The real estate landscape has undergone a significant transformation in recent years. Property owners and operators are exploring innovative ways to repurpose their assets. From changing mall storefronts into entertainment centers to converting empty office suites into cannabis dispensaries, the opportunities are diverse.
Interest in transforming aging hotels, for example, into residential spaces continues to soar, with an anticipated surge of 63% in overall upcoming conversion projects. Several Midwest cities including St. Louis, Kansas City and Minneapolis made the top 10 for most buildings converted to apartments in 2022.
Austin Smith, Hub International
(Photo courtesy of Hub International.)
Four risk considerations in repurposing real estate
With these adaptive reuse opportunities come increased risks that property owners must carefully navigate with flexibility and adaptability. Here are some key considerations for managing risks effectively:
- Know the local codes and zoning laws. Changing the use of a property often requires navigating through complex local codes and zoning laws. Rezoning a building can be a time-consuming and costly process, involving legal fees and renovations to ensure compliance. Older facilities may present additional code challenges, making it crucial for property owners to assess the feasibility of repurposing within existing regulatory frameworks first before committing.
- Be aware of building ordinance upgrades. Renovations and upgrades may trigger the need for compliance with any recent local ordinance changes. Building owners must be prepared to incorporate necessary upgrades, such as sprinkler systems or wheelchair access, to meet updated building ordinances. Understanding the requirements and properly budgeting to adhere to these new ordinances is essential. While there is additional cost for upgrading fire protection such as sprinkler systems, this enhancement can favorably impact underwriting and improve property rates for building owners.
- Understand the established vacancy clause. The vacancy clause in property policies poses a challenge when tenants vacate a space, altering coverage terms and conditions. Obtaining new coverage for a repurposed property with an existing vacancy can be problematic. Property owners must address this clause to ensure continuous coverage. They should work collaboratively with their insurers to identify appropriate solutions, informing them of the timing in which the building will vacate tenants and initiate renovations and construction activity. They also need to make sure that their policy language can accommodate the scope of construction activity planned. In some cases, a separate builders’ risk and liability policy may be relevant to secure proper coverage, while in other cases, insurers may be able to accommodate the work within their current policy language.
- Tread carefully with triple net leases. Large property owners engaging in triple net leases face unique challenges during repurposing, if the tenant is controlling the insurance in place for the asset. Reduced rent in exchange for tenant responsibility for taxes, insurance and utilities means that coverage disappears when a tenant vacates. Property owners must then swiftly secure insurance to address potential risks like vandalism or fire, navigating the complexities of this setup.
Evaluating existing building systems during repurposing
As the purpose of a space evolves, its infrastructure and systems must align with the space’s new and unique needs. Neglecting to evaluate these systems can lead to operational issues and potential liabilities. Consider:
- Fire and life safety systems: Repurposing demands a thorough evaluation of fire and life safety systems beyond sprinklers and alarms. This includes assessing stairwells, emergency evacuation plans and understanding fire hazards specific to the new use. Compliance with safety standards is crucial for ensuring the well-being of occupants, and the operations that resume after repurposing.
- Electrical systems: Different industries will have different power needs. Manufacturing and healthcare facilities, for example, require extensive power with backup solutions. Property owners must ensure that electrical systems can support the operational requirements of the repurposed space.
- Plumbing systems: Repurposed spaces necessitate a thorough examination of plumbing systems, considering materials, pipe life expectancy and occupancy needs. Regular inspections are often required, and compliance with plumbing infrastructure standards is essential for avoiding potential water damage issues.
- Mechanical systems: Strong mechanical systems are essential for addressing air flow and indoor air quality concerns. Ventilation requirements must align with the new business, and adherence to industry-specific mechanical systems codes and standards is imperative.
Navigating a new market
Repurposing real estate presents both opportunities and challenges, requiring careful evaluation of regulatory, structural and insurance considerations. Whether repurposing properties or maintaining existing ones, engaging with an experienced insurance broker is a crucial first step in reducing your risk.
Austin Smith is a senior vice president in commercial risk at international insurance brokerage Hub International out of Grand Rapids, Michigan.