What are the financial considerations when undertaking a commercial to residential conversion project?
Understanding all of the financial considerations for commercial to residential conversion projects is essential when seeking finance for any development project.
Costs can include costs of acquisition, renovation, along with a range of fees, for up to 15 professionals involved in the initial stages from architects, planning consultants, and structural engineers, to ensuring the correct planning permissions, are secured along with property reports.
Then there are utilities, potential taxes, insurance, and marketing expenses to factor in, once the development is ready for sale or lease.
Understanding these expenses upfront can help in securing the right finance deal, managing the budgeting effectively and ensuring a profitable conversion venture.
Despite the upfront costs, commercial to residential property conversions continue to offer a lucrative opportunity for SMEs and property developers in the UK.
Proposed changes to Permitted Development Rights (PDRs) can also significantly reduce planning times and costs for commercial to residential conversions, but this is a moving feast with different Local Authorities having different rules, so our advice is always to get a planning consultant on board, who specialises in this area.
Once a property has been found the project given the green-light, the conversion process then involves a number of steps, including initial assessment, design, and a full conversion schedule to highlight just a few.
Evaluating the financial implications, including costs and potential returns, along with timelines for these steps is essential before undertaking a conversion project.
Miles Wallace, Commercial Finance Director at The Commercial Branch explains why all developers, no matter how experienced, should seek guidance from a finance broker to understand the implications for their project before they undertake any new scheme, as well as assessing the available lending options open to them to factor in the cost of borrowing.
The Rise of Commercial to Residential Property Conversions
Converting commercial property to residential use is becoming increasingly popular in the UK, offering, as it does, good profit margins for builders and property developers.
Against a backdrop of a UK wide housing crisis, caused by a decade-long shortage of new homes property, along with land prices rocketing has meant a decline in the quality of living for many.
However, the recent increase of remote working has forced many commercial landlords to rethink or re-sell many of their commercial properties, and with proposed changes to Permitted Development Rights (PDR) this has done much to create a market for change of use developments from commercial properties to residential homes.
While large homebuilders and PLCs have traditionally focused on ground-up projects, commercial to residential conversions present a multitude of benefits and opportunities to evolve the landscape of urban spaces for SMEs and developers. The relaxation of Permitted Development Rights (PDRs) has also made it easier to navigate planning permission hurdles and kick-start conversion projects more quickly.
Understanding Commercial to Residential Conversions
Commercial to residential conversions involve changing the use of a commercial property to a residential one. While this change of use may now require less planning permission, adhering to specific regulations and standards is still critical to get the final project signed off.
Zoning laws still play a crucial role in commercial to residential conversions. These laws determine the allowable uses of a property, based on its location and designated zone. Property developers must understand and comply with these zoning laws to ensure a successful conversion.
Commercial properties are typically classified under “Use Class E,” which includes various types of commercial activities. Converting these properties to residential use often falls under “Use Class C3,” which covers residential dwellings. Understanding the process and requirements for commercial to residential conversions is essential for property developers looking to tap into this lucrative market.
Importance of Converting Commercial Property to Residential in Today’s Market
Converting commercial properties to residential use has become increasingly important in many cities. The UK is facing a housing crisis, with a significant shortage of homes or land for development. In addition, the Covid pandemic and subsequent remote working patterns have left many office buildings underused or even empty.
Meanwhile, shifts in retail patterns, changing community needs, and the rise of on-line shopping has led to the decline of traditional brick-and-mortar ‘high street’ shops, leaving many retail spaces vacant and providing a golden opportunity for conversion.
Increased Appetite for development
In this environment, there is a greater appetite to see a re-purpose of underutilised or vacant commercial properties into residential units as the conversations, often into shared accommodation or flats, helps address this housing shortage and revitalises urban areas.
Commercial properties, especially those located in high streets, have seen a decline in demand due to changing consumer habits. Converting these properties to residential use can breathe new life into these areas, attracting residents and creating vibrant communities.
Unlocking Hidden Potential
This repurposing of retail and office space has the ability to unlock hidden potential in the heart of once bustling urban areas. Prime locations that were once home to busy retail outlets and workspaces can be transformed into vibrant residential communities, breathing new life into the cityscape.
Cost-Effectiveness and Repurposing
Commercial property conversions also offer significant cost advantages for developers. While office blocks are no longer the flavour of the month for many employees, they are generally the most popular targets for developers. The previous use means there is typically utilities in place and infrastructure in place- making it a much more cost-effective site for development.
Building an entirely new structure, or converting an old warehouse for example, you are effectively starting from scratch and this is where the build costs jump considerably vs. Re-purposing commercial property to residential use.
Sustainability and Architectural Appeal
In addition to the economic and social advantages, converting commercial property to residential spaces also promotes sustainability while retaining architectural appeal. These factors are becoming increasingly important in the real estate industry.
Sustainability is a key consideration in modern construction projects. Converting existing commercial properties reduces the need for new construction, minimising the environmental impact.
Additionally, architectural appeal is crucial in attracting potential buyers or tenants. Repurposing commercial spaces preserves the character and historical value of a building, while architectural drawings play a significant role in visualising the conversion and ensuring that the final residential spaces meet both functional and aesthetic requirements providing a unique selling point for potential residents.
Changes to planning permitted development rights
In a move that will surely be welcomed by all developers, and increase activity in this sector further, legislation was announced by Housing Secretary Michael Gove recently that will extend current Permitted Development Rights (PDR) so that commercial buildings of any size can be converted into new homes without going through the full planning process.
Mr Gove unveiled the proposal to change planning guidance in bid to boost brownfield development.
This legislation requires local authorities to be more flexible in approving planning applications on brownfield land and give significant weight to the benefits of delivering as many new homes as possible, where there is a shortage of land for homes. This change, says Mr Gove, would also require councils to be more pragmatic in applying policies to the internal layout of developments.
The Government hopes that this law change will lead to the start of potentially hundreds of new projects and the creation of thousands of new homes in Cities across the UK by 2030.
Financial Implications and Solutions
While repurposing commercial properties for residential use, can contribute to the solution of the housing crisis there is no denying the benefit and potential financial returns for developers, but understanding the financial implications of any commercial to residential conversion is essential for property developers.
Residential re-sale value offers clear opportunities, but there are a number of hidden costs that should also be considered including
Structural intricacies: Older buildings come with history and unique issues. From weakened walls to aged foundations, special attention is needed to maintain and renovate these spaces.
Unforeseen expenses: Budgeting for conversions and ground-up builds isn’t always straightforward. Unexpected damages or hidden costs can arise, making it important to build in a decent contingency fund
Navigating regulations: Planning permission and building regulations may be relaxing but they can still be intricate. Every council has its specific regulations, and understanding these nuances are crucial to avoid project delays and potential additional costs.
One of our roles as a commercial finance broker is to engage with the respective professionals on each project, from planning consultants, architects, solicitors and even local estate agents, we help to put it all together to make sure a the developer has covered every angle because there are many scenarios that may mean the project is not as profitable as they first thought.
Evaluating Costs and Potential Returns
Before embarking on a commercial to residential conversion project, property developers must conduct thorough due diligence to evaluate the costs and potential returns. This involves assessing the costs associated with the conversion, such as renovation, refurbishment, and compliance with building and safety regulations.
Developers should also consider the potential returns on investment. Factors such as the location, size, and quality of the residential units can have a significant impact the rental income or resale value of the converted property. Conducting a market analysis and studying comparable properties in the area can help developers determine the potential returns on their investment.
Commercial property owners looking to convert their properties to residential use should carefully evaluate the financial implications. They should consider factors such as the current market conditions, the demand for residential properties in the area, and the potential rental income or resale value. Conducting a thorough cost evaluation and potential return analysis is essential to ensure the financial viability of the conversion project.
As a commercial finance broker, property developers or builders ask us to appraise hundreds of sites each year for their viability. Initially they want to ensure that the gearing of any debt is at a suitable level to allow them to use their available funds to buy it and then to potentially develop it.
To support the tender process for certain sites, we work with main contractors to price up schemes to ensure developers get the most competitive and efficient prices, but we also work with local estate agents to work out the end value of the site, which provides the Gross Development Value (GDV) of a project so we can put the whole package together and ensure all of the boxes are ticked.
But if there’s not enough time to get all the ducks in a row, but the developer is confident enough of the metrics and just wants to buy it, then we are able to provide bridging finance for an unconditional purchase of the commercial block and then retrospectively work out the minutiae of planning, the build costs and final value to then refinance the site if required.
But you as a client need to be extremely confident that the scheme you’re thinking of is deliverable for the price you think you can deliver it before going down this funding route.
In addition, while the sale of residential units is profitable, when a scheme overall is above a certain number of converted units, the developer has to provide a certain level of social housing- and this will be purchased at a considerable discount at anywhere from 20 to 60 percent of the market value.
Each local authority has a different threshold, so, developers of larger schemes need to allow for this in their GDV projections.
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Development Finance options
Securing the right finance for a commercial to residential conversion project is vital. While converting a commercial property to residential use can be less expensive than a ground up project, it still involves an array of costs that may need to be financed.
Property developers can explore various financing options, such as commercial bridging loans or development finance. Commercial bridging loans provide short-term financing that can be used to cover the costs of the conversion project until the property is sold or refinanced. Development finance, on the other hand, is specifically designed to fund construction or renovation projects and can be more expensive in the long term.
When seeking financing for any conversion project, property developers should work with a specialist lender or broker who understands the unique financial requirements of commercial to residential conversions. At The Commercial Branch, we have access to the whole of market and so we can help developers find the most suitable lender and financing option for their specific project.
These conversion projects are often large schemes and funders will take into account the developer’s history, experience and net worth when considering their terms for lending. It’s also important to take into account factors such as the property’s value, the developer’s contractors and the project’s anticipated timeline.
Working with a specialist broker can streamline the financing process, increase the chances of securing funding, and ensure that the developer gets the best possible financing terms for their conversion project.
Identifying Potential Properties for Conversion
Every finance deal is completely different and has its own nuances. And obviously every builder or developer has their own specialties and their own experience and knowledge to bring to a project. This is why identifying the right properties, in the right locations, for conversion requires careful consideration and due diligence.
Here are some of the key elements we look for when developers ask us to consider a deal:
Location: Choose properties in desirable areas with high demand for residential spaces. This ensures that your investment will yield a profitable return.
Building condition: Assess the physical condition of the commercial building to determine if it is structurally suitable for conversion. Consider factors such as the building’s layout, infrastructure, access, and overall condition.
Planning permission history: Research the planning permission history of the property to understand any potential limitations or restrictions that may impact the conversion project.
Market demand: Study the surrounding area and identify the current and future market demand for residential properties. This will help you gauge the potential profitability of the conversion project.
Financial feasibility: Conduct a thorough financial analysis of the potential conversion project, considering the costs of renovation, financing, and potential resale value. This will help you determine if the project is a smart move financially.
Strategic due diligence and thorough research are key to identifying the right commercial properties for conversion. We support developers by working with the relevant professionals, such as property surveyors or estate agents to provide valuable insights during the property selection process.
Why Choose A Commercial Finance Broker
Against a backdrop of a shortage of suitable housing, a rise in remote working and a change in retail habits which has left a number of retail and commercial buildings vacant there is a clear appetite for more commercial property renovations to residential.
In addition, recent legislation, extending the permitted development rights will allow vacant commercial buildings of any size can be converted into new homes without going through the full planning process.
Commercial to residential property conversions offer a profitable opportunity for builders and property developers in the UK, but before undertaking any project, property developers must carefully evaluate the potential returns on investment and consider factors such as the resale value of the converted property. The location, size, and quality of the residential units and the demand for such locally can all significantly impact the resale value and overall financial success of the conversion project.
Securing financing for the conversion project is another crucial aspect. Property developers may need to explore various financing options, such as commercial bridging loans or development finance. Working with a specialist broker, like The Commercial Branch, who understands the unique financial requirements of commercial to residential conversions can help developers find the best financing solutions for their projects.