Occasionally, it may prove difficult for owners of Danish industrial or office properties to find a suitable, long-term and reliable tenant.

However, the demand in Denmark for residential real estate, especially in the urban areas in and around Copenhagen, is as high as before the financial crisis. The prospect of a considerable financial yield from renting out residential properties is an important factor in persuading property owners to carry out the building work required to convert commercial properties into those fit for residential use. Such a conversion could constitute an alternative exit strategy for real estate investors looking to release themselves from distressed properties with static or negative value growth.

Distressed properties

Outsourcing, as well as an increased need for custom-built industrial buildings, have left generically designed industrial buildings unoccupied. While the lack of rental income from tenants alone means less profit, larger industrial complexes may also incur different additional costs depending on the purpose and operations of the buildings. Properties burdened by fees and difficulty in finding a suitable tenant will rarely have more value for a potential buyer than for the original investor. Office buildings may be comparatively cheaper in maintenance costs, but with no long-term tenant, the prospect of collecting no rental income will in most cases be unattractive to a potential buyer.

A rising trend

In recent years, former industrial areas and office buildings in Copenhagen have been under construction to create attractive, high-end residences in a city where demand for housing far exceeds the supply. Indeed, the same phenomenon can be observed all over the country, as several provinces are gradually becoming the sites for similar projects. In some cases, old factories are converted into residences while maintaining the spirit, if any, of the former use of the buildings. Other projects are being carried out on a larger scale, where entire areas comprised of several industrial sites become whole new housing estates.

Advantages and challenges

Moving real estate from a low-demand market to a high-demand market has the obvious effect of increasing the potential price of the property and correspondingly the return on investment in the property. As the distressed properties are cheap, the potential return is significant. Many players on the market have already observed the impact of the trend, which has paved the way for easier routes to finance for such projects.

Additionally, real estate conversion may provide several VAT related reliefs. For more on this, see Michael Neumann and Niclas Holst Sonne, ‘What is a ‘development site’? Real Estate Gazette (Issue 20, 2015).

Hindrances and the extent of the challenges they present will typically be specific to the individual property. For some, the restoration of contaminated soil or contaminated adjacent bodies of water present both an expensive and difficult task. However, local authorities may insist that such restoration be carried out before they will allow the property owner to commence works on the site. Other factors, such as local law and practice of the municipality concerned, as well as national environmental, planning and zoning legislation must all be taken into consideration as well. Clearly, the process of converting property from commercial to residential is one that presents many challenges.

It is worth noting that although office buildings will often meet fewer practical challenges as less work is required to divide them into habitable units compared to industrial buildings, both are largely subject to the same rules governing the conversion of real estate from commercial to residential use.

Some particular risks

Older properties

Older properties may require particular care as the age and condition of such properties may mean that unforeseen complications arise along the way to delay the process. Further, these properties may be subject to serious restrictions on renovation or conversion works by the Ministry of Culture.

Construction errors and materials

The materials used in the construction of the building and the very method of construction are both worth careful consideration at the outset. There have recently been issues reported surrounding the use of MgO (magnesium oxide) wallboards, and there are also occasional discoveries of construction errors in larger properties. Moreover, the use of wrong or unsuitable materials may have a damaging environmental impact on the surrounding areas. As the remedial measures necessary to correct such errors can be very expensive, a thorough technical due diligence of the property prior to investment is highly recommended.

Impact of local area

Local development plans are produced on a municipal level and thus may be determined and altered as the political composition of the municipal council changes. Often municipalities will review construction applications on a case-by-case basis and allow political ambitions in the local area to influence the decision, which may cause some uncertainty as to whether the necessary approvals may be issued at all. Conversely, in some municipalities, conversion projects may be aligned to local interests making local authorities more cooperative. Clearly, a thorough legal due diligence of the property in question should be undertaken prior to investment.

Burdens

While easy to ignore, some properties may be subject to registered burdens that hinder the use or intended use of the property. To ensure the smooth running of any conversion project, it is desirable for the property owner to consider the burdens, if any, before going ahead with the project.

Conclusion

Owners of distressed industrial or office buildings may consider converting the buildings to those suitable for residential purposes, as the prospect of leasing or selling such properties is often more promising than is currently the case for industrial or office buildings. Despite the complex nature of larger conversion projects, with the right technical and legal advice to overcome the practical and legal challenges that may arise, projects may be completed within a reasonable timespan. For investors with a short-term exit strategy, the bulk of the profits to be attained by converting may already be achieved once the necessary permits have been obtained and the project planned in sufficient detail. Thus, though large-scale projects from start to finish may be lengthy, investors are not necessarily forced to commit their resources throughout the entire process.

In summary, converting industrial and office buildings can be a lucrative way for investors to turn around their portfolio of distressed assets. Nevertheless, there is an extensive body of legal rules surrounding such conversion work, making it highly advisable for investors to secure the relevant legal, technical and environmental expertise before investing in distressed industrial and office buildings for this purpose.