Opportunity: Converting office spaces into multifamily housing
With an estimated 24% of U.S. office buildings expected to be vacant by 2026, the real estate market faces a transformative opportunity. Developers are increasingly eyeing opportunities to convert vacant office buildings to potential multifamily housing units to address the projected 4.3 million residential unit deficit by 2035. This change not only responds to a growing need for housing but also uses underused properties as remote and hybrid workstyles continue to dominate the workplace. However, such conversions come with unique risk management and insurance challenges. This guide provides a comprehensive overview of such challenges and offers best-in-class risk mitigation techniques.
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Understanding the risk landscape
Identifying the “Right” opportunity
- Commercial real estate as prime multi-family conversion Targets: Office spaces, in particular, present a significant opportunity for multi-family conversions. It’s essential to conduct thorough due diligence on adaptive use projects to navigate site complexities and deal complexities effectively.
- Comprehensive assessment: A detailed understanding of factors such as deferred maintenance, physical damage, revenue streams (if any), easements and zoning restrictions is crucial. This level of granularity enables you and your brokers to accurately assess coverage needs and identify unique project requirements.
- Financing and insurance collaboration: Financing partners may have specific insurance or indemnification requirements tailored to the proposed rehabilitation. Collaborate with your chosen partners to develop practical solutions that are commercially viable and suited to the project's needs.
Structural risks
- Building code compliance: Office buildings that are turned into homes must follow different building codes and standards than a typical new construction project. This includes fire safety, accessibility and ventilation requirements, which can significantly differ from commercial real estate standards.
- Structural modifications: Reinforcing structural elements to support new load requirements and accommodating residential infrastructure, such as plumbing and electrical systems, can pose significant challenges.
Regulatory risks
- Zoning laws: Navigating zoning regulations is crucial. Converting office spaces to residential use often requires zoning changes or special permits, which can delay projects and increase costs.
- Environmental regulations: Addressing environmental issues, such as asbestos removal or soil contamination, is crucial to meeting residential safety standards.
Insurance challenges
- Coverage gaps: Standard office insurance policies don’t cover the unique risks associated with residential properties. Ensuring adequate coverage during and after a conversion is critical. Additional types of insurance coverage may also become necessary based on a building’s use and occupancy.
- Builder’s risk insurance: Conversions require specialized Builder’s Risk policies that cover the specific risks during the construction phase as well as the current shell of the building.
- Liability concerns: Increased liability risks arise from potential construction defects, resident injuries and third-party property damage. Partnering with a broker who understands the need for comprehensive liability insurance tailored to these new risks is essential.
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Best-in-class risk mitigation techniques
Pre-conversion planning
- Detailed feasibility studies: Conduct thorough feasibility studies to assess the structural integrity of the building, zoning requirements and potential environmental hazards.
- Stakeholder collaboration: Engage with architects, engineers, insurance brokers and legal advisors early in the planning stage to ensure all aspects of the conversion are addressed.
- Climate change and operational Loss Resilience: Find out if it’s possible to make buildings more resilient to climate change and other loss risks during construction. This includes flood barriers, hurricane-resistant glass, leak detection systems, or fire protection. Residential insurers are keen on protective measures made to protect physical assets and human life.
During conversion
- Routine inspections and audits: Implement routine inspections to ensure compliance with building codes and standards. Regular audits help identify and mitigate risks quickly.
- Comprehensive builder’s risk policies: Tailor Builder’s Risk insurance to cover all phases of the conversion, including unforeseen delays, cost overruns, and specific construction risks.
- Keep insurers abreast with high-level overviews: Insurers recognize that conversions may deviate from original plans. Keeping insurers informed of any material project changes, delays, or enhancements can ensure that the appropriate coverage is in place.
Post-conversion strategies
- Post-conversion risk assessment & risk control strategy: Conduct an in-depth assessment of the repurposed asset to identify new exposures that result from the change in occupancy and usage (e.g., addition of amenities) and implement a comprehensive risk control strategy to address the identified risks.
- Tenant safety and security: Implement robust security measures, such as surveillance systems, secure entry points and emergency response plans, to ensure resident safety.
- Ongoing maintenance and management: Establish a proactive maintenance schedule to address potential issues before they escalate.
- Third party risk transfer: Any third-party interaction, such as leasing units to tenants or subcontracting for maintenance, repairs or other services, results in exposure to certain risks. Ensure that a standardized contractual risk transfer process is in place to minimize exposure, and to shift the risk of loss to the responsible party.
Customized insurance program: Regular updates to insurance coverage as occupancy and building use change are crucial. Working with a broker with deep expertise in residential real estate is critical to ensure that the appropriate coverage is in place and that all avenues are explored to keep insurance costs as low as possible.
Conclusion
Converting commercial real estate, particularly office spaces, into multifamily housing presents a unique opportunity to revitalize underused properties and meet the growing demand for residential units. By knowing the risks and using the best ways to reduce them, developers can handle the complex changes well and get the right insurance and pay the best prices.
WTW’s team of experts are here to support our clients every step of the way, providing tailored risk management solutions to ensure project success.
Disclaimer
Willis Towers Watson hopes you found the general information provided in this publication informative and helpful. The information contained herein is not intended to constitute legal or other professional advice and should not be relied upon in lieu of consultation with your own legal advisors. In the event you would like more information regarding your insurance coverage, please do not hesitate to reach out to us. In North America, Willis Towers Watson offers insurance products through licensed entities, including Willis Towers Watson Northeast, Inc. (in the United States) and Willis Canada Inc. (in Canada).
