By K.C. Conway, CRE, MAI, Chief Economist, CCIM Institute
Editor’s note: This article is an excerpt from the 3Q18 Commercial Real Estate Insights report from CCIM Institute and the Alabama Center for Real Estate, which redefines, quantifies, and provides best practice examples of adaptive reuse. To read the full report, visit www.ccim.com/insights.
Adaptive reuse has been garnering headlines for more than a decade, but it’s no longer just about repurposing beautiful historic properties in primary markets to entice millennials. Many less sexy but equally newsworthy projects are starting to appear in secondary and tertiary markets, where investors are searching for yield.
We predict that adaptive reuse projects will make up a greater percentage of investment activity than self-storage and other select non-core property types by 2023. But the commercial real estate industry’s understanding of this property segment isn’t keeping up with this growth. The absence of a generally accepted and comprehensive definition for adaptive reuse real estate impedes investment and development.
That’s why the Alabama Center for Real Estate (ACRE), housed within the Culverhouse College of Business at the University of Alabama, in collaboration with CCIM Institute, is working to quantify and qualify adaptive reuse activity across primary, secondary, and tertiary U.S. markets. Market participants need to understand its impact on metrics such as vacancy and absorption; and debt and equity capital sources need segmented data to underwrite more of these investment opportunities. Capital will not flow to what it can’t measure, monitor, or manage.
To develop a recommended industry definition for adaptive reuse, ACRE and CCIM Institute interviewed a broad cross section of industry participants, including developers, brokers, municipal government leaders, CCIM instructors, Counselors of Real Estate, lenders, and investors. Utilizing their input, we determined that the following elements are necessary for a project to qualify as adaptive reuse:
- Existing structure: While adaptive reuse projects may involve some level of new construction or an expansion/addition of space, they always start with an existing structure.
- Functional and/or economic obsolescence: All adaptive reuse projects commence with a property in a state of disrepair, high rate of vacancy, or with highest and best use in transition. In essence, the old use is no longer productive or economically viable, and the tenants have left.
- Change of use: The project/property must involve a repurposing of a prior structure and use, not a mere re-tenanting with tenant improvements.
- Economic viability: The new project/property must pass the ultimate test of highest and best use. Not only does the reuse need to be physically possible and legally permissible; it also has to be economically viable. This final element raises an interesting question about the use of tax credits or other local government incentives. Frequently such incentives are necessary to make a project economically viable due to the cost of assemblage, higher repurposing costs with a greater cost-overrun risk factor than new construction, and speculative lease-up risks. The use of tax credits and incentives does not disqualify a project for adaptive reuse classification.
There are other elements that are common among adaptive reuse projects but not prerequisites for classification. For example, many involve costly rezoning or local ordinance variances. Communities such as Tucson, Ariz., have incentivized adaptive reuse by officially addressing some of these impediments and thus saving developers time and money.
Also, local community support and a local developer or project team are front and center in every large-scale, successful adaptive reuse project that we studied.
In addition, most adaptive reuse projects involve multiple uses, which requires project participants to be skilled in more than one property type, as well as market analysis.
Adaptive reuse projects are typically complex and capital-intensive undertakings that require vision, flexibility, and a diverse project team anchored with local experts. But they can also breathe new life into communities and provide significant returns for investors. With an official definition for adaptive reuse, we can begin to quantify investment activity and further encourage the transformation of cities across the country.
K.C. Conway, CRE, MAI, is CCIM Institute’s chief economist and the director of research and corporate engagement at the Alabama Center for Real Estate (ACRE) housed within the University of Alabama's Culverhouse College of Commerce. Learn more at www.ccim.com/insights.