Adaptive Reuse of Commercial Real Estate: How it Can be Profitable

adaptive reuse

Did you know that the City of Los Angeles is considering implementing adaptive reuse of its existing, underused buildings to create as many as 100,000 units in the future to combat its extreme housing crisis?

The COVID-19 pandemic has accelerated numerous transitions in commercial real estate. Among these, adaptive reuse and sustainability will be the core focus for investors, owners, and operators in the coming years. This methodology requires visionary thinking and strategic and opportunistic capital investment. Adaptive reuse offers a way to breathe new life into abandoned, historic buildings that are replete with opportunities.

Let’s explore the various considerations of this property and also let’s evaluate its profitability through this blog and also check why is adaptive reuse important. 

What is Adaptive Reuse?

Adaptive reuse building is a specific form of redevelopment that in present decades has triggered the revitalization of historic structures around the world. Adaptive reuse definition implies the renovation of an existing structure whose previous purpose becomes outdated or even obsolete. These adaptive reuse projects have made it possible for historic buildings to meet the renewed demand for urban living. Moreover, retrofitting the existing structure with a unique design for new life requires a knowledgeable project team.

This concept of adaptive reuse is related to but still slightly different from a historic preservation or restoration project. 

Why Adaptive Reuse is in demand?

Adaptive reuse has provided a significant source of momentum for the redevelopment of historic urban cores in cities all over the United States. It also provided steady work for architects and other personnel even during the years of the Great Recession. The major reasons behind the demand for adaptive reuse in long term – 

  1. Slows urban sprawl 

When real estate developers search for a new location they may not get as per their choice. Since the city is typically claimed by old buildings or expensive new real estate ventures. Hence, adaptive reuse tends to be a great option for real estate investors to fulfill their dream projects along with adding colors to the cities. This adaptive reuse offers a counter to urban sprawl by restricting the expansion of urban areas.

  1. Environmental Conservation

The fundamentals of environmental conservation are – Reduce, Reuse, and Recycle. This procedure fits the principles well. It reduces the environmental footprint by reducing the use of materials, then reusing the existing buildings, and finally recycling to get a better product. 

  1. Historical Conservation

Adaptive reuse not only allows for the preservation of a part of history but also allows for a showcase of those buildings in the present and also in the future. It’s the bridge connecting the past to the future. A successful adaptive reuse asset class shows the best part of advanced technologies along with innovations. 

What type of business is a good fit for Adaptive Reuse?

The adaptive reuse of old buildings is most popular in small towns and along busy corridors of urban areas. The best suited adaptive reuse projects are for restaurants, retail stores, office buildings, and personal service providers such as salons or cafeterias. These old structures give an aesthetic and vintage look to your business which can complement your innovation. Furthermore, the hot location gives a special advantage by establishing vital relationships with customers and neighbors. 

The pandemic has increased online shopping by 44% in 2020 which represents about 21.3% of the sales made by retail shops. Hence, the rise of eCommerce sales forced the closing of numerous retail stores. 

According to the CCIM Institute, the adaptive reuse of these dead shopping malls and retail stores will be the most impactful trend through 2025 across a major part of California, Florida, Texas, Pennsylvania, and New York. For example, in Los Angeles, Google is repurposing the Westside Pavilion shopping mall into nearly 600,000 square feet of office space. Moreover, the Highland Mall in Austin is an ongoing project of adaptive reuse where it is being transformed into an academic campus for Austin Community College from a retail space. 

Furthermore, hotel properties are also rapidly being reused for alternative uses by both the public and private sectors. For example, California Governor Gavin Newsom has allocated an amount of $1.3 billion for the state to purchase vacant hotels and motels which will be further being utilized as housing and support systems for the homeless. 

Pros and Cons of Adaptive Reuse

According to Think Currituck, in the United States, there are more than “300 billion square feet of buildings that are already built, with opportunities for adaptive reuse ranging from 100 or 1,000 square feet to hundreds of thousands” of square feet in a prime location. This venture has some benefits as follows;

The advantages of Adaptive Reuse

  1. Lower Construction costs – 

One significant advantage of adaptive reuse over traditional real estate investing is that it requires fewer building materials. But it needs more labor thus reducing the construction costs as material costs have skyrocketed in the last few decades. Whereas, the rise in labor costs is affordable. It also forgoes all costly demolition expenses. In terms of economic benefits, adaptive reuse and repositioning of assets can be 16% cheaper in terms of construction costs. Furthermore, if a building is repositioned in a sustainable manner, it also adds to the building’s performance and valuation.

  1. Speeds up the construction – 

Studies suggest that repositioning requires 18% less time in execution. Constructing a new investment property takes significantly longer time than redeveloping an existing structure. Many spaces in remote work may be habitable after only minimal changes. Moreover, adaptive reuse of industrial buildings requires less time than constructing from scratch. And also you don’t have to put the entire building into a pause. Hence, the owner can open parts of the building for business even with an ongoing project.

  1. Optics and sustainability – 

Assets America defines sustainability as a “Characteristic of development that doesn’t sacrifice the ability of future generations to meet their challenges.” Furthermore, one major measure of sustainability is carbon footprint. It also carries enormous environmental conservation too. According to Carl Elefante, “ The greenest building is one that is already built.”

  1. Taxes and Government benefits – 

This methodology also provides certain tax breaks. According to U.S National Park Service, “you can reduce federal and state taxes when completing adaptive reuse of industrial buildings.” The Federal Historic Tax Incentives offer up to 20% tax credit depending on the future of work. Also, it offers a value-add opportunity compared with traditional development. 

  1. Marketing or branding potential – 

It contributes to a business’s personality. Recently, Scenic Investments has planned to reuse an underperforming extended stay hotel in New York, across a SUNY campus to a Class A, 275-unit student housing development. According to them, this current project can create additional value to their potential by replacing the existing building with a vibrant student community with amenities for the students. Hence, through this, they can enhance the student’s life and also create a brand identity. 

The Disadvantage of Adaptive Reuse

Along with several benefits, it does come with some demerits also including:

  1. Lengthy governmental processes – 

Sometimes it becomes lengthy and also costlier due to governmental issues such as permitting, planning, zoning, deriving building codes, etc. Furthermore, let’s explain the cons with an example, in the USA market Uniqlo wanted to make a splash by redeveloping Manhattan’s Soho district. They selected 546 Broadway between Prince and Spring Streets to convert it into a retail space. But for this investment, they were challenged by the permitting process and the building department’s issues. They also had to face various lengthy steps to get beyond the usual requirements for construction. 

  1. Potentially higher construction costs due to various structural issues – 

Sometimes adaptive reuse becomes a problematic issue due to structural constraints. For example, Ibex Construction worked with Greenberg Farrow, the 23rd Street Home Depot. This is a historic building with a 200-foot-long cast-iron facade which is an old infrastructure. According to the president of Ibex, Andy Frankl, they had gone from 100 pounds to 700 pounds for loading on the floors. Taking out the steel structure was problematic for them. 

  1. Hidden Surprises – 

Before you buy a property for adaptive reuse be prepared for everything. Vintage properties often have a century or more dark secrets. Original drawings can mislead you. These properties are often found with hazardous materials, like asbestos and lead paint. Hence, before getting into this sector you must add 10% to 15% to your existing budget for contingencies. 

For example, while retrofitting Forest City’s Stapleton, Denver’s former airport the M.A Mortenson Company has to tear up and recycle 1,100 acres of concrete runways and roads which was nearly two feet thick. They also encountered lots of junk concrete and unplanned pipe, as well as heaps of glycol. Furthermore, the wing deicer a kind of antifreeze had to be processed which seeped through the runways. 

Opportunities in Adaptive Reuse

The opportunities in adaptive reuse depend on the market analysis rather than the supply and demand in the market. Adaptive reuse of office buildings can be profitable in the current trends. But as property uses evolve thanks to e-commerce, AI, evolving retail trends, etc hence identifying prospective tenants for AdRu projects can be complex. 

CRE companies can venture into several adaptive reuse opportunities. These include repositioning any vacant property or mixed-use buildings to rent out to newer tenants or businesses. These include retail buildings being reused and repurposed into mixed-use buildings like collaborative office spaces, multifamily apartments, etc.

Gary Ralston, CCIM, managing partner of Coldwell Banker Commercial Saunders Ralston Dantzler Realty LLC said that more than 25% of current retail space is occupied by non-retail users. And this trend will continue in the coming years thus there is a golden opportunity for AdRu. Furthermore, Ralston also applies a market data analysis tool and economic base analysis tool to illustrate the jobs data in the market. He also discovers rental properties that can grow and come to this sector in the coming years. 

The U.S market is experiencing a boom in adaptive reuse, especially in North America. Due to the rising demand for apartments, condos, and offices in Chicago many investors want to invest in real estate. But since there is a crunch of space the investors are moving to adaptive reuse projects. For example, the Old Post Office offers 2.5 million square feet of office space in the urban areas with the original framework of the century-old building.

With small buildings, developers find it easy to demolish the existing building and reconstruct another one. But with big box store buildings or malls, developers choose to repurpose them without demolishing them. Adaptive reuse of those big size buildings is always a daunting task. The National Association of Retailers conducted a survey where they found 94 different adaptive reuse shopping centers.

We can visualize the breakdown of Adaptive Reuse types through this pie chart. 

Credit for this graphical representation, thanks to the National Organization of Minority Architects for the mentioned data. 

A case study of Adaptive Reuse will illustrate the opportunities more vividly. The Arcade was originally constructed in 1828. It was one of the first enclosed malls in America. It remained to serve as a retail center until 2008 and after that, it was officially closed. It was a business failure. But its charm and historic factors saved it from demolition. About 606 million dollars were invested to reopen this center. The renovation of this project took five long years and in which the historic building was converted into a mixed-use residential building. 

Today, the building serves the local community of Providence Rhode Island by offering much-needed housing in a densely populated area. Moreover, today The Arcade is evolving as a successful hybrid model of commercial as well as residential architecture. 

How to get into adaptive reuse ideas for 2022?

In 2022, the Los Angeles City Council approved an expansion of the ordinance, in which 4,300 apartment conversions are scheduled. As per a recent survey, Los Angeles has converted between 5% and 10% of its 155,000,000 square feet of office space to housing. Furthermore, 4,300 apartments are set to redevelop in 2022. 

Soon, another property Cecil Hotel is going for adaptive reuse. It became famous through Netflix and is planned to be reused as a mixture of hotel and apartment buildings of 290 units. Another future project for 2022 is the stunning Mayer Building which is expected to be retrofitted for creating 79 affordable apartments. Moreover, along with other countries in North America, Chicago is also emerging as a hub for adaptive reuse. It is projected to become a ‘megacity’ within the next decade. Chicago will be home to more than 10 million people and will serve as an economic hub too.

How to recognize the potential of adaptive reuse in commercial real estate in 2022?

While choosing the best property for adaptive reuse into a potential asset, you must consider various factors. These include the location, access to proper onsite parking, and the property’s potential for adaptability.

In addition to this, it is also crucial to seek the local zoning approvals before repositioning an asset. 

Repurposing historic properties for commercial use

Repurposing takes place all across the country but is more prominent in the big cities like New York, Los Angeles, and San Francisco. Below there are a few examples of impressive transformations. 

  1. Emporium in San Francisco: Theater transformed into Arcade

The Emporium in San Francisco is a big retro arcade bar with 44 arcade games and 17 pinball machines, pool, air hockey, skee ball, etc. Moreover, it comes with live music, events, DJs, a movie screen, and a stage with live performances. This building was an abandoned home of the Harding Theater, which originated in 1926 and was repurposed in 2017. When a developer wanted to demolish it the City Council declared it a landmark hence it was transformed. The original structure was maintained but its interior design was refurbished to give a touch of modernity. Furthermore, it was retrofitted into a delightful space for experiencing classic games like Galaga and Dig Dug. 

  1. Google’s LA Headquarters: Airplane Hanger transformed into a workstation

The historic airplane hanger of Los Angeles once owned by Howard Hughes is now transformed into Google’s headquarters. The hanger was used to manufacture the Spruce Goose, a massive aircraft that was intended to be used during World War 2. The place remained abandoned for a couple of years after Spruce Goose left the hanger. This property was then purchased by Google and Google took an adaptive approach. They kept the building’s wooden exterior and retrofitted the interior with concrete and steel to provide a solid structure. Furthermore, they have added multiple stories which further gave a cascade effect with mezzanines that hold the hanger structure. 

  1. AAA Warehouse by Urban Edge Properties: A big-box retail store transformed into a warehouse

Urban Edge Properties has leased a 130,000 square feet warehouse in Lodi, New Jersey. Their real estate investment trust REIT has converted the former big-box retail store into a warehouse and distribution center. The present scenario made a tough situation to fill the big box which convinced them to redevelop the existing structure. AAA warehouse is a grocery distribution center that provides services to smaller stores and convenience stores. It is 20,000 square feet of space and is used to welcome the public and bring a valued retail option to residents.

Risks of Adaptive Reuse

Along with the common threats, there are some hidden threats too which are needed to be identified. The expected risks in adaptive reuse are as follows:

  1. Heating Oil Tanks

While repurposing the buildings during the early part of the 20th-century heating oil tanks were found buried beneath the basements of the existing building. These tanks were often unknown to the tenants and owners due to the age of the buildings. If the building had a boiler system then the presence of oil tanks was possible. As long as the tank has not leaked the reconstruction process could not be done as it is hazardous. Hence, due diligence is crucial before every repurposing.

  1. Clarifiers and Septic system 

It is also quite common to find a clarifier and a septic tank in an old building. These risks are identified by building owners or plumbing plan documentation. It’s crucial to test and sample the soils to assess if hazardous wastes or chemicals were disposed of through the septic tank and whether any leakage has occurred from the clarifiers. 

  1. Lead Paints

Many buildings do have lead paints where the lead content is more than 5,000 parts per million. During removing lead the employer must conduct air monitoring and check the exposure to lead as it causes hazards. 

  1. Mercury Switches

Mercury switches contain liquid mercury and they are often found in older-style thermostats. Due to the toxic risks of mercury exposure mercury switches are considered hazardous waste and should be handled with care.

Due Diligence is a must before Adaptive Reuse Projects

Therefore, due to the following risks before adaptive reuse, due diligence is crucial and it should be performed by professionals with due diligence and engineering expertise. The historic building should have a detailed report of due diligence. It must include the extent of repairs needed and costs associated to make the site viable. The ultimate goal of a due diligence process is to ensure that the team for repurposing is fully informed. And a due diligence report works as the deciding factor in greenlighting a project.

Bottomline

In this present situation when the environment is turned upside down due to the pandemic, real estate investors must remain vigilant and innovative. This approach to becoming innovative makes adaptive reuse an intriguing strategy to offer lower costs to acquire investments and build something completely new. The significant factors of cost savings, low-interest rates on leverage, and potential future tax incentives make adaptive reuse projects a profitable sector of investment.

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