Money Growing: A New Orientation for Real Estate


"The applicability of changing a premises varies depending on its economic efficiency. Lets say, in a given place offices are no longer necessary, and housing is required. It actually changes the market. If you do not make a profit on the property it is necessary to react quickly to the new market conditions and change the function of the property," chairman of the board of Mirax Group Alexei Adikayev says.

The type of building essentially influences its capitalization. "The capitalization of real estate is defined by its location, its functional purpose and its technical condition. The developer/owner has guessed a movement of the market and has had time to reorient - and has raised the capitalization," manager of the department of construction management at CB Richard Ellis/Noble Gibbons Konstantin Ruban says.

However in any case changing the functional purpose of a building usually means working on your mistakes. "A situation where it is necessary to change the purpose of a new building, is more likely a mistake of the developer because it is proof of the rough approach to development. Redevelopment is traditionally necessary, when the building has outlasted its means," director of development at Swiss Realty Group Ilya Shershnev says.

Everything started with industrial zones

As with much in the real estate market, the technology of changing the category of a building came to Russia from the West. “Most of such cases were in Germany, where office real estate was first needed, then hotels, then housing. Accordingly, properties changed their profile,” Adikayev says.

Such transformation cannot be called a particular type of redevelopment as redevelopment assumes much more significant reorganization." To change the function of a premises practically nothing is needed to be preplanned. For example, take out the walls on a floor that has apartments and you will have open space. Place desks and transparent partitions and you have yourself an office. Or make the rooms smaller and you get hotel rooms. The main condition is that the engineering be done in line with the requirements of the building.

In Europe, according to Shershnev, such practice has been normal for a long time. "There this phenomenon has much greater scales. For example, a power station in the center of London became the Tate Modern Museum of Modern Art. I recently stayed in the Scotsman hotel in Edinburgh which had been transformed from a historical building that housed a newspaper's editorial offices," says Shershnev.

The amount of reorganization frequently defines what new purpose an old building will take. "At the moment the most popular variants of re-profiling are factories and warehouses into shopping and office centers. The cause for all of them is a continued misbalance in supply and demand in the specified segments of the market. Besides the structural characteristics of old buildings - the height of the ceilings, columns - in many cases corresponds to the requirements of the market and allows them to be used with minimal investments in new quality. For shopping centers one of the most important things is the characteristics of the site which the building initially possesses," director of the department for assessment and consulting at Colliers International Larissa Afanaseva says.

In connection with active programs on the reorganization of industrial zones the type of re-profiling we most commonly meet on the commercial real estate market is the change of the functional purpose of industrial territories. "As a result of such redevelopment mainly B and B+ office space has come onto the market. For example, in the reorganized territory of Krugozor children's toy factory as a result of the reconstruction of factory buildings a class B business center has been built. The first stage of the project is already ready and the second stage will be completed in the fourth quarter of 2007," deputy head of the department for research and analysis at Praedium Alexander Kadchenko says.

According to him, an example of the creation of a shopping and entertainment complex in the place of an industrial area is located on Savvinskoi Haberezhnaya. "Here an entertainment club will open in the near future. Club Garage currently located at Pushkinskaya will move to the location and will be renamed," the expert says.

The creation of entertainment centers on the territory of industrial zones is atypical, however in Moscow there are already some similar examples. "The fashion recently has become to build entertainment clubs in place of factories. At the Ordzhonkidze factory several workshops have been converted into clubs - De La Guarda and B1 Maximum, and the Arma factory near Kurskaya station has become a cult place after its reconstruction into Gazgolder and Yakut-Gallery," says the director of commercial real estate management and development holding Miele-Real Estate Andrei Bushin.

New tendencies

A change in the function of a building also happens often enough outside industrial territories. “There are examples of the administrative buildings of scientific research institutes located outside the city center, becoming warehouses. A proprietor can take this step because of unsuccessful placement of offices in a property,” says Kadchenko. In particular, one of the office buildings of the Automobile and motorbike scientific research institute, located in the Vodny stadium metro station area, despite being multistorey, has completely become warehouses.

There are also reverse examples. "The construction of office premises on the territory of warehouses is quite common and is foreseen in initial projects. On average the office part makes up about 10% of the territory of the warehouse, but depending on the needs of the tenants can be increased up to even 50%. In any case it is done in advance, or for administrative premises a separate building is provided," Bushin adds.

According to experts, commercial, trading premises often change their function to offices. "There are variants when in trading halls, owing to the presence of high ceilings, office mezzanines have been created. Miele has one such premises at Krasnokholmsky Naberezhnaya." Initially it was a classic shop in a Stalin building with a 200-sq.m trading hall and 7-meter high ceilings on the first floor. We have adjusted the initial documentation and have constructed overlapping, thus, making a 400-sq.m office.

To change the functional purpose of a premises can also prompt a change in the owner of the building. "The purpose of a real estate property is defined at the creation stage of the project, with the results of analysis of the best and most effective utilization of a site. If a deal is made for the sale of a land plot with a ready project the new proprietor can change the project and construct instead a hotel or business center, or for example, a multipurpose complex," considers Kadchenko.

Often the function of a building is changed when construction is dragged out. “The long-term construction of Dom Knigi on Profsoyuznaya Ulitsa was turned into Cherry-Tower office and commercial center can serve as a good example. The building at 15a Oruzheiny pereulok, was conceived and constructed as a business class residential building but became a class A business center," Michael Gets, vice president of strategic development at Blackwood, says.

Frequently a developer is ready to reprofile unfinished and empty buildings and those that haven't been used since their construction was completed. "In this case, more often than not, there is a change in proprietor, for example, a hotel property is reprofiled as an office building. Fragma is reconstructing the Northern Hotel by adding additional storeys to the already existing 8 floors and is creating on its base a multipurpose complex with a business center, hotel, restaurant, 97-sq.m conference hall, sauna, bar, gym and billiards room," says General director of Vesco Alexei Averyanov.

More often, he says, this happens if the construction of the property has not been completed. For example, Sheremetyevskoye Podvorye hotel complex was planned to be built on Nikolskaya Ulitsa, but later the customer reprofiled it as a class A shopping-office center. Similar examples can be considered as redevelopment as in most cases the building has partially been rebuilt according to a new format, and the concept and strategy of promotion are completely changed."

In any case, according to Michael Gets, the most popular change of a special-purpose designation in the market is the change in premises from housing to uninhabited. The opposite almost never occurs. "Certain infrastructure is necessary for housing - schools, kindergartens etc. Naturally if the function of a premises changes from an office to housing it is necessary to add or search for infrastructure in the immediate proximity," argues Adikayev.

"In Russia developers have found a way out of this situation and often call apartments housing. The idea is that using this approach apartments do not fall under the category of housing and can be considered as hotel real estate," Shershnev explains. According to him, if it is a question of getting approval "they intentionally make the wording unspecified in documents, for example: an "administrative-industrial building" which for a long time has been used for offices, but nothing has changed in its documentation. "The shopping-office-entertainment center is practically a universal formula," Shershnev says.

A Complex Operation

To change the functional purpose of a building is not a simple task. "There is a General plan of development of Moscow which is detailed in the town planning of territories belonging to each administrative district and municipal area. The town-planning department decides the function of a building, the planned construction or reconstruction of a property, including property for transportation infrastructure, the possible demolition of existing buildings and the relocation or reform of industrial enterprises for other purposes.

Moreover, territories are zoned by housing, industrial and cultural, and there are also certain restrictions on the placement of "non profile" properties in these territories. For example, residential properties cannot be placed in industrial zones as industrial enterprises often have sanitary-defense zones, and for the same reasons these enterprises are not located in residential zones. "These town-planning strategies for the development of territories are approved by the Moscow government, have legal power and are the basis for the acceptance of decisions concerning each specific premises by enforcement authorities," says Ruban.

Therefore, as Afanaseva points out, the very first restriction in "changing the orientation," which can make reprofiling impossible, is a disparity of the future new purpose by the town-planning plan for the development of the city. As an example Afanaseva gives the restriction of the number of offices in the Central Administrative District.

The next obstacle may be the buildings' construct: columns, distances between bearing walls, the height of each level - all these factors can seriously affect which new variant a property can be used for, and its efficiency. "On the whole, if there are no town planning restrictions the new use of a property is defined on the basis of serious market research, the complex study of the characteristics of the site and the property and financial calculations proving the efficiency of a new variant. There are situations where the characteristics of the building need to be changed, requiring additional investments, in these cases it is better to demolish the building from an economic point of view and construct a new one.

In Alexei Averyanov's opinion, changing the format of a commercial real estate property is often impossible without partially rebuilding it. "Therefore reprofiling the project should begin with the reconstruction of the building and bringing the area into conformity with the chosen format," he says. In this case it is a question of redevelopment.

To start the procedure of changing the functional purpose of a building, it is necessary to firstly address the administration of the district, and if the intentions of the prefecture coincide with the ideas of the developer, to start trying to get approval from the Moscow government. "In Moscow decisions on changing the special-purpose designation of small real estate premises are made by the prefecture. If it concerns a large subject a corresponding governmental order of Moscow should be made. Each decision is individually considered. After receiving the go-ahead from the authorities a new rental agreement for the land plot is agreed. Rental rates are defined by the area of the land plot and a base rate, differentiated by the activity of the tenants on the land plot and territorially-economic zones," says Kadchenko.

Transferring a building from one category to another is complex and costly. "Usually a lawyer is used to deal with any questions that arise. The real estate segment that a premises will belong to is defined in the early stages of the project when a blueprint of the building passes through the different approval stages. Such restrictions are not present when reprofiling, though each special case can have certain problems. The most problematic is turning a non residential building into a residential one, sometimes it is just not possible," says Gets.

According to him, "legislative restrictions mainly apply to properties that have historical value, for example monuments of architecture, and some sports facilities, but in most cases reprofiling a building is possible though it demands a lot of time and money."

Main reasons

According to Kadchenko there is only one reason that can impel an owner to change the function of a premises: a radical change in the given segment of real estate or in the competitive environment or a significant event in the market, indirectly influencing the premises in question. For example, the announcement of the project to build the Fourth transport ring. However, Afanaseva says the main reason for reprofiling is usually the desire for big returns.

"It is unlikely any private investor will provide funds for the reprofiling of a premises if it does not provide a certain level of profit. Changing the function of a premises, as a rule, should directly increase the capitalization of the object. An exception to this is the reprofiling of a premises for social needs where an increase in capitalization, is obviously, not the goal," says Afanaseva. According to her, to foresee and ensure a growth in capitalization, it is necessary to carry out a complex analysis of the market, the location and the characteristics of the premises from the point of view of the current and proposed new format." Once the function of a building has been changed, its capitalization must increase, otherwise there would be no sense in wasting so much power on its alteration," adds Bushin.

"Industrial workshops are easily converted into commercial centers, but in a former scientific research institute it is only possible to design office premises - the ceilings would be too low for shopping and entertainment complexes, and there would be difficulties in installing ventilation equipment and the expenses on demolishing walls and corridors within the building would be too high, etc. Therefore, in this case, it would be easier to demolish the whole building and construct a new one. But this would not change the function of the previous premises as the premises would no longer exist," says Bushin.

"It is important to consider the market capacity of the specific region where the premises is located, to generate the optimum project including this or that volume of commercial area. In the case of a premises being ideally located in a region for its target audience the capitalization of the premises increases and this is the most widespread scenario of development of a similar situation," Averyanov adds.

However, according to experts, nothing influences the capitalization of a building more than changing it into a multipurpose real estate premises. According to Gets, " in partially reprofiling, the proprietor is diversifying the risks in creating multipurpose complexes."

"The capitalization of premises that don't have a special-purpose function increases. It is a significant advantage to be able to use a premises in different ways and to be able to choose the most effective. In such cases capitalization will be approximately 20% above singly categorized premises. Similarly capitalization will fall, if the building is turned into a premises that has only one function. The realization of a premises strongly depends on the fluctuation of prices for the specific type of real estate," Adikayev summarizes.