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Developers Head Back to the City

As the credit crunch tightens its grip, planned retail projects in suburbs, exurbs and small towns — ranging from regional malls to little strip centers — have been falling apart for lack of financing. And no wonder, since the halt in residential subdivision development has left greenfield retail sites around urban peripheries looking like long-shot investments.

Something funny is happening on the flip side, however. Urban retail has continued to thrive, even through the Wall Street tumult of September and October and the pullback in lending by big banks.

Developers backing massive billion-dollar urban renewal projects in which retail is slated to play a key role are pushing ahead on construction. Smaller deals are getting done, too.

Jeff Fuqua,president of Sembler Co., based in St. Petersburg, Fla. doesn’t foresee the market shutting down. “Discounters and grocers and other big-box retailers are all still doing deals, just at a slowed pace,” Fuqua says. “Right now urban settings look much more attractive to retailers than the suburbs.”

Retail in big cities, a notion scorned 10 and 20 years ago by national chains fearful of high crime and low demographics, is in vogue. Not even banking meltdowns can shake the hunger of names such as Target, Wal-Mart and Costco to become more established in major markets.

“The big-box chains want more stores in Chicago and other big cities around the country,” says John Melaniphy, president of retail consultancy Melaniphy & Associates. “It’s the sheer number of people that are bringing them into the city. The sales volumes in urban stores are incredibly good in many cases, merchants are finding.”

Right time,right place

Paul Travis, president and CEO ofdeveloper Washington Square Partners in New York, recalls that “two decades ago it was difficult to persuade any big retail chain to come to New York. Everybody was very nervous about large cities.”

But the old perceptions have changed as a new generation of urban condominium development and urban blight cleanup have made cities inviting again. Travis installed Target in a 230,000 sq. ft. center called River Plaza in the Bronx two years ago on the nine-acre site of a former warehouse and auto repair facility.

The $70 million project is fully leased today. It attracts a vast array of shoppers coming from such disparate surrounding neighborhoods as wealthy Riverdale and working-class Washington Heights.

River Plaza was such an unqualified success that Travis has moved on to his latest project. It is a 200,000 sq. ft. retail center in Jamaica, Queens, paired with 400 apartment units in a planned 12-story tower on a modest two-acre site previously occupied by a warehouse that had been vacant for 30 years.

Travis expects to be at least 70% pre-leased when he breaks ground on the $300 million project next year. “There is a whole stable of retailers today who understand the demographics in markets like Queens and the Bronx, and they’re eager to come into these places,” he says.

Travis won’t identify his lenders on the Queens project, but he does say that the 70% pre-lease threshold is a key in allowing a project to move forward with financing. And urban developers are reporting that tenants aren’t hard to find, in spite of the headlines about a slow Christmas shopping season ahead.

The nation’s No. 2 drug store chain, Walgreens, has opened 550 stores this year. The company has announced that its construction schedule will be scaled back, but it still intends to open 350 stores a year through 2011. Other chains have made similar announcements: they’re slowing expansion, but not quitting on it.

Consider the case of Menard Inc., a regional home-improvement center based in Eau Claire, Wis. The company is currently putting up a huge 170,000 sq. ft. hardware emporium on the west side of Chicago on the site of an old cosmetics and soap factory.

Drug and grocery stores have signed on to flank Menard, which has told local brokers it wants to put up a half-dozen more stores around Chicago’s downtown. Meanwhile, the company has put projects in emerging suburbs on hold.

How will Menard pay for this? The privately held company’s CEO, John Menard Jr., is reputed to be worth more than $5 billion. The company is so flush with money that it finances most of its own expansion out of cash flow.

Michael Bell, the president of real estate advisor Pentad Realty Inc. in Chicago, is in the hunt for Menard sites himself. He’s also searching for sites for Walgreens. “Walgreens has a lot of outmoded urban locations that lack the space for a drive-through,” Bell says. “So they’re looking for newer sites that give them more space.”

Execution is key

Is money for expansion a problem? Bell says no. Retailers are working with smaller banks in many urban neighborhoods to finance new stores, and they’re also working with private-equity sources.

“I have a consortium of European investors I’m working with who have $1 billion to invest in the U.S. retail sector,” Bell reveals. “They’re willing to put $50 million or more in individual deals. As bad as the American economy is right now, the rest of the world still wants to invest in our real estate.”

The key to the latest spate of urban investment has been the growing willingness of municipalities to grant incentives that fill in financing gaps. In Yonkers, N.Y., Cappelli Enterprises is leading a partnership that aims to build the $1.5 billion River Park Center on top of a blighted parking facility owned by the city. Ultimately, the project will include a 750,000 sq. ft. shopping center, 6,500-seat minor-league ballpark and offices, a hotel and residential units.

Yonkers is expected to soon pass a local ordinance extending $200 million in tax-increment loans to Cappelli to allow the project to begin construction next spring. The money will pay for roads, sewers and parking. The state is expected to chip in another $80 million in tax credits linked to the site’s brownfield status.

Joseph Apicella, executive vice president with Cappelli, says he is working with a consortium of banks that have stood behind River Park. “Banks are still willing to lend money on quality developments that are well located,” Apicella says. “However, this project wouldn’t go forward without the city and state grants.”

Outsized ambitions

Urban development typically involves redevelopment, and it takes a special kind of entrepreneur in some cases to see the possibilities in a sea of abandoned factories, crumbling apartment buildings and graffiti-strewn strip centers.

Sometimes new retail gets built on top of old retail, which is the case in Los Angeles where two years ago in February 2006 Capri Capital Partners LLC acquired the Baldwin Hills Crenshaw Plaza, a tired mall south of Los Angeles International Airport.

Capri Capital Partners plans to take the existing 860,000 sq. ft. center, anchored by Macy’s and Sears and Wal-Mart, and upsize it to 1.5 million sq. ft. with the addition of a lifestyle wing and a movie theater and restaurants. But that’s only the start.

The company also intends to develop up to 1,000 residential units — a mix of apartments and condos — in buildings as high as 12 stories, along with a 400-room hotel and a 150,000 sq. ft. office building. All this will go on the original 43 acres, with a projected cost of $750 million between now and completion in 2015.

The retail portion of this mixed-use project is going up first, with construction kicking off next year. “Retail is the catalyst. It is what will make marketing the apartments and offices easier later on,” says Rosalind Schurgin, CEO of the Festival Cos., project manager and developer. Festival has managed the mall for the past five years.

Schurgin concedes that she could have left the existing mall, which is 98% leased, untouched and continued to operate it as it is. But she, like many other urban retail developers today, had outsized ambitions from the start. “We’re not creating a few stores here. We’re creating a whole neighborhood,” she says.

Bullish on the inner city

Chicago-based Capri Capital Partners is a real estate investment management firm with $5.3 billion in assets. The firm has demonstrated that it isn’t afraid of the meanest streets.

Capri Capital is planning a 120,000 sq. ft. grocery-anchored shopping center called Metropolis on Chicago’s south side, adjacent to the notorious Robert Taylor Homes public housing project that was recently torn down. The blighted neighborhood has no supermarket, pharmacy or bank for many blocks in all directions.

“We’re in the inner city, but we’re also in the path of new growth,” says Stephen Lane, a Capri partner who heads its asset management division. He figures that in a city’s worst neighborhoods, the real estate can often be acquired so cheaply that “the downside risk is very minimal.”

The projected is slated to break ground in the fall of 2009, with a completion date of fall 2010.

Array of new entrants

Many of the new-breed urban developers are suburban converts. Chicago-based Joseph Freed & Associates LLC, for instance, started building strip centers in the late 1960s and spent the next three decades working in the suburbs.

But the company jumped into Chicago in a grand manner in 2001 when it acquired the historic flagship Carson Pirie Scott department store on State Street, a downtown retail avenue suffering from a dowdy image.

Then more than a year ago Freed took control of the long-delayed Block 37 project nearby. It will contain 280,000 sq. ft. of retail space within a mixed-use complex that includes offices, hotel, residential units and a transportation hub.

Carsons is gone and Freed is giving the old building a total makeover. Twenty years ago Block 37 couldn’t get off the ground because no retailers wanted to be a part of it. Today signed leases are cascading in from such elite names as Godiva Chocolatier, Aveda skin care and Muvico movie chain. A gourmet grocer has signed on to take part of Carsons’ space, too.

The City of Chicago established a theater district, a new park along Lake Michigan and downtown student housing, all in the past five years and within shouting distance of State Street. Meantime, there has been a binge of condo construction, too, bringing new residents to the area.

“The economics downtown weren’t right for Block 37 in the past,” says Paul Fitzpatrick, Freed’s senior vice president of development. “But the pieces are in place now. Retailers love the varied demographics around State Street. We have local residents, office workers, tourists, students and people at night seeking entertainment. They’re all wrapped up in one very dense area. In the suburbs, by comparison, any shopping center is usually aimed at a single demographic in a far less dense neighborhood.”

Reversal of fortunes

Michael Beyard, a senior resident fellow at the Urban Land Institute in Washington, D.C., believes the polyglot around re-emerging urban centers like State Street in Chicago represents a momentous societal shift. “The shopping mall was invented after World War II, and ever since then we’ve been expanding farther and farther into open spaces around the suburban fringe,” Beyard observes.

But now there has been a pullback, Beyard believes. “The suburbs are over-served with stores today. Retailers are moving back to the urban core to be part of something significant. People no longer are going out to just shop; they are shopping when they go out.”

The “going-out part” involves more complicated social interactions, like theater and parks and schools and architecture and history, says Beyard. “Cities provide all that in an important way.”

In Washington, D.C., where Beyard is located, as recently as 10 years ago Seventh Street stretching north of the National Mall was usually empty after dark. Then came along the new Verizon Center for basketball and hockey, followed by a convention center nearby.

Then the city created a district along Seventh Street for small playhouses. Retail has flooded in, with developers like Western Development Corp. of Washington and Hines Interests LP in Dallas getting involved in various projects. Today the avenue is crawling with traffic and shoppers at all hours.

“The transformation has been amazing, and it’s all occurred within the short span of five years,” says Ari Firoozabadi, associate vice president of investment at the Washington office of Marcus & Millichap. “It was clearly the convention center and the Verizon center that made this possible. Anchors are important in any redevelopment program.”

Years ago developers, even if they were bold enough to consider retail, would look at dense urban neighborhoods and decide there was no place to build. That mindset is changing as the economy continues to be de-industrialized.

Deep pockets required

Sembler Co. has embarked on a 52-acre, mixed-use project called Town Brookhaven, located on the north side of Atlanta. It will include 500,000 sq. ft. of retail, 1,000 residential units and 150,000 sq. ft. of offices. The firm undertook a painstaking assemblage of seven properties, encompassing mostly old and outmoded 1940s-era apartments, before breaking ground last year. The total investment is $500 million. Fuqua, president of Sembler, says the development landscape is growing more challenging.

“Two years ago we could bring just 10% of our own money to a deal. Now lenders are going to require 25% equity from a developer, which will make urban projects more difficult to work,” he says.

“We may rely more on public financing help in the future. Either that or land prices are going to have to go down, which hasn’t happened yet.”

There is less likelihood a retailer will make a mistake in an urban market, Fuqua says, because there is so much more population density than in the suburbs. “The urban markets have less retail competition. In the end, it comes down to tenants wanting to go where the people are.”

H. Lee Murphy is based in Chicago.

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