The retail sector continues to face competition from E-commerce, with many big box stores closing and sitting vacant. Medical office, however, will remain an investment favorite as superior healthcare real estate performance makes them attractive for equity investors.
So, what do these two trends have in common?
Scott Mason who heads the Health Care Group at Cushman and Wakefield said in an interview that improvements must be made in the physical backbone of health care. One way would be eliminating the traditional but inefficient office building with lots of doctors in their individual offices, each with their own receptionist and billing person. For one health care system this meant putting their doctors in abandoned supermarkets with plenty of free at-grade parking or hospitals leasing entire office buildings.
Hmm… interesting. That got me thinking, what would the due diligence look like for repurposing an abandoned supermarket into medical office space? Let’s look at the acquisition due diligence process.
Zoning Study and ALTA Survey
I think the first trigger point is that there will be a change in use of the property. Therefore the impact on zoning requirements should be the first issue to be investigated. If there are zoning issues that can’t be resolved, the deal may be undoable. A Zoning Study should be commissioned.
Parking is a primary concern, so let’s use the parking requirements for the two uses in the Indianapolis Zoning Code – I assume it will probably be similar to many metropolitan areas. I’m going to assume a 50,000 square foot building which is not unusual for a free standing supermarket according to available data.
A survey is the best way to verify the parking count and the buyer will always do his own, but the seller may be agreeable to provide a copy if he has one. Hopefully it will show parking space or list the total. If one isn’t available, a survey just to confirm site parking count is not expensive and the buyer needs that data. As a last resort, one can spend a few hours at the site counting the spaces. Once into the acquisition process the buyer should get a complete ALTA (American Land Title Association) Survey.
According to the Zoning Code (Section 732-211 Table 2.10-A Minimum Numbers of Off-Street Parking Spaces Required by Use) a retail space is required to have 3.5 spaces per 1,000 gross square leasable area. A stand-alone supermarket will probably have leasable area equal to gross area so there needs to be parking for 175 cars.
Parking requirements for medical office space is one space for every 200 square feet of gross area. So if the entire building area is devoted to medical, dental, optometrists and clinics there has to be 250 spaces.
Having an ALTA Survey available at this stage will be very helpful. The Zoning Study will describe issues such as setbacks and landscaping requirements which are part of a typical Zoning Code.
Under the current Indianapolis zoning requirements grocery store parking stalls have to be 10 feet wide but standard stalls can be 9 feet wide, so there may be room for additional spaces by restriping. In addition, modifications to landscaping and the elimination of truck parking that would most likely be present can provide additional spaces. There may be an opportunity to add 75 additional spaces, which would meet the total required 250 spaces.
Property Condition Assessment
Assuming that the parking issue can be resolved and that there are no other zoning issues, the next due diligence task is a Property Condition Assessment (PCA) and Phase I Environmental Site Assessment (ESA). The Property Condition Assessment consists of a site visit to determine physical condition of the property. These include:
- Exterior site including paving, site drainage, exterior lighting and landscaping
- Exterior Walls
- Interior Structure
- Interior partitions and finishes
- Heating, Ventilating and Air Conditioning System
- Pluming System
- Electrical System
- Fire Protection System
A Property Condition Report is prepared with the site findings, photographs, cost estimates for conditions found that require immediate repairs, and estimated costs for reserves to address systems replacements that will reach the end of their useful life over 12 years of ownership.
However this is a special type of project. The interior of the building will be gutted. Entirely new HVAC, plumbing, electrical and fire protection systems will likely be needed. These will be designed by the architects and engineers for the renovation project. So the most useful information for immediate repairs will be the exterior site and roof conditions, the size of the HVAC equipment (which will most likely be on the roof), the size of the electrical service, the size of the domestic water supply if it’s accessible, and whether or not there is a fire protection system.
This is a prime example of why communication with your consultant at the beginning of due diligence is so important – knowing the end goal allows us to customize the scope of work.
Phase I Environmental Site Assessment
The Phase I ESA includes a site reconnaissance to identify visible signs of releases of hazardous materials at the site. In addition, records will be reviewed concerning the past and current history of the site and nearby sites that may indicate a problem with hazardous materials. Current owners and operators will be interviewed regarding their knowledge of the property. The findings for all these actions will be analyzed in a report including any recommendations for additional inquiries.
Gas stations, auto shops and dry cleaners are common sources of contamination in shopping centers, so the current or previous presence of these operations should be identified and assessed carefully, including the potential for vapor intrusion concerns.
For older supermarkets (constructed pre 1981), an Asbestos Survey and Lead-Based Paint Inspection should also be conducted prior to renovation activities to ensure these hazards are properly handled and disposed of. These studies can be added on to the Phase I Environmental Site Assessment.
Due diligence for this type of acquisition, where a major change is contemplated to the property, should include architects and engineers, and perhaps energy efficiency consultants. These professionals can answer many other questions regarding the efforts required in the remodeling.
I may sound like a broken record, but communication is key! As my colleague Joe Derhake, PE mentioned on the recent Due Diligence 101 Webinar, we can better advise you if we understand what you are trying to do on a business level.