Tip of the Month - December, 2018

Structural Changes & Changes in Use-Adaptive Use

Source: Principles of Real Estate Management (15thEdition)
              Institute of Real Estate Management (IREM)

Rehabilitation and modernization can lengthen the economic life of a property.  Rehabilitation is the process of renewing the equipment and materials in the building. It entails correcting deferred maintenance.  Modernization (correcting functional obsolescence) is inherent in the rehabilitation process. To make the property competitive, similar equipment of more modern design will replace the original equipment.  New carpeting, upgraded electrical service, equipment that is more energy efficient, or any other physical improvement that does not affect the use of the property can be rehabilitative. The list of possibilities in this arena is virtually endless.  When a real estate manager proposes physical changes, the management plan must include an expense budget and/or a capital budget showing the allocation of funds for the changes and the anticipated impact on NOL (net operating income), cash flow, and property value.  The owner may also require an analysis of debt service (if the funds are borrowed) and cash flow.

A recommendation to change the use of a property must be well founded.  Such a procedure is complex, expensive and therefore not usual.  However, the rewards of a successful change in use are often substantial.  Once a change of use is implemented, reverting to the original condition is difficult.  The property owner and manager must always carefully weigh the anticipated improvement in performance expected from a change in use against the risks of that change.  The most common changes include adaptive use, condominium conversion, and demolition for new development.

Adaptive use: is a way to reduce development costs, convert
obsolete property to meet new market demands, preserve historical architecture, or revive a location that is not achieving its highest and best use.  A recycled building many not achieve the same rent per square foot as a new one, but the start up costs are lower and the debt service requirements are usually less.

This web page was updated on 12/01/2018.