Due Diligence in Historic Adaptive-Reuse Saves Developers Time and Money
By Caitlin Jones & A. J. Johnson
6 min read
Tax Credit Advisor April, 2006: Performing careful due diligence and budgeting with historic adaptive-reuse projects can save considerable time and money, according to Tom Capp, executive vice president at Madison, Wisc.-based Gorman & Co.
Capp said that even though this approach can be costly, it is worthwhile because it helps a developer to identify, and to plan for, otherwise unexpected discoveries that would occur anyway once the project is underway. A key part of the due-diligence process, he noted, is taking care in selecting which projects to pursue in the first place.
“Instead of grabbing one project out of two, we now take one out of every seven or eight,” Capp said. Even though the due diligence involved can lead to “six-figure” expenditures “we think it’s money well spent,” he added.
Reasons for Due Diligence
Capp, who spoke last month at the National Housing & Rehabilitation Association’s annual meeting in Miami Beach, Fla., said there are several reasons why due diligence has recently become crucial to the planning process for adaptive-reuse projects:
- The recent sharp increase in building expenses. Although all developers have faced increases in building cost, those pursuing adaptive-reuse projects have been especially hard-hit, given the highly specialized materials and building techniques involved. Careful due diligence at the beginning of the process can save big money down the line. “If you don’t plan for it, you can be pretty sure contractors will hit you with a higher price later on,” said Capp.
- The need to anticipate fast-changing environmental and other regulatory standards. Federal, state, and local regulatory standards are changing rapidly, “not just year-to-year, but sometimes multiple times in the course of a one-year project,” he said. Accordingly, it is crucial to quickly identify the resources that must be brought to bear to deal with these changes.
- Pressure from financing authorities and investors to identify prospective costs up front. Capp said that tax credit syndicators and lenders are demanding more detail about building expenses before releasing funding. Housing finance authorities are also asking for more information about costs when developers apply for tax credits.
Examples of Unexpected Expenses
Capp provided a number of examples of unexpected expenses that Gorman has encountered in its adaptive-reuse projects.
Perhaps the best example, he said, was Majestic Loft Apartments, Gorman’s conversion of a 14-story office building into 135 loft apartments in downtown Milwaukee, Wis. During the rehabilitation of this building, the developer was beset by multiple surprises – a hidden elevator, an unexpected public sewer pipe, new environmental regulations that required removal of all windows, and unanticipated lead and asbestos abatement – which resulted in about $600,000 in added expenses. (See Case Study Box, page 15)
In a project in Racine, Wisc., the developer discovered a 12-inch difference in floor height, despite a careful review of building plans. The additional gypsum and labor required to solve the problem resulted in $40,000 in unexpected expenses.
During the adaptive reuse of a hospital, Gorman discovered three separate heating, ventilating, and air conditioning (HVAC) systems installed between the ceilings and floors above – again despite a review of building plans. “Unless you were allowed to rip into the ceiling, nobody would have noticed them,” said Capp.
During the rehab of a high school in Moline, Ill., bird droppings were found throughout the entire building. Capp said that the handling of the droppings cost $110,000, and was even more expensive than removing lead-based painting throughout the project, because a highly-specialized consultant had to be hired to do the job.
Initiating Systematic Due Diligence
Learning from such examples, Gorman has developed a systematic approach to budgeting and due diligence for its historic adaptive-reuse projects.
The first part of the process involves assembling a team, composed of outside consultants as well as members of the firm, to review a prospective rehabilitation. This team should include a least one structural engineer, an environmental consultant, an historic consultant, and the prime architect, said Capp.
Once the team is assembled, all of its members should tour the building together, along with the firm’s construction superintendent, he said. For the first walkthrough, it is also important to include the market analyst.
Each of the team members is provided with a checklist, which is used to generate a report “that is sometimes quite extensive,” said Capp. He added that the firm has begun to schedule a “quick response” meeting on the same day as the tour, followed by a full meeting of the team as soon as all the reports are written.
The initial due diligence should also include a special effort to find and analyze building plans. This includes researching previous owners, searching through local government archives, and working with the State Historic Preservation Office (SHPO), said Capp. A related effort is systematically identifying past renovations.
“We now see the issue [of building plans] as so important that we have staff focused on searching them out, and we don’t accept an answer that there are not any plans,” he said.
This first wave of due diligence is particularly helpful in eliminating prospective projects that Capp describes as “deal stoppers,” ones that are simply too expensive or difficult for the firm to pursue.
“It is often easier for me, the developer, to say of course we can make a project work,” said Capp. “But now we wave off a lot of buildings, whereas in the past I would have committed to them before any analysts had taken a good look.”
Big Ticket Items
Capp said that as the due diligence moves forward, separate teams are established to pursue careful analysis of the cost of a project’s “big ticket” items. One team reviews HVAC systems in the building’s interior. A second team, he said, examines the building’s envelope, including its roof, exterior masonry, replacement brick, and doors, and windows. He noted that special care must be taken in evaluating window expenses, which because of the high cost of repair and SHPO demands can run “into the seven figures.” A third team reviews environmental issues.
Structural analysis of the building is a crucial part of this process – and can help anticipate special construction requirements that can be very costly if they emerge after the planning process, said Capp. For example, developers must keep in mind that the load-bearing requirements for a completed building are sometimes quite different from those required during the construction phase. This happens when heavy machinery must be brought in to pursue a part of the adaptive reuse, and then later removed before construction is completed, he said.
