With its rapid population growth and ever-growing tourist market, Florida has been one of the hottest destinations for retail development for years. But the market has become a victim of its own success.
Intense competition has driven up land costs and has led to construction material and labor shortages. Moreover, the annual beating the state has taken from punishing hurricanes — a cycle that is expected to continue — has meant higher insurance costs. Lastly, while the state welcomes growth, officials are also mindful of avoiding sprawl and protecting wetlands, leading to some of the most arduous approval processes in the country.
The upshot for developers: if you can negotiate all the obstacles, it's a wonderful market, but be prepared for anything. At the same time, the projects having the most success are those that address many of these concerns. And those are, you guessed it, mixed-use projects, especially high-density projects that meet residential and retail needs while using up less land than conventional retail properties.
As it stands, retail developers can barely keep up with the demand in the market. Even with the development pipeline at 4.9 million square feet, vacancies at retail projects are below 5.5 percent — the lowest point in five years. Meanwhile, rents are expected to reach an average of about $16.75 per square foot this year, an increase of about 4 percent compared to 2005.
Land has always been an expensive commodity in water-constrained Florida, but inflation has been particularly sharp during the last two years. According to CB Richard Ellis, the most expensive parcels in the state, on Hollywood Boulevard in Pembroke Pines, and on I-95 in Dania, now cost more than $1 million per acre. The average value of an investment retail sale transaction has increased by 53 percent since the fourth quarter of 2005, from $115 per square foot to $176, and by almost 90 percent since the first quarter of 2004, says a report from Grubb & Ellis. The researchers expect prices to remain high throughout the rest of the year.
Part of the problem stems from the fact that retail developers are competing for the same parcels as residential builders, who are feverishly trying to keep up with Florida's rapid population growth. The state's population will reach more than 19 million by 2008, from approximately 17.8 million today, and is expected to grow to 22.2 million by 2015, according to the state's Office of Economic and Demographic Research.
This boom in residential construction has helped drive up costs for all kinds of development, including retail. According to Reed Construction Data, project costs for non-residential building in Florida went up an average of 8.18 percent from the second quarter of 2005 to the second quarter of 2006, and that's excluding the price of land and off-site labor. Moreover, subcontractors are hard to come by, both because they are busy and because many potential laborers are shying away from the state because of its skyrocketing rents, so available subcontractors have the upper hand when it comes to job pricing.
Daniel Herman, senior vice president of development with Developers Diversified Realty, says he has been able to find new subcontractor labor in Florida, but he's getting increasingly worried about hiring the right people for the job.
“The challenge is finding someone who's qualified,” he notes. “The quality of workmanship is not always what we would like to see.”
“There is a scarcity of contractors and subcontractors, so prices have risen dramatically,” says Robert Breslau, president of Fort Lauderdale-based Stiles Retail Group.
Breslau, whose company will soon break ground on a project that will contain the state's first Ikea, admits that Stiles has been looking more closely at its development pipeline.
“There are definitely projects where we will wait six more months and look at where construction costs have gone,” he notes.
DDR is also trying to stay cautious in Florida, taking up only those projects where there is a possibility of passing increased construction costs on to retailers.
“We are keenly aware of that equation,” says Herman.
Unfortunately, high construction costs are not the only thing that worries developers in the region. Brett Casto, president of Sarasota-based Casto Lifestyle Properties, brings up an equally daunting challenge — the uncertainty of getting a work permit.
As the state continues its fight against suburban sprawl and superfluous real estate projects, Florida communities are required to update their land use plans every six months. So if a developer plans a 500,000-square-foot project in January, but the site plan later changes the amount of required retail to 200,000 square feet, the whole undertaking has to be reconsidered.
“Particularly with large projects, you have an extra layer of regulation — it's not only municipal and county, but regional and state,” Casto explains. “It's uncertain sometimes if site plan approval will [be granted] because the requirements are constantly changing.”
According to Geoff Smith, vice president of development with Chattanooga-based CBL & Associates Properties, Inc., that tends to scare off a lot of newcomers. Attractive land opportunities are hard to come by and it takes real determination to get through the state's regulatory red tape.
“There are definitely more challenges here than in any of the other states, so that has caused a lot of developers to try one project and then leave,” he notes. “But it's like anything else — you just have to work harder on it and act faster.”
Another growing concern is insurance. The more conservative companies might refuse to offer property coverage altogether to a shopping center that is located within a possible flood zone, but even if a developer manages to get the deal done by agreeing to a much higher-than-normal rate, he will likely be required to buy flood insurance from the National Flood Insurance Program. However, the federal policy limits its coverage to $100,000 for the shopping center and everything inside, a number that may be too low for a large property.
This may change — Congress is currently looking into increasing coverage to as much as $130,000 — but in the meantime, Florida developers are taking a big financial hit.
Since last year's hurricane season, when the NFIP had to pay 20,861 claims in Florida, totaling approximately $545.5 million, insurance premiums have gone up by as much as 600 percent in some areas, according to Bill Beckham, president of Miami-based HBA Insurance Group.
“If you have to go seek new bids, the cheapest [increase] I've seen at this point is about three-fold,” he says. “And obviously, the closer you are to the water, the more expensive it's going to be. If you are east of I-95, it will be very difficult or very expensive to buy loss of income [coverage].”
One way developers have been combating the land use hurdle is by concentrating on mixed-use and high-density retail centers, the kinds of projects that often appeal to sprawl-wary residents. Such developments have the added advantage of getting maximum value out of a piece of land.
“In urban areas, the land has become so valuable you can't afford a single-story building any longer,” Breslau says. “You put the shopping center on the first floor, and put something else, either office or residential, on the fourth, fifth and 10th floors. Florida is starting to get used to vertical developments and multistory buildings.”
Mixed-use projects are not without their drawbacks — “construction costs are rising, interest rates are rising and overabundance of residential in certain parts of the market is going to make this more challenging,” Breslau notes. On the other hand, mixed-use seems popular with the state government.
“It's easier from a regulatory standpoint — it's usually a development that residents will embrace, [particularly] if you can take an older project and make it better,” says Casto.
At the same time, some people feel that the difficulty of getting a shovel in the ground in Florida might be a good thing.
For years, residents have complained that there was no comprehensive real estate planning, with anyone being able to build anything as long as they could pay for it. That's all changing.
Now, say the executives at Tampa-based RMC Property Group, “it is difficult to get projects built, considering the run-up in construction costs, as well as the increase in insurance costs.”
Balancing all these factors, though, should result in better-designed developments poised for future success.