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Development Pinch Hitters

After decades of plant closings, Kalamazoo, Mich. wasn't having much luck attracting new commercial developments. Merger activity in the pharmaceutical industry also thinned its population of life sciences jobs, most notably in 2001 when Pfizer laid off 500 employees at its Kalamazoo office.

Faced with limited growth prospects and an aging stock of office and industrial space, however, local economic development officials took matters into their own hands.

Their bold solution was to develop a batch of speculative properties on their own. In 2003, for example, the Southwest Michigan First economic authority built a 58,000 sq. ft. life sciences office center. It's also in the early stages of developing a massive 600,000 sq. ft. center with laboratory and office space.

“We realized that we needed to bring more knowledge-based jobs into Kalamazoo, but we also needed to provide these businesses with the infrastructure they need,” says Ronald Kitchens, who last year became chief executive officer at economic development group Southwest Michigan First. The non-profit group serves as the region's chief economic development entity.

Kalamazoo isn't alone. A growing number of development authorities in economically challenged cities invest public dollars in speculative building projects aimed at attracting businesses. Others are simply buying up large tracts of land, then selling that land to developers who are building new projects on the sites.

Some development authorities are even helping finance local start-up businesses, betting that young companies will lease the completed space down the road. A study released by Ohio State University in 2005 found that 27% of U.S. communities have tapped local economic development corporations to either help develop or fully build speculative shell properties within the past five years.

Examples abound from coast to coast. Officials in the former oil town of Ardmore, Okla. (population 30,000) are building a speculative, 125,000 sq. ft. industrial shell near their airport. In Mobile, Ala., the state pension fund is developing a 35-story office tower. What will soon become the tallest office tower in Alabama also has no signed tenants. Pittsburgh area officials, meanwhile, are buying up huge tracts of land for future industrial and office developments.

A space race

Speculative development is a new twist on a traditional economic development model. The old model relied on simply marketing sites and properties rather than building them outright. To some observers, this evolution proves that economic development groups are no longer hindered by their status as non-profit, public entities. Instead of just sending out colorful brochures and hosting lavish events for visiting site-selection consultants, say sources, these groups are embracing a far more entrepreneurial and sophisticated approach to growing local economies.

Site selection consultants believe this transition was bound to happen, especially in second-tier cities under pressure to create new jobs. Speed is a factor, too, as companies no longer conduct arduous cross-country jaunts to find the best sites. Instead, most companies narrow their search down to as few as half a dozen sites within days, thanks to high-tech site selection software.

“The public sector is getting more and more involved in the development process,” says Bob Ady, president of Chicago-based site selection firm Ady International Co. “I'm not really sure where this will end up either.”

Jeff Finkle, president and CEO at the International Economic Development Council, a trade group based in Washington, D.C., says that shell-building campaigns have helped many cities attract new businesses. “When the fast decisions need to be made, it's imperative that the facilities are there for these companies to move into.”

Finkle also believes that many private developers, especially those who lived through the construction glut of the 1980s, aren't jumping at the chance to risk their own dollars on second-tier markets. Some builders have no choice, as lenders typically demand significant pre-leasing commitments before they will underwrite a project.

This gap has forced many economic development authorities to take on the risk of building projects, too. “This is mostly done where the [private] development community is not taking the risk or is missing the market,” he adds.

Good medicine

Kalamazoo certainly fits that bill. Like many of the gritty industrial towns that dot the Rust Belt, the city of 77,000 supported nearly a dozen paper plants and a taxicab factory on the banks of the Kalamazoo River. Western Michigan University is one of Kalamazoo's largest employers. With a countywide poverty rate of 25%, double the national average, the business community realized six years ago that a turnaround was in order.

Kalamazoo economic officials not only seized on this opportunity to single-handedly develop properties, they have also filled these buildings with tenants. That's why economic development official Ronald Kitchens says that many of Kalamazoo's speculative projects actually resemble build-to-suits.

In 2003, Southwest Michigan First completed a 58,000 sq. ft. life sciences facility near the Western Michigan University campus. Not only was the Southwest Michigan Innovation Center built debt-free, it was also developed without any pre-leasing commitments, according to Kitchens.

Three years later, the building is 100% occupied by 16 different companies. Kitchens says that Southwest Michigan First used $5 million of its own funds, plus an additional $7 million in private donations, to build the facility.

Several tenants in the Southwest Michigan Innovation Center are start-up firms that serve the life sciences and pharmaceutical industries. What's also unusual about this project is that many of those companies also receive venture capital from the landlord.

During the past year, Kitchens has cobbled together a $50 million venture fund by tapping both public and private capital sources. His group is using that capital to establish equity stakes in many of the start-ups that agree to relocate to Kalamazoo. The average stake is roughly $3 million, says Kitchens, adding that most of the beneficiaries are fledgling life sciences or pharmaceutical firms.

One such company, four-year-old NanoMed Pharmaceuticals, designs advance drug delivery systems for cancer patients. In June, NanoMed announced plans to lease 10,000 sq. ft. of office space at the Kalamazoo Business Park. Southwest Michigan First invested $5 million in the development of the project. In 2005, Southwest Michigan First distributed 140 proposals to lure companies into the Kalamazoo area, specifically targeting the life sciences industry. Those proposals offered a slew of tax incentives and grants to attract companies to the region.

The authority also has developed 2.5 million sq. ft. of speculative industrial and office space in the Kalamazoo region to date. Its largest project should be completed by 2008, when it completes a 55-acre life sciences center.

Kitchens expects that project will add 600,000 sq. ft. of laboratory and office space to the area. He also expects the space to fill up soon after it's completed. Like the Southwest Michigan Innovation Center, this too is a speculative project. Kitchens says that the bulk of the $120 million project will be financed through private donations. The balance will come from the State of Michigan.

“I would love it if we didn't have to get involved in the development of these facilities because we don't want to compete with the private developers,” says Kitchens. “But they weren't exactly flocking to build new developments here, and we need the jobs that these facilities can house.”

Landing sites

Economic development officials in Pittsburgh found themselves under similar pressure six years ago. But instead of following Kalamazoo's lead by taking on the speculative development risk, they chose to woo private developers. Their core economic base of steel and heavy manufacturing gradually tanked over the decades leading up to 2000 when officials mapped out a $2 billion plan to add speculative office and industrial around Pittsburgh's International Airport.

According to Bernie McShea, senior vice president of business investment at the Allegheny Conference on Community Development, this billion-dollar initiative was past due. In late 2000, for example, McShea hired Deloitte Consulting to conduct a 10-county feasibility study in order to find attractive sites for industrial and office tenants. But after reviewing scores of industrial sites 20 acres or larger and 80,000 sq. ft. office buildings in the region, Deloitte delivered a sobering message.

“They told me they would only feel comfortable presenting three sites and just five buildings to companies interested in relocating to this region,” recalls McShea. The analysis also determined that newer office and industrial properties, plus re-zoned sites for future office and industrial uses, were sorely needed. Deloitte suggested that so-called “shovel-ready” sites could help the region lure more businesses, especially companies anxious to relocate their staff quickly.

Most of these projects are light industrial facilities, though several Class-A office buildings have also been developed privately outside of the Pittsburgh CBD. Allegheny officials have in recent years set aside thousands of acres of hilly terrain located between the city and the airport to make way for new office and industrial parks. The State of Pennsylvania has already spent $26 million to upgrade the public infrastructure of this area.

One private developer that has worked with Pittsburgh economic officials is Squirrel Hill, Pa.-based Buncher Co. In February, Buncher began developing a 400,000 sq. ft. speculative warehouse property at Clinton Industrial Park. “We typically prefer to work with local developers in the region, especially by securing shovel-ready land for their sites,” says McShea.

Indeed, politics play a huge role in the lengths to which economic development groups are willing to go to secure new jobs. Getting elected on a “growth” platform means creating new jobs.

Still, it's essential that economic development authorities do their homework. Otherwise, last-minute zoning and land use issues could persuade the interested company to relocate elsewhere

To Finkle of the International Economic Development Council, this can also mean taking on the added role of builder. “If the developers are not serving your marketplace, you just can't wait for them to come along.”

— Parke M. Chapman is senior editor.

Holding firm: Economic development pro says sharing the risk is ill-advised

When economic development officials don hardhats, defenders of the practice say it's because private developers aren't willing to tackle the project. But to Mary Jane Olhasso, economic development director for the City of Ontario, Calif., this reluctance on behalf of private developers often speaks volumes about why speculative projects probably shouldn't be built.

“This isn't the business we are in. Our mission is to make the business case for the site and then step back,” says Olhasso.

For many cities struggling to rejuvenate local economies, that's a tall order. Ontario, which occupies the center of California's booming Inland Empire region, doesn't fall into that category: Last year, for example, a bidding war broke out for a 30-acre parcel of Ontario land zoned for commercial use. The buyer ended up spending $22 million for the site, which turned out to be $7 million above the asking price.

With its growing population and diminishing supply of sites, developers can't get enough of the Ontario market. Olhasso says that this demand means she can avoid dangling pricey incentives packages in front of developers, not to mention building shell projects that might go dark. What she's willing to do is help developers assemble sites and conduct feasibility studies — but that's about it.

“If the developers aren't taking the risks on these projects, there could be big problems in the future,” says Olhasso. “What if an economic development group builds the wrong project?”

Despite Olhasso's aversion to shell building, Ontario officials are helping developers with large-scale projects. The biggest example is Piemonte, a 1 million sq. ft., mixed-use project under developed at the city's edge.

In 2005, Ontario's redevelopment agency sold 94 acres of land to Pannatoni Development for $26 million. Proceeds from that sale will be used to build an 8,500-seat community events center adjacent to the site. Another private developer, Toll Brothers, is building more than 750 for-sale homes at Piemonte.

“We're not actively offering any of these developers incentives to build in Ontario,” says Olhasso. “The incentives are all on the back-end once their projects are completed.”
— Parke M. Chapman

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