Due-ing It Right

Why Architects Should Play a Role in the Due Diligence Phase for Developers.

A key consideration for investors in the development industry is the principle of due diligence.  People speak of due diligence with respect to the effort made to review and understand the conditions influencing the opportunities and constraints inherent in a potential development project, be it development on bare land, to development of brownfield sites, to redevelopment of existing buildings for new uses.

This due diligence will commonly manifest in a review of the property ownership status of the building, a review of any liens or encumbrances that may be attached to the property title, environmental site assessments intended to reveal the risks associated with previous owners or uses of the property, a preliminary building inspection/walk through, and so on. Many developers, having made such a preliminary review, may believe that they have done all that they could reasonably do to assure themselves of the risks and constraints inherent in a site in which they may have an interest.

However, especially in the case of determining the opportunities and constraints of redeveloping existing buildings, architects with a specialty expertise can provide a vital service to the development community with respect to due diligence. In a recent example a developer, having purchased an existing building with main floor commercial space and upper floor residential tenants, for full conversion to commercial office purposes, was surprised to discover several unexpected constraints only after purchase. As it was revealed, due to the significant number of major changes that were required to upgrade the building to current (and minimum) building code life-safety standards, not only was the conversion from one occupancy type to a new occupancy type so expensive as to render the return-on-investment unfeasible, but it was also discovered that the existing tenants had been occupying the building for many years without the local Authority Having Jurisdiction (AHJ) ever having granted an occupancy permit for such use of the facility. The end result was ownership of a building that could not fit the pro-forma for conversion into new uses, and eviction of the existing rent-paying tenants on the order of the local building department, as the property had never been authorised for those types of tenant uses. The result: legal issues; tenant issues; building department issues; loss of revenue; diminishment of the initial investment; additional costs; and considerable stress for all involved.

In another recent instance, an owner/developer had purchased a light-duty industrial occupancy building for conversion into office and mercantile uses. After purchase, the intended conversion of the building to new uses triggered a rezoning application, which then triggered a significant increase in expensive parking requirements for the site (which the owner believed were superfluous to the concept as the new building occupants did not actually require any additional parking for their uses). In addition to the zoning/parking issue, which was eventually resolved at a variance hearing with a compromise where the local AHJ accepted installation of a smaller number of now unused parking spaces, the change of use from one occupancy class to another again triggered significant code-related upgrades that had been unanticipated by the owner, and which required substantial additional investment.

Avoidable Problems

In each case, the new owners were surprised to encounter significant costs and impediments to the profitable use of their new buildings, even though they had completed, in their estimation, sufficient “due diligence” prior to acquisition of the property.

In the case of an institutional investor, with access to a significant portfolio of past projects and experience, or with sufficient capital to invest in professional architectural and engineering expertise, these examples may seem to be a case, albeit an extreme one, of “buyer beware.”  However, especially for the small-scale investor, this flaw in the due diligence process can be the difference between success and significant financial loss.

So, what can be done to protect oneself from such additional building-related occupancy surprises ahead of time? The case can be made that architects can play an important role in assuring that additional due diligence concerns can be answered and addressed, which can allow for greater confidence that the prospective real estate development proposition will find success.

Architects, especially those with a specialization in the development field, can be of significant benefit to prospective developers, either large scale or small scale, by providing a reasonable, often fixed-fee service, in reviewing the existing building’s code deficiencies with respect to change of occupancy or use. This service is related to the work typically provided in order to obtain a detailed facility condition report of an existing building but can be tailored to the proposed intended re-use. The degree of changes needed to convert a building from one occupancy type to another is highly dependent on both the occupancy classification of the existing building, but also on the intended use of the building in the future. In some cases, the proposed changes may be so profound the developer would be urged to revise their plans to minimize needed changes, reconsider the change of use proposition, or even be suggested that a different building might be more appropriate for the intended use.

In the case of review of the existing occupancies of the building, many jurisdictions have publicly searchable records of occupancy. While the information is generally available to anyone with a computer, it is not readily available unless one already knows that it exists and how to find it. Architects already working in this industry will be knowledgeable about such sources and can provide reporting to the owner of the implications of the information revealed in the research.

The benefit for prospective building owners in engaging an architect for this type of due diligence research is that the developer can proceed with greater understanding of the inherent constraints of their project. The result could improve the potential return-on-investment by identifying additional impediments, constraints, and opportunities, long ahead of time.

Investors undertake the due diligence process largely on the principle that knowing the constraints of a project will allow for the owner to plan to mitigate those constraints. Eliminating the potential for future profit-draining surprises is the purpose of the due-diligence exercise, so it stands to reason that owners should consider engaging an architect for specially-focused architectural services, just as they do lawyers, environmental assessment engineers, and so on in the due diligence phase, for the purpose of clarifying the opportunities and constraints inherent in their redevelopment projects.


Kyle A. Lewkowich, MAA, MRAIC, is an architect and Senior Project Leader with the Government of Manitoba, as well as a principal at Magpie Architecture and Design.

This article was written with contributions by Jason Robbins, MAA, MRAIC, principal, JC Robbins Architecture.

 

 

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