Is Adaptive Reuse Right for You?
Mark Twain once advised, “Buy land — they’re not making it anymore.” That’s not true about buildings, but owners, developers and investors nonetheless can see impressive profits by buying existing buildings for repurposing instead of starting from scratch. Such “adaptive reuse” is rapidly gaining ground, but you need to weigh some factors before taking the leap.
Move toward adaptive reuse
Adaptive reuse refers to more than merely refreshing a tired mall or retenanting an office building. It involves adapting an existing building for an entirely different purpose than the one it was originally intended for, without demolition. For example, think of converting an industrial building to mixed use, a hotel to office space, retail to multifamily or a furniture store to an urgent care center.
The driving forces behind the upswing in adaptive reuse are numerous, including:
- The shrinking supply of undeveloped land,
- Changing demographics,
- Land use trends, and
- The evolution of retail from brick-and-mortar stores to online.
Municipalities are increasingly open to the concept because of lost sales and property tax revenue caused by these trends. Some, like Los Angeles, have developed incentive programs that loosen the rules regarding zoning, density, parking and accessibility, as well as building code requirements.
Moreover, the competition for older existing properties is less intense, leading to reduced purchase prices. The projects come with lower materials and labor costs than new construction and generally reach completion faster. Older structures often have superior materials, such as stone, too. And adaptive reuse projects may qualify for federal Opportunity Zone tax breaks if located in distressed areas.
Historic buildings are appealing to some potential tenants and could be eligible for federal Historic Tax Credits (HTCs). To qualify for HTCs, a building generally must:
- Have been substantially rehabilitated,
- Placed in service before the rehab began,
- Be a certified historic structure, and
- Be eligible to be depreciated, or, if in lieu of being depreciated, amortized.
With respect to the credit, “substantially” means that within the applicable period — typically 24 months although possibly 60 months — the rehab costs exceed the greater of the building’s adjusted basis at the beginning of the period, or $5,000. For a building to be depreciable, it typically must be income-producing or used in a trade or business.
The HTC program provides credits, equal to 20% of qualified rehabilitation expenditures, that owners can use to offset federal tax liability on a dollar-for-dollar basis, prorated over five years. In addition, some states offer historic tax credits.
Factors to weigh
Not every piece of existing property makes a strong candidate for adaptive reuse. Typically, projects target properties that are in disrepair, have high vacancy rates or aren’t at their highest and best use. You also must consider the relevant market conditions, including demographics, density, and retail and manufacturing trends.
The feasibility study for an adaptive reuse project should be more rigorous than normal, taking a close look at both economic and legal feasibility. Among other things, you should evaluate location, area needs, zoning, land use and other restrictions, incentives, safety, and accessibility.
In addition, you’ll need to review the existing property’s condition (from the foundations to plumbing, electrical, HVAC and other systems), as well as lingering issues from previous uses (for example, environmental problems, easements and historical preservation restrictions). Finally, you’ll want to conduct a comprehensive financial analysis.
Get the buy-in
Market conditions and economic feasibility are critical, but don’t overlook the importance of securing community support, particularly if you’ll need to obtain approval from a local governing body. Get the community on board early, through town halls or other meetings. Addressing concerns and explaining benefits may help preempt opposition that causes delays.
For additional information contact Nick Sarinelli, CPA, CFE or Doug Collins, CPA on (973) 298-8500 or visit our real estate services page.