When Commercial Real Estate Goes Residential

The COVID-19 pandemic saw millions of office workers transitioning to working remotely from home. Statistics reveal that more than 4.7 million U.S. workers work at least half of the time remotely.¹  As a result, many businesses have chosen to downsize their offices. According to Politico:
“Pandemic-induced changes in work patterns have taken an especially acute toll on the central business districts of cities—ecosystems that rely on a daily flood of office workers who frequent coffee shops and lunch spots, stop at restaurants and bars after work, and drive public transit ridership.”¹
At the same time, single-family home construction has slowed due to labor shortages and supply chain disruptions. The price of land has increased as well. According to CNBC:
“The U.S. Census found that 12.3 million American households were formed from January 2012 to June 2021, but just 7 million new single-family homes were built during that time.”²
One outcome of these converging circumstances is the current trend of converting empty or underutilized commercial spaces into much-needed housing. However, this concept (called “adaptive reuse”) is broader than just conversion to housing.
To further discuss this topic, first, let’s define some terms.

Investopedia defines commercial real estate as follows:

“Commercial real estate (CRE) is property that is used exclusively for business-related purposes or to provide a workspace rather than as a living space, which would instead constitute residential real estate. Most often, commercial real estate is leased to tenants to conduct income-generating activities. This broad category of real estate can include everything from a single storefront to a huge shopping center.” ³

Online education platform, MasterClass, describes adaptive reuse like this:

“In architecture, adaptive reuse (also called building reuse) refers to the repurposing of an existing structure for new use. For example, converting an old church into a restaurant, an old train station into an office space, or an old windmill into a home. Adaptive reuse architecture breathes new life into historic structures by converting them into something useful for the surrounding area, like low-income housing, student housing, community centers, or mixed-use creative venues. Commercial real estate developers most commonly handle adaptive reuse projects because they have the financial means and construction expertise required to renovate these structures successfully.”⁴

Identification of Properties

A variety of commercial property types are great candidates for adaptive reuse—from converting existing lodgings (like motels) into small apartments for the homeless to turning large-scale shopping malls or big-box stores into residential villages.

One example of the latter is Alderwood Mall, located in Lynwood, WA, a suburb just north of Seattle. In 2020, developers began turning a large portion of the 41-year-old mall into a 300-unit apartment complex named Avalon Alderwood Place. This project is geared to low-to-middle income workers and does not entirely erase the retail side of the development as commercial tenants will take up 90,000 square feet of the property.

Avalon Alderwood Place opened this year (2022) and has become the new anchor of the shopping center. A spokesperson for Brookfield Properties, which owns the property, states:

“This project is a great example of evolution in the shopping center industry. Today, people prefer to live in smaller spaces and want walkable developments rather than relying on vehicular transit. This project caters to these needs.”⁵

With all that being said, identifying suitable candidates for conversion is always a challenge. Many commercial buildings are just not appropriate as residential dwellings. For example, many large office buildings have wide and deep floors and little air and light because they were built for storage—not human occupancy. Shopping malls have many of the same issues as large office buildings, and it may be more practical to tear them down and start over completely.

In contrast, an apartment must have air and light supplied by windows. In addition, each apartment needs its own plumbing and electrical wiring, which often must be rebuilt from scratch. For these reasons, extended-stay hotels work best as conversion candidates.

On the positive side, it is important to note that older commercial office buildings and hotels often have interesting construction details that are hard to duplicate (e.g., high ceilings or intricate or iconic building facades). These architectural details are popular with buyers and renters and add to the property’s overall value.

Rezoning Challenges

Any adaptive reuse project is bound to have legal and regulatory hurdles to jump—especially when zoning regulations prohibit change. For example, a study conducted by the Turner Center at the University of California at Berkeley found that over 40 percent⁶ of commercially-zoned land in the large metro areas of Los Angeles, San Francisco Bay Area, San Diego, and Sacramento prohibit non-commercial uses—thus, preventing thousands of potential residential dwellings in a state where the housing shortage is acute. 

With the goal of helping to alleviate the housing crisis in California, the state’s Department of Housing and Community Development has instituted a program called Project Homekey. This program has provided $800 million to city and county governments to purchase and repurpose existing vacant motels, hotels, dormitories, and assisted living facilities into permanent affordable dwellings. It is projected that over 6,000 new residences will come out of this effort.

An essential step in an adaptive reuse project is understanding zoning. Checking this out first prevents wasting time on a property unavailable for a project like this. If you are interested in a certain property, get online and start researching. Following is a list of actions to take:

• Examine the local area: If you want to rezone a commercial building, check out things like new roads or new buildings. You may be able to use these to your advantage.

• Learn about zoning laws: Knowing local zoning regulations is paramount. These laws can be researched online or at the local planning department.

• Talk to members of the community: There is often some opposition to adaptive reuse projects from neighbors. Engage with them. Keep them informed. Make a good impression. And understand that neighbor pushback will have an impact on the planning department’s decisions.

• Apply for rezoning: Once you have completed the groundwork, fill out the paperwork and submit it to the planning department. Depending on the area, fees will run from hundreds to thousands of dollars.

• Analysis: Once the paperwork is submitted, the planning department will begin investigating the project. Be prepared to respond to any questions that come up.

• Commission Meeting: Your rezoning petition will be made public, and a commission meeting will be held where any member of the public can air their questions and concerns. At this meeting, you will be able to explain your plans.

• Legislative body meeting: The planning department will send its recommendation to a legislative body for a final decision. If your plan is denied, you will have to wait a designated period of time before you can apply again.

Adaptive Reuse Financing

There are two basic categories of developers interested in adaptive reuse:

1. The deep-pocketed investor with the funds to handle the project “in-house” or can obtain traditional financing
2. The mission-oriented developer that needs to find flexible funding

Mission-driven companies strive to make a positive impact on social or environmental issues. While their project must be profitable, they also define success by improving societal conditions that need addressing.

Identifying, deploying, and developing the correct financial tools must be accomplished quickly in order to take advantage of these narrow windows of opportunity. And there is help out there and ways to compete with moneyed investors, especially for smaller projects.

Many cities and states provide incentives that encourage this type of social entrepreneurism,  such as:

• Financial assistance programs
• Not requiring building code variances
• Waving loading and parking requirements
• Expedited project approvals.

There are several benefits of choosing an adaptive reuse project as opposed to a new build.

Cost Savings

Adaptive reuse projects have a positive impact on the bottom line. For example, a 2017 article by Trade & Industry Development states:
“From a cost perspective, a complete building rehabilitation costs about 16 percent less in construction costs and 18 percent less in construction time than new construction.”⁷

Tax Benefits

Adaptive reuse developers may be eligible for the Federal Historic Tax Credit (HTC), which offers up to a 20 percent credit. Once the project is finished, this credit can be claimed at a rate of four percent over a five-year period.

Environmentally Sustainable

Building conversion projects use far fewer construction materials than new construction projects. In addition, the lack of demolition means less heavy machine and energy usage. As a result, adaptive reuse projects leave a smaller carbon footprint.

Developers generally go through similar steps when choosing a good candidate for a conversion project. These steps are as follows:

1. An assessment of the structure’s condition: The condition of the building in question is crucial to the project’s success. Vacant buildings or those needing extensive repair may cost more to renovate than demolish.
2. A cost-benefit analysis: A cost-benefit study compares the cost of renovations to the price of a total tear-down and new construction.
3. Assessing redesign feasibility: Developers typically work with an architect or contractor to help them determine how feasible a redesign is.

When adapting buildings for reuse, some emphasis must be placed on smart home technologies. Intelligent devices are no longer reserved for only the most cutting-edge properties. Dwellings of all types, sizes, and values have embraced smart IoT devices—and people now look for apartments that have existing intelligent tech. This new approach to the multifamily experience encompasses IoT devices that communicate with each other. Smart apartment amenities can include:

• LED lighting systems that allow automation and remote control of the lights.
• Smart outlets that enable tenants to turn wired appliances on and off by a simple tap on their phone or via voice commands.
• Smart thermostats that automatically adjust heating and cooling for optimal performance.

• Various sensors throughout the apartment to detect things like fire/CO, leaks and moisture, when windows and doors are opened or closed, motion, etc.
• Smart locks that allow access to the apartment without requiring a traditional key.
• Voice assistants (such as Alexa and Siri) placed throughout the apartment use artificial intelligence (AI) to play music, update “to-do” and shopping lists, turn lights on and off, and more.
• Smart refrigerators that are able to detect when food supplies run low or are passed their “sell by” dates. The smart fridge can add these items to a shopping list on a voice assistant.

Power over Ethernet (PoE) technology transmits both electrical power and internet data over a single Twisted-pair Ethernet cable. PoE eliminates the need to depend on unreliable WiFi and it removes the need to run electrical wires. More and more developers are turning to PoE lighting systems for their residential apartments.

There are many benefits to PoE:

1. PoE is safe: According to the National Fire Protection Association (NFPA), the third most common cause of fire in dwellings is due to electrical equipment malfunction or faulty wiring.⁸
2. Remote control: A PoE lighting system can be controlled from anywhere.
3. Easy integration: PoE-enabled apartments allow easy integration with existing devices such as the HVAC system and window blinds.
4. PoE is flexible and customizable: With PoE lighting, tenants will be able to adjust the lightning in their apartment to meet their individual needs.
5. Automation: PoE lighting in common areas of the building can be controlled by a set routine that saves money.

Adaptive reuse is an integral part of the development plans for downtown areas in most major cities. Paul Levy, founder, and CEO of Center City Philadelphia, acknowledges that repurposing older commercial buildings is an increasing trend in the U.S. Mr. Levy said:

“That’s been a 20-year phenomenon in most cities; it just becomes more urgent at this moment. I think we know how to do this in downtowns; the conversion of buildings from one use to another is something we’ve been doing across the country.”²

Adaptive reuse allows for change but is still grounded in what currently exists. This innovative approach ensures that resources and land are not wasted and can become a vital part of the future.

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Resources:

1) Politico: Cities with empty offices see new room to expand housing

2) CNBC: America is short more than 5 million homes, and builders can’t make up the difference

3) Investopedia: Commercial Real Estate (CRE)

4) MasterClass: What is Adaptive Reuse Architecture and Why It’s Important

5) Bloomberg cityLab: The Dying Mall’s New Lease on Life: Apartments

6) Turner Center for Housing Innovation – UC Berkley: Residential Development of Commercially Owned Land in California

7) Trade & Industry Development: Embracing Adaptive Reuse for Corporate Real Estate

8) mhtlighting: 5 Advantages to Living in a PoE Smart Building