some low-income housing,” Clarke says. “But using CCIM methodologies, we knew we needed to get the highest possible net rents, which at that time were coming only from apartments. The other team offered to buy the building, but the city had to guarantee $30 per-square-foot triple-net rents over 30 years, which had a net present value of $36 million. Our plan asked for the buildings free, $4 million in cash, and a parking structure: total NPV of $11 million.”

After the project’s approval, Clarke conducted additional studies for the developer, architect, lender, and tax credit investors. The project received strong local supportand national attention for its preservation of the school campus — a local landmark — as well as exterior building features such as entryways, windows, and architectural details. In the first phase, on the interior, the developers framed 69 rental lofts from classrooms preserving original maple floors, oak doors, and slate blackboards. Even old hallway lockers were replaced with new ones to provide tenant storage.

The $33 million project included the conversion of four historic buildings to rental and for-sale lofts and office space. The campus revitalization opened up Albuquerque’s new East Downtown neighborhood to redevelopment and includes four new-construction loft projects, as well as restaurants and other retail. For Clarke, the project led to other consulting assignments such as a comprehensive housing study for the Federal National Mortgage Association — and a bit of fame. “When I mention the project, people instantly recognize it, and it’s a great project to have in my deal résumé.”

photo caption: To retain the building's character, the Albuquerque, N.M., high school's original windows were removed and shipped to Chicago for reglazing and restoration.

photos: Paul Kohlman

Going by Your Gut

While market analysis sold the city of Albuquerque on the loft conversion project, that type of in-depth study isn’t always feasible. “Market studies in a town the size of Corvallis are almost meaningless, since comparables would come from markets four to 10 times bigger,” says Gary Feuerstein, a principal of Endex Engineering in Corvallis, Ore. With a partner, Feuerstein has redeveloped several properties in this town of 50,000, most notably an 1887 National Register of Historic Places railroad depot into corporate apartments and meeting space. “An outsidernever would have developed the depot in the same way, simply because they could not understand such an opportunity through available market data,” Feuerstein says.

Feuerstein’s market knowledge is intuitive. “There just is no substitute for living in the same place for 40 years to anticipate what the market might support,” he says. “We understood that Corvallis has a good deal [of demand] for this kind of project. Oregon State University, Hewlett-Packard, CH2MHill Engineers, and several software companies generate considerable above-average traffic.”

While Feuerstein’s gut notions led him to match the property to the market need, sometimes the process is reversed: The demand leads to the property search. Andy Bergfeld, CCIM, owner of Bergfeld Commercial Realty in Tyler, Texas, found a niche to fill by analyzing a local office survey in his town of 100,000.

“Sixty-eight percent was the average occupancy rate for downtown class A offices,” he says. “But when you looked at buildings that had parking, the occupancy rate jumped to 98 percent. If I could offer class A office space with parking, I could lease it easily.”

In other projects, it all goes back to location and the deal’s details. Richard D. Whitney, CCIM, SIOR, principal of Whitney Commercial Real Estate in Asheville, N.C., helped two clients find and renovate an old textile mill into office space. “The industrial market of western North Carolina was hit particularly hard by the recession and the effects of NAFTA,” he says. “We wound up with millions of square feet of vacant industrial product.”

But the particular property that Whitney identified was a “30,000-sf abandoned loom facility — a brick building built like a bomb shelter — on about five acres on the periphery of the Biltmore Village historical shopping district.” Along with its good location, the property’s reuse is freeing up more than an acre of land that “has been carved out debt free and is being marketed as a land lease or build-to-suit opportunity."

Looking for Good Bones

Finding the right properties for adaptive reuse is half the battle, Bergfeld says. The property he finally bought with two partners is on Tyler’s Main Street, about a block south of downtown. He drove by the building numerous times without considering it because he assumed the empty lot next to it belonged to an adjacent building. In addition, the building was “really ugly,” he says.

The town’s main furniture store in the 1930s, the 2.5-story building had been covered with wide aluminum siding and “no money had gone into the store for a long time,” he says. Since the store was made up of showrooms, the big open spaces held few structural surprises and made the interior renovation easier. “It’s a well-built building that I knew I could do something with,” he says.

Feuerstein agrees that a solid structure is critical. Of his dozen or so adaptive reuse projects in Corvallis, most have converted industrial to office, multifamily, or retail. “We like properties that are not understood by the mainstream, but with good bones and turnaround potential,” he says. He and his partner purchase and manage their properties, relying on their engineering skills. “Since we have the capabilities to design the space, we can offer preliminary planning for the space at very little cost to tenants. This is a better way to keep tenant options open until a lease is in place,” he says.

While the rapid pace of adaptive reuse projects in some markets makes the process look easy, it often requires patience and creative thinking. “The biggest stumbling block is the unknowns,” says Whitney, whose clients faced petroleum contamination and asbestos in the Asheville textile mill renovation. “We also determined that the floor elevation changed two feet in the 300-foot length of the building. One of our challenges was dealing with the Federal Emergency Management Agency, because our floor is eight inches below the flood plain. There are restrictions on how much money we can put into the building without having to take extraordinary measures to comply with current FEMA regulations.”

photo caption: The brick refacing of this former 1930s furniture store facade and details such as a wrought-iron balcony added value and increased the building's leasing potential.

photos: Bergfeld Commercial Realty

Realizing Profit Potential
In a climate where new product prices are out of reach for some investors, adaptive reuse can provide good returns for those willing to take the risk. Whitney’s clients bought their building for about $28.85 psf and put in $25 psf in improvements. “If they sell the project fully leased at a 10 percent capitalization rate, their $1.6 million investment will be worth $3.3 million,” he says.

The renovation of Feuerstein’s railway depot “cost about 80 percent of the cost of new construction and could not be matched in character,” he says. Although no adaptive reuse project is typical, shell rehabilitation can cost $10 psf to $50 psf and tenant buildout can run $30 psf to $80 psf, he says. “Most tenants can take advantage of the old commercial or industrial finishes,” he says, saving significantly on interior finish costs.

“Most renovations, even up to class A space, still are less costly than new construction and we pass savings on to our tenants,” Feuerstein says. “Our occupancy rate overall has been above 90 percent for the past few years, including the apartment portion.”

And good tenants increase the buildings’ value, Feuerstein adds. “It’s not uncommon to see building values go from $40 psf to $100 psf when a good tenant moves in. We see the most significant value increases two to three years later when the appraisals acknowledge that the buildings have become viable, stable commercial projects. Escalation of 15 percent per year for a few years is not uncommon.”

When turning his furniture store into offices, Bergfeld added value through substantial cosmetic changes. He ripped out the half-story mezzanine and gave the first-floor spaces 15-foot ceilings. The second floor has a street-side balcony and a domed roof where ceiling heights range from 10 feet to 17 feet. He also retained the interior’s oak floors and pine beams. Outside he refaced the façade in brick, with detailing to make the building look historic. “I wanted to retain the charm of an 1880s building in a southern town,” he says. The main-floor entrances are French doors topped by arches, and the upstairs balcony is detailed wrought iron.

Bergfeld’s past experience as an office-leasing specialist helped him design the space to attract local tenants. The two floors are divided by central hallways with about 3,400 sf on either side. He kept the common areas small, installed period reproduction fixtures, and can drop in walls or leave the space open. He has leased out half of the second floor to a law firm and is negotiating with a tenant interested in the entire first floor.

For building redevelopers, adaptive reuse is a bit of a passion — but a practical one. Feuerstein now is developing two more corporate apartm ents in another historic structure: an 1892 classroom building that was moved from the Oregon State campus to land adjacent to the depot. “We think the next two apartments will expand our ability to accommodate late arrivals, maybe even boost the overall occupancy rate.”

“Adaptive reuse is something I enjoy,” Bergfeld says. “I bought [the furniture store] at an 8.5 percent cap rate and I created a building that couldn’t be built for what the rehab cost. Cap rates are so much lower now than when I started in real estate. You have to get creative and build value into the building. The rehab represents a greater risk, but the return will be higher.”

photo caption: Corvallis, Ore.'s 5,000-sf 1887 train depot was converted into well-appointed corporate apartments that appeal to professionals on temporary work assignments in the area.

photo: Endex Engineering

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