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Commercial Department: Q&A: K.C. Conway, chief economist, CCIM Institute: October 2018

 

Q&A: K.C. Conway, chief economist, CCIM Institute

Adaptive reuse surges in response to market dynamics

Vacant land is increasingly scarce and land prices are becoming more expensive in many metro areas throughout the U.S. These are two factors fueling growth in adaptive-reuse projects that involve commercial real estate investors turning older properties into newer, more economically viable ones by changing their primary use.

A report released this past third quarter by the CCIM Institute and the Alabama Center for Real Estate estimated that adaptive-reuse projects comprise between 1 percent and 2 percent of the U.S. commercial real estate market, a share that could double in the next five years and make adaptive reuse a larger property segment than established noncore sectors like self-storage. CCIM Institute Chief Economist K.C. Conway spoke with Scotsman Guide about this emerging market for commercial mortgage brokers and their clients.

How do you define adaptive reuse and why should mortgage brokers care about it?

First, [it involves] an existing building. You can expand it, you can renovate it, but you’re starting with some sort of an existing structure. Two, it always involves some sort of functional or economic problem or obsolescence. You could have a warehouse today, [and] if it’s not really high-clearance, 30- to 40-foot [doors], you can’t do e-commerce and put conveyor systems in. Economic obsolescence is something that’s external to the property — an industry left or the (local) economy deteriorated. It’s something the property owner doesn’t control.

The third really key differentiator in our definition is that it has to involve a change of use, so just re-tenanting or modernizing an old office building … is not adaptive reuse. You’ve got to put the thinking cap on and figure out, “What do I do with this thing?” Can I take an old church and make it into lots of apartments? Can I take a mall that has sailed and make it into an e-commerce warehouse?

What are the major factors influencing this trend?

No. 1, we have this trend back to the city from the suburbs. [Millennials] don’t want congestion. They don’t want commutes. … The second big driver is what’s happening in e-commerce and retail. A lot of this adaptive reuse is going to come from [the problem of] what do we do with suburban malls that go empty? What do we do with big-box retail stores? We’re looking at the banking industry that’s really in a contractionary mode. What do you do with closed branch banks?

Cities are aligned to cooperate and to be more flexible in how to redeploy these assets. We have a new generation coming into the workforce that wants to be more urban than suburban, which means a lot more pressure and demand on urban assets. And most cities don’t have large swaths of land left anymore, so you’re going to have to take and work with something existing there.

Are developers running into local-government roadblocks that make these deals harder to complete?

We literally interviewed dozens of developers that have actually tackled projects, and I’d say about two-thirds, three-fourths got them successfully over the (finish) line. Probably another one quarter gave up in the process. What they found out is [that] most people in planning, zoning and city management, they’ve never had a course in adaptive reuse. This wasn’t around when they went through their collegiate career or graduate schooling.

There are a lot of variables that intimidate them. So, one of the things we want to do is highlight the range of things that can happen in adaptive reuse, open their mind to it, and also highlight those cities that have been pretty progressive.

How are lenders responding to adaptive reuse, and what should brokers expect when they seek financing?

The lenders are deer in the headlights on this. They’re struggling. The regulatory environment has been the biggest problem because bank regulators … created this provision called HVCRE — high-volatility commercial real estate. It said, if you make one of these [loans], we’re going make you hold 50 percent more capital than you normally would.

[Lenders] got some relief in a new congressional bill that was passed earlier this year. They reduced the penalty from 50 percent to 30 percent additional capital. But when people try to tackle these adaptive-reuse (projects), the regulators have kind of taken the position of this [involves] a construction loan. If it’s a renovation or rehab loan, it doesn’t get treated as HVCRE, so it doesn’t have the capital penalty, and the banks would be more disposed to do it. 

K.C. Conway is chief economist of the CCIM Institute and director of research and corporate engagement for the Alabama Center for Real Estate (ACRE) at the University of Alabama’s Culverhouse College of Business. As a commercial real estate industry speaker, his presentations have accurately forecasted real estate trends and changing market conditions across the U.S. He is a recognized subject-matter expert on valuation, ports and logistics, housing economics, senior housing, bank regulations and real estate finance. Reach Conway at (205) 348-0188 or kcconway@culverhouse.ua.edu.


 

Neil Pierson is editor in chief of Scotsman Guide Media. Reach him at neilp@scotsmanguide.com or (800) 297-6061.

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