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Mixed-Use Gets Tested

We have to admit that we've loved the industry's turn toward mixed-use projects. The environments companies are creating across the country are often inspired and unique and break the historic trend of cookie-cutter projects dotting the landscape. Designers as well have found ingenious solutions for enabling retailer brands to shine through without detracting from an overall aesthetic for entire properties.

We know these kinds of projects require more work and money to build. From our vantage point, the effort has been worth it.

The trend emerged due to confluence of factors. Communities across the nation are tired of the established retail venues. Furthermore, many cities lost downtowns with the rise of suburban malls. Mixed-use centers allow the retail to return to town centers. And that means people don't have to drive everywhere. Mixed-use enables some to live, work and play in a smaller area.

The mixed-use trend also emerged at a time when every commercial real estate sector was rising. Sectors — such as office and hospitality — which suffered steep downturns due to overbuilding and to a drop in tourism after 9-11, respectively, had been on the rise again. Investing in mixed-use, where you rely upon this stew of different services to work together, makes a ton of sense when every property type is in an upturn in the business cycle.

Lastly, mixed-use was the result of affluence. Retail real estate firms have enjoyed a long string of success — ever since the turn of the millennium. Therefore, the industry was flooded with cash that could be put to use building these projects.

Yet from the beginning, everyone knew that the real challenge for mixed-use projects would emerge when the economic climate got a bit stormier. That day has now arrived. Naturally, multifamily is the sector most affected by the broader problems facing the single-family housing market. It is widely recognized that developers built too many condos in some markets. The outlook for rentals, meanwhile, has gotten strong in some places as people move out of homes they can no longer afford and into apartments. There are also huge doubts today about the retail sector. Sales have slowed with both December and January posting meager same-store sales growth.

Further, the number of store closings is on the rise (see p. 70) and retailers are downscaling previously ambitious expansion plans. None of this has greatly affected the results of retail real estate developers. Vacancies are still near historic lows. And many REITs were still pushing through rental increases during the fourth quarter of 2007. But the issues surrounding retail do raise the question of whether further development is warranted.

Lastly, slowing employment growth clouds the outlook for the office sector. January broke a long stretch of job creation in the U.S. with employment rolls shrinking by 17,000 jobs. And unemployment recently jumped from 4.7 percent to 5.0 percent.

So what happens now? In our view, we think that we'll see a lot fewer announcements for mixed-use projects, especially as securing financing has become a ticklish proposition. But it will also be illuminating to watch how existing mixed-use projects fare. We think the concept remains strong and worthwhile. And we hope it weathers a downturn well.

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