By Keenan Ordon-Bakalian, AttorneyThis article was originally published in the August 21, 2020 edition of the Daily Journal of Commerce Oregon.
In a matter of months, the coronavirus outbreak has fundamentally impacted the commercial real estate (CRE) landscape. Foremost, COVID-19 remains a humanitarian and public health crisis. Companies across the Pacific Northwest have moved quickly to safeguard their employees and transition to new ways of conducting business.
Across various industries, leaders will use the lessons learned during this pandemic to reimagine the nature of their businesses and the role that offices and commercial space will play. Within the CRE industry, it has become apparent that merely adapting to variable conditions will not be sufficient. COVID-19 has led to a mass exodus of traditional tenants and a significant decrease in leasing activity expected in the near future. Creatively repositioning existing properties will be essential for the industry to weather the coronavirus storm and be well situated to capitalize on future growth opportunities.
Many existing properties are ripe for repurposing, including hotels. A new survey of American Hotel & Lodging Association (AHLA) members shows the pandemic continues to have a devastating effect on the hotel industry and its employees. In response to an AHLA survey published on July 29, over half of the respondents said their hotels are in danger of falling into foreclosure, and only 37% of respondents said they had enough business to bring back at least half of their employees. Because there will be significant lag time for the hospitality industry to return to normal, hotels are prime to be repurposed into healthcare facilities or affordable housing, due to existing infrastructure and having many individual rooms.
Retail space, however, remains the sector of the CRE industry where developers, brokers, architects, and end users can implement some of the most creative repositioning strategies. A recent report from Coresight Research predicts that as many as 25,000 U.S. stores will close in 2020. Even before the coronavirus outbreak, suburban malls were experiencing store-rationalization trends with reduced shopper traffic and closures. Coronavirus shutdowns may represent a turning point for this sector of the industry.
Boutique retail spaces are expected to remain resilient and emerge from COVID-19 with new or existing tenants in place. However, big-box retail and larger assets face the prospect of repositioning their spaces in order to ensure continued viability. Large retail space has a variety of repurposed uses, including being converted into centralized culinary hubs for the growing “digital restaurant” industry. Repurposing large retail spaces into kitchens and delivery points for multiple restaurants will allow CRE to meet the online food delivery industry’s growing need for space. Alternatively, the large square footage of these retail spaces is also conducive to social distancing and these spaces may lend themselves to office collaboration centers where employees can work safely.
Big-box retail can also be reinvented to serve multiple purposes at once. These properties can maintain their retail character in front, while repurposing the back portion of the space to serve as distribution centers or warehouses for e-commerce. This would allow shopping centers to remain viable while not losing their character of use. Suburban shopping centers are also well positioned to recapture parking areas as outside space for restaurants to facilitate socially distant dining.
Underperforming retail sites also have the potential to be repurposed as last-mile warehouses, because of their close proximity to population centers and existing infrastructure improvements. Specifically, many big-box retail spaces have multiple access points and loading docks, which allows for an efficient transition to industrial use. Retail-to-industrial conversions have accelerated. According to CBRE Group, in the past three years, 13.8M SF of retail space has been converted to 15.5M SF of industrial space. This trend is likely to continue because of coronavirus and the ongoing consumer transition from brick and mortar to online shopping.
Even as Oregon moves forward with incremental reopening, it has become apparent that things will not return to the way they once were. The time for developers to act is now. Brainstorming adaptive reuse projects is one thing, but it takes time to put these projects into effect. The regulatory structure of a specific jurisdiction can dictate the duration of a project, which can take months or even years, with highly regulated environments creating challenges along the way. Proactively engaging with both the planning and economic development departments of the local jurisdiction can help developers roadmap prospective repurposing projects and establish community support.
Adaptive reuse projects are not without their hurdles. Converting a property from one use to another doesn't always require a zoning change, but when it does, it can take anywhere from two months to a year or more. Additionally, developers also need to remain cognizant that their new vision for a property may be drastically different from the current use. Shopping centers may have existing tenants with long leases or tenants that own their spaces outright. Negotiating with these tenants can draw out a repurposing project and create barriers to obtaining approvals, especially if existing tenants are opposed to the new development plans.
Developers also need to remain alert for structural deficiencies and ensure there is a plan in place to address them, prior to commencing a repurposing project. Conversions of older buildings may require unanticipated work that can result in change orders, cost increases, and even wholesale design changes. Taking an active role in the due diligence phase, in conjunction with design professionals, can help guard against these issues.
There is some good news for developers. Due to COVID-19, jurisdictions are more open to ensuring the CRE economy gets back on track. As jurisdictions search for creative ways to maintain their tax base, support jobs, and revitalize their local economies, adaptive reuse projects are far more appealing to cities than seeing buildings remain vacant.
Keenan Ordon-Bakalian is an attorney in the Jordan Ramis PC land use and development practice group. Contact him at Keenan.firstname.lastname@example.org.