Rehabilitation, Redevelopment And Repositioning In Established Markets
These three R's of the property investment cycle are playing an important partin a profitable investment strategy.
John Pantone

Pantone

The strategies of acquiring newly constructed and leased facilities or purchasing entitled sites for ground-up development have become extremely competitive — pricing is at a premium and offers little room for the value-added strategy. Finding redevelopment options under replacement value is an attractive diversification strategy in this market climate, and one that is building in popularity across the nation.

Identifying these opportunities requires a blend of science and art available to most experienced developers. The science is reviewing regional locations, demographic details and traffic patterns that identify viable, existing location candidates for infill redevelopment or repositioning. It essentially mirrors almost exactly the same process for new ground-up development. The art comes in adopting the bones of the existing structure, seeing a future tenant base, and reconfiguring that property to meet those needs.

Since the majority of existing centers meeting a redevelopment or repositioning business plans are in mature communities, there is a pre-set demographic profile to assist in building the performance models and attracting tenants seeking access to a new customer base. Effectively identifying well located but underperforming assets in target communities is the next step. In today's marketplace, opportunities abound.

From the Northeast to the Midwest, and from the South to the West Coast, retailers have been departing legacy facilities, deteriorating downtowns and outdated strip malls in ever increasing numbers. They are seeking expansion markets and the efficiencies of build-to-suit operating platforms in newly constructed centers. They are forced into the departure trend by changing parking demands, outdated floor plates, shifting demographics and the de-malling trend that is creating outdoor lifestyle-driven layouts for many new developments. But even as retailers depart for these newer locations, there is still a population base in the communities they are leaving. Or maybe, as the case is in the more mature urban markets, there are structures that no longer function in the modern environment.

These trends have opened the door for the adaptive reuse of aging or outmoded properties, a task not always appealing to an owner or investor looking for a stable cash flow and the simplicity of triple net asset management responsibilities. But for an experienced developer with vision, determination and a good grasp of retail tenant needs, the chance to create value is extremely attractive. This in turn creates the diversification niche, wherein a developer or equity investor can keep a pipeline full and flourishing by adding a few of these infill projects, keeping nimble in an ultra-heated market.

While one might conclude that the reuse of older centers and/or re-tenanting of vacant boxes allows for open competition among any type of owner and investor interested in retail properties, this is not always the case. In fact, these opportunities typically require the same skills and expertise possessed by retail developers building ground-up properties, with a strong eye for servicing tenant demand and a design bent that creates the vision for the conversion to a new use format.

More and more developers are attracted to redevelopment projects, and particularly rehabs and repositioning of existing structures. The trend of smart development and a return to investment in urban or mature suburban cores have showcased the value of redevelopment investment opportunities.

As a joint venture equity investor, Buchanan Street Partners has had great success identifying redevelopment investment opportunities, with some on a pretty substantial scale. Country Club Plaza in Sacramento, California, was a project that involved the aggressive redevelopment of a 339,000-square-foot enclosed mall. When reviewing an adaptive reuse project, the key is identifying qualified sponsors to work in conjunction with us. In the case of the Country Club Plaza, Buchanan Street Partners formed a joint venture with Arizona Partners. The focus was on upgrading the interior spaces of the well located, 1960s-era mall positioned just 15 minutes from downtown Sacramento, to fit a more modern expectation. The addition of a food court, large atrium and reconfiguration of inline locations produced an exciting, vibrant new mall appealing to a roster of new, contemporary tenants while improving sales and visibility for the mall's original anchors, Macy's and Gottschalk's.

On another front, Illinois-based Pine Tree Commercial Realty, a regional developer of open-air centers throughout the Midwest markets, has taken advantage of the recent departure of Wal-Mart and Kmart from a number of locations in its target operating markets. While the company made its mark with new, secondary and county seat market located retail center development, it is beginning to fill its pipeline with creative redevelopment programs as well as its traditional ground-up projects.

After taking ownership of a former Super Kmart site encompassing 20 acres in Evansville, Indiana, Pine Tree immediately moved forward on reconfiguring the box as East Lloyd Commons. The building, which Kmart vacated in 2004 as part of a downsizing program, was completely gutted and renovated for four anchors, with new sub-divided spaces ranging in size from 25,000 square feet to 65,000 square feet. Pine Tree also included the addition of 22,000 square feet of new construction in its redevelopment program on the building's east side. The new space was designed as locations for smaller, inline shadow boutique shops, with spaces ranging between 1,000 and 5,000 square feet. The site was also re-entitled to offer a freestanding pad in the sizeable parking lot. New tenants operating at the center now include Michaels, Best Buy, Goodman's Department Store and Panera Bread Co., with other regional and local retailers.

“This is a really exciting area and the acquisition offered a great opportunity to recreate a well located retail center,” says Peter Borzak, a principal and founder of Pine Tree, referring to the center's location on the northwest corner of Lloyd Expressway and Burkhardt Road. “Evansville is the largest city in Southern Indiana. It anchors the tri-state area of southwestern Indiana, northwestern Kentucky and southeastern Illinois. Also, the retail corridors surrounding the project along Green River Road and East Lloyd Expressway offer the area's dominant shopping destinations, totaling more than 3 million square feet of retail.”

Among the numerous major national specialty retailers and discounters at other locations near this key intersection are Kohl's, Target, Linens ‘n Things, Dick's Sporting Goods, T.J. Maxx, Sam's, Wal-Mart Supercenter, The Home Depot, Staples and Circuit City.

That does not mean that there are not challenges to these investments. As Borzak says, “We have found that purchasing these vacant retail boxes has presented unique challenges with regard to construction issues. Retrofitting an existing building is more mysterious than ground-up construction, and there are usually more surprises. We have typically been building in higher contingencies for these deals.”

In general, many of these contingencies can focus on unforeseen removal of hazardous materials due to the age of the facilities, infrastructure not in line with original and potential tenant related redirects. “Once you get into the walls, reconfiguring the space, you just have to be prepared to find things that you didn't expect to see,” says Borzak.

Because of these mysteries and lack of existing cash flows, redevelopment properties do not appeal to many investors. Institutional capital is willing to pay aggressive cap rates for a long-term single-tenant or stabilized multi-tenant retail property, but it is not as willing to take on the risk and subsequent challenges of a vacant or aging property. This bodes well for the entrepreneurial owner/developer and the nimble equity investor that can capture the potential upside of the rehabilitated properties, and, at the same time, can mitigate the assumed risk through expertise, market relationships, operational efficiencies and on-the-ground foresight.

The fact that many vacant, aging retail locations are in mature urban and suburban environments in densely populated environments offers unparalleled opportunity for the right team. For the developer or owner with established tenant relationships, local market expertise, knowledge of environmental issues and construction expertise, reuse becomes almost the same blank canvas as a vacant patch of graded dirt, often at attractive savings compared to new development.

An even greater benefit is the general willingness, support and interest of civic officials in assisting the effort to return dormant or non-performing properties to the tax rolls. For example, Mid-America Development Partners has had tremendous success with a 220,000-square-foot retail center in the Chicago suburb of Homewood, Illinois, according to David Bossy and Michael Firsel, founders and principals of the firm. Formerly occupied by Jewel and Venture, the property had remained vacant for years. Yet it was well positioned in a demographically appealing community of stable, middleclass households. Mid-America, through extensive demographic research and a strategic marketing effort, was able to attract a roster of high powered brand names to the center pursuant to the overall renovation of the asset. Best Buy, T.J. Maxx, Bed Bath & Beyond, JoAnn Fabrics, a mix of sit-down and fast food restaurants, and a retail banking operation ultimately rounded out the final tenant mix.

The local city government supported the creativity of the reuse program. The vision was to create a mix of tenants appealing to a local void of home improvement, convenience and lifestyle retail options. Homewood's city council saw sales-tax rebate incentives for Mid-America as a way to potentially return an estimated $70 million to $80 million in retail sales annually to the local economy, not to mention adding employment opportunities to the community. While the new center was unable to completely utilize 100 percent of the available square footage due to a dead-space balcony on the backside of the property, ultimately the area's strong demographics and Mid-America's strong tenant relationships put the center at a fully leased operating capacity — and it was delivered at a cost approximately two-thirds of replacement cost.

In Redwood City, California, Buchanan Street Partners is underway on a joint venture with Blake Hunt Ventures and The Innisfree Company in the redevelopment of a full downtown city block known as On Broadway.

The project is located above a 580-space city-owned parking garage and is surrounded by more than 3,000 parking spaces throughout the downtown. Time and capital savings from the benefit of this existing capacity put the project ahead of the curve in terms of mitigating development costs.

Through its redevelopment program, civic leaders have indicated the desire to see Theater Way developed as a world-class outdoor dining and pedestrian environment, offering the chance for the redevelopment of On Broadway to become a landmark destination in the emerging “hot spot.” On Broadway is located across the street from the Fox Theater, which is one of the premier downtown live performance venues in the county. More than 300,000 people live within this affluent trade area bounded by San Carlos, Menlo Park and Woodside. Construction started in November 2004 with project completion scheduled for early 2006.

Ultimately, the three R's open the door to opportunities in a competitive marketplace. It's not so much that they offer a better strategy than new development, but taking on these types of projects does offer a chance to diversify a project pipeline with viable opportunities in an era of dwindling land resources and rising construction costs. The savings come from reuse of existing structures, but also in accelerated timelines, civic support, streamlined approval processes and built in customer bases for attracting retailers. In an era where smart development and New Urbanism are being pushed to the forefront of civic agendas, now is not a time to avoid redevelopment opportunities. For the capable investor, it is an open window of opportunity.

John Pantone is senior vice president overseeing principal joint venture equity investments for Buchanan Street Partners from the company's Chicago office.