Buildings of Future Past: Adaptive Reuse in Construction

Why are old power plants and churches quietly becoming the hottest spots in town?

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Adaptive reuse has often been used for economic regeneration, environmental sustainability and historic preservation. More recently, economic necessity has driven a surge in adaptive reuse — increased office vacancy rates and "dead malls" are providing a supply of structures to reuse, while housing shortages are driving reuse demand. Historically, these conversions were often constrained by zoning and other regulations, but policy makers have been giving increasingly affirmative support, opening up the potential pipeline even more.

Multiple projections estimate that 90% of real estate growth within the next 10 years will entail the adaptive reuse of existing buildings rather than new construction.

In this white paper, we explore:

Kinds of adaptive reuse
Potential benefits and drivers of adaptive reuse
Mitigating risk and overcoming barriers to adaptive reuse
Adaptive reuse as an AEC market niche
Navigating insurance challenges and underwriting considerations

Kinds of adaptive reuse

Adaptive reuse falls into one of four categories:

Renovation. Changing a building's interior to suit a new use, while making only minor changes to the exterior.

Integration. Keeping the interior in place while building a new shell around the structure — essentially the opposite of renovation.

Preservation. Maintaining the architectural features of an existing structure while updating building systems to meet current codes, improve efficiency, and accommodate new uses.

Facadism. Keeping the "street feel" of an historic structure or city block while replacing everything behind the facade.

Potential benefits and drivers of adaptive reuse

Adaptive reuse has many benefits and drivers. Here are key ones to consider and some real-life examples to help you envision them in action.

Economic regeneration

Adaptive reuse may foster economic growth, sustainability and community revitalization by creating jobs, increasing property values, qualifying for government incentives and more.

Economic regeneration in action

A 1912 coal-fired power plant in Savannah, Georgia was converted into a luxury hotel at a cost of $375 million. It features many elements original to the power plant — the developers placed a private dining area at the bottom of the old smokestack and left some of the original controls and switches in the lobby walls. The lobby also features a veritable natural history museum.

Outside the plant, the Savannah River Walk has been extended to the boundaries of the old plant to anchor an entertainment district that features outdoor markets and numerous restaurants and shops.

Environmental sustainability

The National Bureau of Economics reported that conversions have about 75% less embodied carbon than new construction. A balanced approach to sustainability that considers cost and environmental impact is crucial.¹

Environmental sustainability in action

To achieve the full environmental benefits of adaptive reuse, designers must carefully select new systems that are compatible with the overall development goals. For instance, inefficient old windows can be replaced with modern insulated window systems that address solar heat loads — but if the project requires keeping a historic facade, these windows may need special detailing. In almost every case, however, existing heating, ventilation and air conditioning (HVAC) systems can be substituted for the original HVAC systems.

A holistic approach to sustainability is required where cost is balanced with the overall environmental impact. The construction sectors of the UK and Canada give high priority to environmental, social and governance (ESG) initiatives, with ESG scores mandatory for all major projects.

In the US, most government-owned buildings must meet certain sustainability ratings, such as LEED certification or ENERGY STAR® ratings. Many tenants also look for such ratings when selecting leased spaces, and many private owners seek such certifications for their own use. However, because LEED standards were developed with new building in mind, LEED certification can be a challenge with adaptive reuse, and careful planning is required to ensure a reused building gets the certification it deserves.

Historic preservation and reduced urban sprawl

Older structures may be eligible for historic preservation tax credits, and conveniently, these structures may create more desirable dwelling units and hotels because they often have operable windows and architectural character that provide a boutique experience. Another benefit to adaptive reuse is that such structures are usually located in dense areas, so reuse prevents urban sprawl.

Historic preservation in action

A major technology company's 450,000-square-foot multilevel office space in Los Angeles is housed within a historic hangar where aircraft was manufactured. What was once a 750-foot-long wooden hangar now houses offices, conference rooms, a fitness and wellness center, a large event space and cafes — all while preserving the hangar's historical exterior and seamlessly blending the original architecture with modern elements to create a unique environment.

Historic preservation serves many purposes, such as maintaining cultural heritage.

Cost savings

While labor costs are often higher, materials costs tend to be lower as many of the existing building features remain in place.

Cost savings in action

In cases where only light work is required, it can lead to significant time savings as there's no need to excavate and pour foundations, and structural work can be vastly reduced. However, there are bigger risks of financial overruns from the discovery of hazardous and differing site conditions.

Economic necessity

Cultural shifts such as an increase in hybrid work arrangements may make buildings obsolete, leaving landlords and lenders with low-performing or non-performing assets and forcing building owners to convert old office buildings into new uses.

In the second quarter of 2024, Washington D.C. office vacancies reached a new high of 22.4%² and in San Francisco vacancies have risen to 37%,³ according to data from CBRE. With little relief in sight, building owners have increasingly converted old office buildings into new uses — especially residential and hospitality spaces.

Economic necessity in action

According to RentCafe, the number of apartments scheduled for conversion from old office spaces in the US has increased from 12,100 to 55,300 from 2021 to 2024.⁴ Such buildings may have been vacant, historical or industrial spaces or blighted properties that require environmental cleanup to make them livable.

The rate of such conversions is accelerating rapidly. Before 2023, about 40 office buildings a year nationwide were converted into multifamily housing and other uses, but in 2023, that number jumped to 100 — a 150% increase, according to a recent analysis by CoStar and CBRE.

The National Bureau of Economic research estimates that about 11% of office buildings in the US are physically suitable for conversion to residential uses, and we expect the number of conversions will grow until the office market stabilizes or individual markets run out of suitable conversion.

Mitigating risk and overcoming barriers to adaptive reuse

With all the benefits to adaptive reuse, there are still many barriers.

Regulatory barriers

Real estate developers are familiar with zoning and other challenges to development, but adaptive reuse may require even greater zoning changes, driving up costs and time and resources.

Change can be concerning for communities, as repurposed buildings carrying out new functions can disrupt historical identity.

Take action. To address regulatory barriers, developers should align adaptive reuse projects with local government and community needs, such as unmet housing needs, economic revitalization and the project's impact on traffic and education.

Addressing community concerns and gaining community trust through open dialogue can be even more essential for such projects than it is on other projects.

Adaptive reuse almost always requires the developer to bring the project up to building codes, so make sure you're working with local code officials.

Local governments barriers are a unique subset of regulatory barriers. For example, in January 2023, the City of New York issued its Office Adaptive Reuse Study.⁵ This study provided 11 recommendations to promote adaptive reuse, including:

Making buildings constructed before December 31, 1990 eligible for the most flexible regulations for conversion to residential use
Expanding conversion regulations to all office districts
Permitting conversion to different housing types, such as supportive housing
Providing financial incentives to promote conversion to economically infeasible uses, such as affordable housing and childcare facilities

Less flexibility

On a new structure, the architect can design to meet the owner's program with only a few physical constraints — often imposed by zoning and other regulatory requirements. With adaptive reuse, the architect is constrained by the existing structure. With integration, this constraint is less of an issue than with renovation because the design can expand beyond the existing building perimeter.

Take action

Perform a feasibility study to evaluate the potential for adaptive reuse, considering factors such as cost, regulatory constraints and market demand.
Use modern technology, such as building information modeling (BIM), to plan and visualize the integration of new elements into the existing structure.
Develop a flexible design that can accommodate the existing structure's limitations while meeting the new use requirements. This design may involve creative solutions to spatial constraints and structural challenges.

Parking

Many historic buildings were built with insufficient parking for modern use, which can seriously impact the attractiveness and value of the adapted property to prospective tenants.

Take action. To overcome this challenge, developers may want to look to adjacent properties that can be connected to the reused project.

As a general rule, parking garages are an eyesore, and the overall project may gain community support if the facade of an existing parking garage is modified to match the reused building's facade as part of the overall project.

Financial constraints

Office conversions also must contend with financial constraints in the form of acquisition costs and interest rates.

Take action. As office vacancies persist, acquisition costs should fall. This relationship is particularly true with respect to Class B or C office buildings that tend to have higher vacancy rates and lower rents, making a conversion more economically enticing.

Project financing and tax incentives

Project financing is challenging because of uncertainties such as discovering hazardous materials or needing specialty subcontractors, which can lead to delays and cost overruns, coupled with higher maintenance costs for traditional structures compared to new construction, making it harder for lenders to justify funding based on projected profits.

Take action. Partnering benefits new developers by helping to make financial underwriters more comfortable and more likely to extend financing; and experienced developers may expand their reach by accessing capital and other relevant experience (for example with local authorities).

Reduce the risks of unknowns by having an environmental survey performed on the site to locate as many hazardous materials as possible and perform limited demolition in areas to identify potential problems.

Shift risk back to contractor and consider whether the seller will make this a condition of the developer's obligation to buy the structure to be reused.

Consider government incentives meant to provide support for adaptive reuse, including:

Historic tax credits. Architects, engineers and developers in the US tend to target buildings that are typically at least 50 years old, as these structures may qualify for tax credits tied to the reuse of historical properties. Certified historic structures are entitled to a 20% federal tax credit.

Energy efficient tax deductions. Adaptive Use Projects that achieve certain energy efficiencies are also entitled to tax deductions calculated as between $0.50 and $1.00 per square foot depending on the savings from a retrofit, according to the IRS.⁶

Tax abatement for affordable housing. Many states and localities offer tax and other incentives for construction of affordable housing. While these incentives are usually offset with rent restrictions, they can make the project more financially viable.

Grant funding. Grants are also available for some projects. These grants typically involve historic properties but can include affordable housing and other projects.

Hazardous materials and asbestos. Older projects are likely to be contaminated with lead paint, polychlorinated biphenyls (PCBs), asbestos and other hazardous materials. All historic projects are likely to feature some form of underground storage tanks. These environmental risks create several barriers to financing.

First is the inherent risk that the new developer will become a potentially responsible party (PRP) under Superfund and other environmental legislation. These risks can be handled through normal means of contractual risk transfer and the right kinds of insurance, but there's a cost.
The second risk is to project financing. We're familiar with a project on a military installation where all known asbestos was abated. After the contractor demolished the building, however, asbestos was detected in a mastic that had been applied between the concrete masonry unit (CMU) structure and the brick facade. This discovery caused an immediate cessation of all work and the need to implement a new abatement plan.

Excessive change orders

Once you start to peel the onion on an existing structure, there's no telling what you may find — rotted beams or columns, hidden rooms or decayed bricks. These surprises often result in the need for large change orders that lenders may not be willing to finance. Developers of these projects should have as much contingency as they can get in their financing agreements and should have access to additional equity to address such risks.

Adaptive reuse as an AEC market niche

Architects and engineers can't rely on existing as-built plans due to their absence or outdated nature. Therefore, it's recommended to use modern technology to map out spaces and create virtual models. Contractors, especially those involved in historic renovations, must be familiar with traditional building techniques and seek specialty subcontractors for trades like stone masonry and slate roofing. Estimating time and costs can be challenging due to the rarity of these trades.

Experienced architect, engineer and construction (AEC) teams are beneficial as they know where to look for potential issues, such as inadequate plumbing or unexpected structural elements, which can lead to additional costs and time. These challenges create market opportunities for seasoned professionals in adaptive reuse projects. High-rise renovations in cities such as San Francisco, Chicago and New York are particularly challenging due to structural complexities, presenting significant opportunities for knowledgeable contractors in this specialized field.

Navigating insurance challenges and underwriting considerations

To manage adaptive reuse projects, it's vital to have the right broker who understands and seeks out the risks involved. Gallagher has worked on many such projects, turning old mills into apartments, adapting power plants to new uses and working on historic structures. The coverage is available in the market, so the key is understanding how best to mitigate the inherent risks associated with these projects.

Two key coverages include:

Business risk: Adaptive reuse projects may face claims under builders' risk and environmental coverages. While obtaining a business risk policy may be similar to new construction, many insurers limit coverage to 36 months, with extensions being costly and difficult. Environmental coverage is crucial due to potential issues like hidden mold, lead paint or asbestos in older buildings.

Professional liability: We've seen issues with professional liability insurance on adaptive reuse projects. Inadequate investigation can lead to design claims, and construction managers must also be concerned about professional claims on such projects.

In conclusion

Adaptive reuse is a forward-thinking approach that breathes new life into existing buildings by repurposing them for contemporary needs. This method not only enhances the built environment but also addresses practical and cultural demands, making it increasingly relevant for future developments.

At Gallagher, we have extensive expertise in adaptive reuse projects and prioritize early engagement with our clients during the due diligence and planning phases. This proactive approach helps identify and mitigate unique risks from the outset, ensuring a smoother process through to project closeout. If you're considering an adaptive reuse project, we invite you to connect with one of our specialists to explore how we can assist you.

Sources

¹Gupta, Arpit et al. "Converting Brown Offices To Green Apartments," National Bureau of Economic Research, Aug 2023. PDF file.

²"San Francisco Office Figures Q3 2024," CBRE, 1 Oct 2024.

³"Washington DC Office Figures Q3 2024," CBRE, 8 Oct 2024.

⁴Neculae, Andreea. "From Boardrooms to Bedrooms: A Record 55K Office-to-Apartment Conversions Expected in Major Cities," RentCafe, 11 Mar 2024.

⁵"New York City Office Adaptive Reuse Study," New York Planning Office Adaptive Reuse Task Force, Jan 2023. PDF file.

⁶"Energy Efficient Commercial Buildings Deduction," IRS, updated 19 Jul 2024.

Disclaimer

The information contained herein is offered as insurance Industry guidance and provided as an overview of current market risks and available coverages and is intended for discussion purposes only. This publication is not intended to offer legal advice or client-specific risk management advice. Any description of insurance coverages is not meant to interpret specific coverages that your company may already have in place or that may be generally available. General insurance descriptions contained herein do not include complete Insurance policy definitions, terms, and/or conditions, and should not be relied on for coverage interpretation. Actual insurance policies must always be consulted for full coverage details and analysis. Insurance brokerage and related services provided by Arthur J. Gallagher Risk Management Services, LLC. (License Nos. 100292093 and/or 0D69293).