Commercial conversions – making the most of your assets

Alan Pemberton, managing partner at building and property consultancy Tuffin Ferraby Taylor LLP, looks at the growing trend for converting empty commercial property in to residential units

The commercial property market is currently in a situation where there is a surfeit of central office space, yet at the same time the residential market is clambering to fill the void left by a shortage of affordable housing. This situation is now leading some of the biggest players in the commercial sector to look at the benefits and opportunities of putting a finger into the residential pie.

In the previous recession, we saw that the property slump halved the value of office buildings, leading to many owners and developers converting their out-of-date and out-of-favour stock into upmarket residential accommodation.

This time round it is not the top end of the residential market that is proving enticing, but the middle and bottom end where demand continues to be high and the Government continues to encourage spending. In line with this, a number of the big institutional investors have begun converting unwanted commercial units into residential offerings.

Significantly, these are groups who in the past have steered clear of investing in anything other than offices, retail and industrial buildings. The attraction now for moving into residential is that they are able to hand over the management of the property to the housing associations, whilst retaining the freehold for valuable assets.

Competition for commercial tenants is tough and occupiers’ requirements are being led by increased standards in everything from sustainability to technology. Updating an aging office block to be able to compete at the rental levels secured by modern, high tech office blocks is an extremely expensive process and a cost that will take a long time to recoup.

No matter what situation the housing market is in, prime real estate is always highly sought after. This time around, the significant lack of affordable housing on the market also seems to be a force in the fuelling demand for residential conversions.

The financial incentives for converting from commercial to residential can be extremely enticing to a property owner that has ‘dead stock’ in their portfolio. For a start, it provides landlords with the opportunity to reduce the market rent void, but beyond this it also opens the opportunity to releasing capital by selling units to private buyers, whilst still retaining the freehold for the building.

For large investors the appeal is not just about finding a solution for the stock already on their books. With large amounts of money ready to be spent, they are able to maximise their return on investment by acquiring disused property at the bottom end of its value and take advantage of competitive tendering for the repair and conversion work.

Office conversions, for whatever market and in any economic environment, represent a useful means of recycling redundant property. This is a model that has been heavily adopted in the US where it has proved highly successful.

It is not just a move in to the residential market that could be considered. A number of the leading budget hotel operators have made public their plans for expansion and are constantly looking for new central sites. With an existing layout of modular units coming off of long corridors, a large multi-storey office block may well prove to have a layout that lends itself to conversion.

Feasibility
It is fair to say that not every property owner or manager will be keen to make the jump from commercial to residential. Equally it is true that not every property will lend itself to conversion in a cost effective manner.
For anyone considering this option, it is important to make sure that a feasibility study is carried out before investing too much time and money. A detailed survey of the building will help you to gauge what the practical limitations are and whether or not the building is structurally suitable for residential use.

We have seen from examples, such as the circular Rotunda building in Birmingham, that feasibility is not so much about the shape of the building but more about the original construction. With creative architects and effective space planning, anything is possible. In the case of the Rotunda building, architects managed to work with the space they had to create wedge shaped apartments. This quirky approach coupled with the building’s iconic appearance make for very desirable residential property.

Unlike in previous property slumps, one of the key factors driving conversions to commercial property this time around is the prospect of funding from government sources to develop affordable housing. The Homes and Communities Agency (HCA) is currently looking at a potential funding model to encourage the commercial sector to provide much needed housing that is required in many of the UK’s cities.
This model of involving institutional investors in affordable housing is seen as being able to provide a boost to the affordable housing market without ‘commercial landlords’ needing to get bogged down in the nitty gritty of becoming a residential landlord. By employing housing associations to handle the management of converted buildings, the investor is pumping finance into the sector and benefiting from the security of regular rental income. There is also the potential for the properties to be disposed of into the affordable sector once institutions have realised their yields.

From an investment point of view a mixed occupancy property can allow for the investor to recoup some of the costs of conversion by being able to sell off higher spec units to private buyers at an atractive premium.

Sustainability
Reusing existing stock is arguably the most sustainable form of property development. To make a conversion as sustainable as possible it is important to retain as much of the original structure and fabric as possible.

Yet old buildings, in general, are the worse polluters and converting them provides investors with the opportunity to increase the worth of a property by installing energy saving technology. Carrying out this work in a sustainable manner can also increase the future flexibility of the building by enabling further conversion at a later date to be done in a cost effective manner.

One of the biggest lessons to be learned from this recent recession and property slump is that it pays to be flexible. Utilising building stock to make the most of market changes and new opportunities for income can add an extra commercial element to traditionally commercial property players, even if it does mean laying the foundations for a move into the demanding yet profitable, residential market.

To contact Alan Pemberton, tel: 0121 644 4000 or email: apemberton@tftconultants.com