How to Conduct Due Diligence on an Adaptive Reuse Project
Adaptive reuse refers to the process of taking an existing building or structure originally designed for one purpose and adapting it so that it can be used for another. The goal is to breathe new life into old buildings. Adaptive reuse promotes environmental, cultural and economic sustainability, and is an alternative to new construction, particularly in densely developed urban environments. The concept is simple — but the process is a lot more complex.
Adapting an existing building for alternative uses requires a developer’s vision and a focused assessment of the obstacles and opportunities, which differ from those of new, ground-up construction projects or turnkey buildings for sale. Each property that needs to be adapted carries unique risks and potential rewards that require detailed investigation and planning, so it is critical to devise a comprehensive development plan to transform the property.
“The guiding light for adaptive reuse of an existing building is to determine what conditions exist, what changes are required, and what obstacles must be overcome to enable the building to be used as intended.”
Each step must be carefully evaluated to confirm that the desired transformation from its current use can be achieved, using an investigation and planning process referred to as “due diligence.’’
What is Investigative Due Diligence for Adaptive Reuse?
Though described as a process, the term “due diligence” in fact refers to a standard of conduct. It means that the investigation must be undertaken with the degree of diligence due under the circumstances of a particular project. Unlike ground-up development, where a developer and its architect can start with a clean slate to design a new building to desired specifications, adapting an existing building for a new use requires a focused investigation into all conditions that currently exist within the building. A viable plan can then be devised to repurpose what exists to accommodate the desired new use.
When adapting an existing building — particularly if the structure is old or functionally obsolete, or if it was occupied by an industrial user with operations implicating environmental concerns — the property must be investigated even more thoroughly.
Some questions to consider as part of the adaptive reuse due diligence process include:
- Are existing load-bearing walls structurally sound and will their location conflict with the intended interior layout?
- Are existing elevators and electrical, plumbing, HVAC and telecommunication systems adequate and functional? If not, what is required to upgrade or replace these systems to satisfy the needs of intended users?
- Are there existing environmental concerns, such as asbestos, abandoned wiring or lead plumbing, or any other legacy or environmental concerns that must be remediated?
- Do zoning or private land-use restrictions exist that may interfere with the intended new use?
- Are the roof and foundation in good repair and adequate?
- Are the current requirements of the Americans with Disabilities Act satisfied?
- Is parking and loading access sufficient?
- Are there building code violations that must be corrected?
The time frame for conducting a due diligence investigation for adaptive reuse depends upon the size and the complexity of the project. For many ventures, a timeline of 90 to 180 days may be sufficient, but if governmental approvals are required, the time frame will likely need to be extended to correspond to the local governmental approval process.
Conducting due diligence typically requires a team of professionals collectively possessing expertise in all aspects of material concern. In most circumstances, the due diligence team will include: a general contractor; an architect; a structural engineer; an interior designer; an environmental consultant; a financial consultant; and a marketing consultant or broker with knowledge of the marketplace. It will also involve one or more attorneys experienced in evaluating title and survey, land use and other redevelopment issues, including negotiating economic incentives with governmental authorities, if applicable. Depending upon the specific criteria of the development, other specialists may be appropriate. Typically, either the developer or its development counsel will be responsible for coordinating the due diligence team and the process.
Steps for Conducting the Due Diligence Investigation
As with all development, when conducting an investigation for adaptive reuse, there are four general areas of concern that need to be investigated.
- Market demand.
All issues pertinent to achieving a successful adaptive reuse of property fall within these four broad areas of concern and must be diligently investigated and comprehensively answered before project construction commences. There is no simple formula for evaluating the scope or the intensity of investigation into each of the four areas of concern. Each project carries its own set of issues and concerns, and so it must be assessed on its own merits. The guiding light for adaptive reuse of an existing building is to determine what conditions exist; what changes are required; and what obstacles must be overcome to enable the building to be used as intended.
Market demand is the most fundamental of all due diligence concerns for adaptive reuse of commercial, multifamily, industrial or mixed-use property. A building may appear perfectly suited for the use a developer envisions, but it’s important to know that there will be adequate demand once the project is completed.
This seems like an obvious requirement, but some developers seem to approach development with a “build it and they will come” mentality. In fact, they will come only if there is adequate demand. A marketing consultant or experienced real estate broker with relevant knowledge of the marketplace may be an appropriate professional to help you assess market demand.
Assuming adequate demand, can target customers or users get to and from the property with ease? An analysis must be made of existing or proposed roads and highways serving the project, traffic flow, driving time, availability of parking for project consumers, loading areas for delivery trucks, availability of public transportation, pedestrian traffic and other factors that may affect accessibility for consumers and users.
A traffic engineer could help to address many access issues; an architect should be able to assess and plan for compliance with the Americans with Disabilities Act; and a real estate attorney can determine access easement rights. Access to Wi-Fi connectivity, fiber optics or other means of digital information accessibility may need to be investigated by appropriate telecommunications professionals.
Can the property, once adapted to a new use, be used as intended? Consideration must be given to zoning and private land-use controls, availability of utilities, existing easements and leases, environmental concerns, structural issues and design limitations, capacity limits, the roof, windows, wiring, plumbing, foundation, HVAC mechanicals, required licensing and other factors that may affect or prevent the intended use.
Professionals such as civil engineers, structural engineers, qualified environmental consultants, land use attorneys and property condition assessment consultants and engineers may be necessary to investigate and understand issues impacting use.
Within the area of finances, a developer must consider both the hard and the soft costs of acquiring and adapting the building, as well as the cost of equity and of debt financing compared with the expected revenue stream to be generated by the project. “Hard costs” are the tangible brick and mortar costs directly related to physical construction. “Soft costs” are project costs other than hard costs for items such as architectural and engineering design, project planning, inspections, permit fees, loan fees, taxes , accounting, legal and costs and expenses for other similar intangibles not directly related to the physical construction of the project.
Challenges discovered during the due diligence process can significantly impact the overall cost of the project. Most environmental concerns and structural concerns, and many access concerns, can be fixed but it will cost money. How will these added costs affect the overall budget and economic viability of the project?
To offset these additional costs, a developer should determine the availability of tax credits or government-funded development incentives. These may commonly include tax increment financing (TIF), sales tax revenue sharing, real estate tax abatements, historic preservation tax credits, and other development incentives from government funding sources. An experienced development attorney can help ascertain whether a project qualifies for governmental development incentives and assist in negotiating economic incentives for the project.
Adaptive reuse can be rewarding, but care must be taken to become aware of all the challenges and obstacles, and to find cost-effective solutions before the project moves forward. Since the process can be expensive and time consuming, proceeding without caution can be financially catastrophic.