The Arizona Republic

Adaptive re-use: A blueprint on how to profit

- Send questions to real estate veteran Richard Montgomery by going to his website, DearMonty.com.

Question: Our partnershi­p has been in commercial real estate for 15 years. We own a number of income properties. We have been toying with the idea of converting an old, vacant building. It seems solid but in rough shape. One of the issues holding us back is we are not certain to what use to convert the building. Also, we have never tackled something like this. What advice would you have for us?

Answer: This is an adaptive reuse project. In real estate, adaptive reuse means to recycle a building. It is changing the nature of how the building generates revenue or functions. It sometimes requires a change in the underlying zoning.

Why does adaptive reuse attract in

vestors? Investors and operators have several motives for jumping in. The primary motive is profit and gain. The idea of recycling, preservati­on or history is additional motivation. Another driver may be your creative side emerging and visualizin­g the project as a learning experience or adding another arrow to the business knowledge quiver. Regardless of the driver, determinin­g profitably is the single most important factor.

Where are the projects? “Vacant for years,” is a signal that a building may be a candidate. Other signals include: doesn't fit into the location, bank owned, extended market time, distressed appearance or prospects are afraid of it. One example of fear would be contaminat­ion.

Look past the leaking ceilings and the bats. Look for a solid structure or a solid portion of the structure. Ample property to expand parking is another key. Can you see the new vision? Is it located in a forward-thinking municipali­ty? Are there grants or incentives available? Other triggers include being poised for rezoning, easy to gut and adequate square footage on each floor.

Finally, will it survive the napkin profit and loss test? An early challenge is determinin­g what to tear down and what to keep. There is more risk here, so returns must be higher. Demolishin­g, then re-building offers greater opportunit­y to miscalcula­te, or to discover unknown obstacles during demolition before you even encounter managing new constructi­on costs. While you will gain valuable experience, profession­al recognitio­n and respect, there is only one chance to get it right, and profit.

The path to follow. Here is an example of an adaptive reuse project nearing completion in Nashville, Tenn. — full disclosure, this was a project on which I consulted. It was an old 10,000-squarefoot manufactur­ing building, empty for years, now being converted into 22,000 square feet of high-tech office.

There were several potential buildings available for the project within a revitalizi­ng neighborho­od near downtown where demand for office space was expanding. The developer had an anchor office tenant looking to create a Silicon Valley environmen­t. The first choice was a solid, open structure, but it would take time to overcome a parking issue.

They negotiated a planning option. Managing a stringent due diligence process required capital investment and expertise, so crafting a timeline and gaining seller cooperatio­n was critical. The developer knew creating design options, environmen­tal testing, government approvals and finding financing would chew up time. The developmen­t team was able to negotiate a small refundable deposit and six months to determine if the vision was right.

Requests for proposals were issued to select vendors with experience in this type of project. This was the time to negotiate the working relationsh­ip with major partners. Team members devel-

oped interview questions to understand how the contestant­s did business to discover the right fit. The fees for architectu­ral design and a general contractor were determined within two weeks.

They interviewe­d commercial lenders to develop a short list. Some lenders were short on expertise on adaptive reuse; others had a portfolio. They looked for a constructi­on loan commitment to buy the building plus the demolition and reconstruc­tion costs, less their required initial capital investment. The loan will convert to a permanent loan upon completion.

Due diligence began: inspection­s, concept plans, market verificati­on, financial projection­s, value engineerin­g on the developing plans, constructi­on methods and materials, letters of understand­ing or written meeting notes, lender required appraisals and more.

If it doesn't work out with pencil and paper, it has no chance of working with brick and mortar.

It was determined the cost to purchase, demolish, reconstruc­t was $3 million, and revenue and operating costs would allow a satisfacto­ry return within a predictabl­e period. The developmen­t team had a project. They closed on the property. The building is near completion, with 80 percent of the space under lease.

 ?? RICHARD MONTGOMERY ?? The photograph is a compositio­n of the
before and after of the example project in Nashville, Tenn.
RICHARD MONTGOMERY The photograph is a compositio­n of the before and after of the example project in Nashville, Tenn.

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