Adaptive Reuse: Repositioning Commercial Real Estate for Today's Markets

By Jeff Bennett

There are very few times when the collision of forces in the business, financial, political, and social worlds generates benefits for everyone. But for owners of urban area real estate, this is one of those times.

The owners of many of our cities' original signature buildings are at a decision point concerning their buildings' future. These assets are aging. Many are underperforming financially. New fire and earthquake regulations make renovation challenging. At the same time, the market reflects the current insatiable appetite for living, working, and recreating in core urban areas that did not even exist five years ago. Renovation money is plentiful in the private sector and through public programs. Political will favors, and in some locales encourages, rebuilding our urban centers and generating a sustainable urban economy.

Enter stage right — the new real estate notion of "adaptive reuse." In this article we examine how owners evaluate their assets in order to reposition or reinvent their real estate in response to this business opportunity.

Evaluating the Asset

Owners analyze five key areas in deciding whether to update and maintain the status quo, renovate and reposition, or demolish and start anew: physical condition, lease constraints, anticipated market conditions, regulatory climate, and financial factors.

The physical analysis is straightforward. We examine the building structure and the condition of its utility delivery systems. Adequate support infrastructure like access, utilities, and technology is critical. As with all real estate, location drives everything.

Current lease constraints are often the most significant hurdle in implementing adaptive reuse. Lease terms may expire after the date targeted for opening the renovated facility. Early termination rights seldom favor the landlord. Relocation rights are usually available, but relocation space may not be. Adaptive reuse can sometimes be meshed with a tenant's own plans to expand or modify operations.

Because markets in evolving economies can be extremely time-sensitive, the market analysis examines projected conditions on the probable reopening date. Market trends for the various postrenovation uses are studied, as are emerging and declining tenant sectors. Finally, issues affecting stability of the local economy must be identified and vetted.

The regulatory analysis will examine compliance with zoning and environmental requirements related to the existing building and proposed new uses. We must identify a city's openness to make regulatory changes required to accommodate the owner's proposed project ideas. Some projects embraced by one jurisdiction may be politically infeasible in another.

Finally, a financial analysis will examine restrictions in current loan documents; the cost of new construction and permanent financing; potential partner/investor opportunities; tenant buyout costs; the potential for litigation from exiting tenants; the availability of nonconventional financing (e.g., brownfields projects and economic development fund resources); and the availability of state, regional, and local incentives (e.g., tax abatement) that may make the project financially feasible.

Once this initial analysis is complete, the owner will be in a better position to decide whether adaptive reuse is an option for its building.

Developing the Adaptive Reuse Strategy

Adaptive reuse means change, and the change is usually dramatic. A retail building like the old Meier & Frank store is transformed into a mixed-use project, with retail, office, hotel, and residential uses. The old Blitz-Weinhard buildings become the mixed-use epicenter that invigorates the Pearl. But unless a building is vacant or has a limited number of tenants, making an adaptive reuse project work is likely to take years of planning.

The owner needs vision and must have the ability to assess and take risk. It must exhibit an ability to sell that vision to equity investors, lenders, city decision makers, and the marketplace.

If the building is occupied, a plan must be implemented to buy out, relocate, amortize, ride out, or incorporate existing tenancies into the project. If cash flow is needed during the renovation project, any new tenant leases must incorporate language to accommodate the noise and disruption that is certain to occur during construction. Thus, an interim occupancy plan is almost always a component of an adaptive reuse plan.

Selection of the right team is key. Innovative thinking is a must. Negotiating with regulators and achieving needed approvals requires perseverance. Engaging "the right people" may make or break a project — few adaptive reuse projects get done without connections.

There is ample opportunity today for adaptive reuse in our region, not just in Portland.

Milwaukie's downtown is undergoing a revitalization unseen in its history. If the Kellogg Treatment facility south of downtown is decommissioned as part of Clackamas County's ongoing effort to consolidate sewage treatment in its unincorporated area, the Milwaukie redevelopment story will expand in a way that will make the city's downtown area a regional destination. Oregon City is considering a redevelopment proposal for Clackamette Cove. The project will transform an existing gravel-processing facility into a state of the art mixed-use residential, office, and recreation project. Other such projects are located in the historical area of downtown Hillsboro in association with the extension of Westside Light Rail. Owner wisdom and innovation have been and will continue to be the keys to making these projects work.

This article is intended to inform the reader of general legal principles applicable to the subject area. It is not intended to provide legal advice regarding specific problems or circumstances. Readers should consult with competent counsel with regard to specific situations.

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