Presented By: Marks Paneth LLP
Adaptive Reuse is the Future of Commercial Real Estate
A look at how some of the most influential owners and developers are approaching their investments and adapting for the future.
In many ways, the COVID-19 pandemic has accelerated transitions that were already occurring in commercial real estate, such as advances in technology and e-commerce, changed spending habits, shifting interests and preferences of younger generations, remote work, and the growing need for health care.
As such, adapting and repurposing commercial real estate assets to suit new and different needs will be the core focus for investors, owners and operators in the months and years to come. This shift will require visionary thinking and strategic, opportunistic capital investment.
Below are insights into how some of the biggest names in the industry are seizing upon this opportunity to transform the commercial real estate landscape and reshape it to their advantage.
From an investment standpoint, rent collections and financial performance have been surprisingly strong, making multifamily a resilient and highly desired asset class among investors. The COVID-19 pandemic has driven strong asset prices and dynamic location and technology adaptations among developers and owners.
“I think we will see outdated, obsolete assets being repurposed,” said Michael McMahon, executive vice president of portfolio management and director of tax at RXR Realty. “For instance, some of the older Class B office buildings might be ripe for conversion to residential — particularly if that residential includes a rent-stabilized component, as the recently passed NYC Climate Mobilization Act includes an exemption for buildings with rent-stabilized units.”
According to Craig Berger, founder and CEO of Avid Realty Partners: “We are seeing investors and developers shift focus to suburban garden-style apartments, and away from high-density urban locations. Larger apartment sizes are back in favor as we work from home and space fills a more important need.”
Redbrick LMD took a pause during the early months of the shutdown to produce a white paper around post-COVID design changes that would enhance its multifamily buildings under development. Those changes include contactless entry, faster vertical transportation, ultraviolet air, high-efficiency particulate air, other air exchange and flow considerations, and larger units with more balcony and terrace space, said Louis Dubin, a managing partner at Redbrick. “We are positioning these new buildings on the Capital Riverfront with a health and wellness theme,” he added.
Chris Weilminster, executive vice president and chief operating officer of Urban Edge Properties, knows that current market conditions require creativity and flexibility — especially regarding retail space. His real estate investment trust recently transformed a former retail site in New Jersey into a warehouse and distribution facility.
“Knowing that big boxes are increasingly tough to fill, we considered redevelopment as we looked for a replacement tenant — leaving options open for industrial, warehouse or retail,” said Weilminster. “In the end, and with some strategic improvements, we were able to attract the ideal tenant: Triple-A Warehouse, a grocery distribution center that services smaller stores, and will use 20,000 square feet of the space to welcome the public to shop at wholesale prices.”
Weilminster noted that the redevelopment efforts to attract this tenant resulted in a win-win for both Urban Edge and the community: “With this use, we are able to fill the space, as well as bring a valued retail option to residents.”
Prologis has found that conversion opportunities to transform malls and other properties into distribution centers are fewer than expected, and decisions must be made wisely. Its global insights and research team recently published a special report on “The Reality of Retail-to-Logistics Conversions” and noted that restrictive zoning and a lack of truly appropriate space are challenges for retail-to-logistics conversions. “Retail conversions to logistics could amount to 5-10 [million square feet] per year (50-100 MSF over the next decade),” the company wrote.
Jake Bisenius, president and chief information officer of AmCap Inc., said that many towns are still ready and willing to embrace the adaptive reuse of retail space.
“One of the trends we have seen in our suburban shopping centers is the willingness and desire of towns to add more density and walkability,” he said. “We think this trend will continue to pick up with the uptick of people leaving urban cores for the suburbs. We can see some towns wanting to add to their tax base and repurpose parts of our vast parking fields in suburban areas to other uses, like multifamily and last-mile distribution.”
Christopher Conlon, executive vice president and chief operating officer of Acadia Realty Trust, said that, among their suburban assets, direction from retailers is helping identify the property improvements needed to meet the demands of quickly changing retail dynamics. Consumer interest in options, such as “buy online, pick up in store” is accelerating, as is the option to “ship from store.”
“Big name retailers are leading this evolution,” Conlon said. “More space is being allocated to fulfillment — sales floors could shrink. These strategies are still in the early innings, and we look forward to more input from retailers in order to satisfy them through this transformation.”
Many are focused on how to manage the retail sector of real estate, but conversions and adaptations in the hospitality sector are also seeing renewed interest.
Evan Podob, a partner at Scenic Investments, cited a current project as one example of this: an underperforming, extended-stay hotel in upstate New York across from a State University of New York campus, which the developer plans to take through a change-of-use process and redevelop into a Class A, 275-unit, student housing development.
“We have always been focused on the repurposing of real estate,” said Podob. “In this instance, the current use is not maximizing the potential of the underlying real estate. We can create additional value by replacing the existing building with a vibrant student community with amenities for our student users, helping to enhance student life and connections to the school and the community. Our detailed and extensive development process helps us to recognize properties that might have a higher and better use for their future.”
The LCP Group is currently looking at a major hotel in the downtown area of a major city, part of which may be converted to residential work/live units.
“We are exploring this option and believe that it will be feasible because of incentives awarded from the city,” said LCP Group Chairman E. Robert Roskind. “One important issue in this case will be the use of the public space, including excessive meeting space for a hotel that will be half of the size that it was previously. Finding a profitable use for this excess space will increase our return on the investment.”
Bill Edwards, executive vice president of core holdings at Rockefeller Group, said: “We view our restaurant tenants as in-building amenities. We want them to succeed and we’ve been working to help them adapt to all the new and shifting requirements. We have restaurant tenants that have remained open since March — even when they were restricted to take-out. We’re proud of what they’ve been able to do, and we’ve been working with anyone who has asked to accommodate outdoor dining, with three restaurants operating on our plazas right now.”
Rockefeller Group also recently signed a lease with popular Greek restaurant, Avra, in a location that formerly housed a Fidelity Bank; Major League Baseball is nearing completion of its flagship store in a former street-level, television studio at the same address.
“In dynamic cities, the only thing constant is change. These are just two examples of how properties and property owners need to be flexible and willing to adapt to revitalize their properties and, in turn, New York,” Edwards added.
A view of the future
In an environment turned upside down by the pandemic, real estate owners and operators must remain vigilant, forward-thinking and creative. This makes adaptive reuse an intriguing strategy — one which can offer lower costs to acquire investments in high barrier to entry markets; significant cost savings on redevelopment projects; low interest rates on leverage; and potential, future tax incentives offered by federal and municipal governments.
The market’s most savvy investors have taken notice and, as investment strategies shift to accommodate today’s needs and predict tomorrow’s demand, commercial real estate may never look the same.
Michael Hurwitz, partner and REIT group leader at premier accounting, tax and advisory firm Marks Paneth LLP, can be reached at 212.201.2230 or firstname.lastname@example.org.