With regard to commercial real estate, when does a trend become a stable asset class? The answer is not in any sudden visibility on the local landscape. Instead, it occurs when institutional investors discern value in a given development type. This is why a massive mixed-use development called Avalon, in Alpharetta, Ga., seems to have become the poster child of mixed-use projects.
This 1.1 million-square-foot development of Cincinnati-based North American Properties was sold to PGIM Real Estate, an investment arm of Newark, N.J.–based Prudential Financial, in 2016. Though the sum was undisclosed, North American Properties insiders did call it the largest single-asset transaction in the history of the Atlanta region. PGIM was a busy if not a pioneering buyer of modern, mixed-use developments. In 2015 the firm acquired Mercato, a mixed-use lifestyle center in Naples, Fla., for a reported $240 million. Both these projects sold at strong pricing levels, according to Danny Finkle, a senior managing director in the Miami office of HFF and a co-head of the firm’s national retail practice group.
“Successful mixed-use projects are highly synergistic,” said Finkle. “On a price-per-square-foot basis and on value at the time of sale, valuation and underwriting account for the short- and long-term benefits of the multiple uses within the property. For that reason, successful mixed-use projects tend to be in high demand from investors and trade at a strong price level.”
Mixed-use developments are unified communities generally built around retail and with added-on real estate types: office, multifamily, single-family residential, hotel or medical offices. Traditional urban high-rises are forms of mixed-use with ground-floor retail and multifamily or office space above. Transit-oriented developments are often mixed-use, but most of the newer projects are either ground-up (sometimes called “place-making” developments) or else redevelopments of existing structures, such as an old mall.
In Atlanta, a plaza offering retail, cafés and entertainment will be the glue binding Colony Square’s other uses together
A big part of what has driven Prudential’s decisions regarding large mixed-use projects such as Avalon is the retail element. “Depending on where the mixed-use is located, we see retail rent premiums 15 percent to 25 percent above what one would expect in a given trade area,” said Ryan McCullough, a real estate economist at CoStar Portfolio Strategy, a Boston-based affiliate of CoStar Group. “In Avalon, asking rents were above $45 a square foot, and that was way north of what we would expect to see in suburban Atlanta, where rents were closer to $25 to $30 a square foot.” Other segments of Avalon performed equally well. Multifamily rents were at about $1,700 to $1,800 per unit, whereas the typical Atlanta suburban apartment rent was closer to $1,200 per unit, according to McCullough.
When a mixed-use project is done properly, people want to live and work there because of the amenities, such as retail, says Suzanne Mulvee, director of research at CoStar Group. “When you add these other pieces, the retail performs better than average,” Mulvee said. “The components combine, so when a mixed-use project goes to market, investors think about strong multifamily, office and retail cap rates. But the real value is that you are applying strong cap rates against better cash flows.”
North American Properties got into mixed-use back in 2010, when, coming out of the recession, it acquired Atlantic Station, in midtown Atlanta. Through the repositioning of that property, North American Properties acquired a mixed-use skill set and an affinity for these types of projects. The firm’s current projects include the redevelopment of Colony Square, in Atlanta; Revel, a 110-acre ground-up development in Gwinnett County, Ga.; and Riverton, a 418-acre ground-up development in Sayreville, N.J., that North American Properties calls the largest mixed-use development in that state’s history. The firm, which continues to bet big on mixed-use, with some $3 billion in development and redevelopment projects this year, no longer builds straight retail.
“It all revolves around retail: The street-level energy and commerce is the backbone of Main Street U.S.A. and of any successful mixed-use development”
“People who have gotten mixed-use right have invariably been retail developers,” said Mark Toro, a North American Properties managing partner who is a co-founder of the firm’s Atlanta office. “Understanding the requirement of retailers, restaurateurs and the street-level experience is the absolute key. If you get the street right, everything else takes care of itself. It all revolves around retail: The street-level energy and commerce is the backbone of Main Street U.S.A. and of any successful mixed-use development.”
North American Properties is hardly alone among big institutional firms committed to mix-use development. Some shopping center REITs, too, see a future in such projects. New Hyde Park, N.Y.–based Kimco Realty Corp., which owns roughly 450 shopping centers, has been active over the past several years assessing the best possible uses for each of those assets. “Mixed-use opportunities, whether it be adding residential, office or hotel components, or just reconfiguring retail itself to adapt to what the customer is looking for is, to us, what increases the value of our real estate going forward,” said Kimco COO David Jamieson. “We are currently working on $1 billion of development and redevelopment and have $2 billion in [future] development.”
Kimco is working with a local multifamily developer, Alterra Property Group, at its Lincoln Square property, in Philadelphia, doing an adaptive reuse of Lincoln Square’s historic train station into what is to be Philadelphia’s first Sprouts Farmers Market. And the company’s redevelopment of the 325,000-square-foot Pentagon Centre, in Pentagon City, Va., will include two residential towers.
Kimco and Alterra Property Group are converting a historic train station in Lincoln Square, Philadelphia, into a Sprouts Farmers Market
“What’s unique about Kimco is that, because of the sheer number of sites we control, we have the opportunity to layer in these projects over the next 10 to 20 years, continually adding to the value of the portfolio,” said Jamieson. “We have the raw materials. Markets have matured around us, and that has given us the opportunity to work through our portfolio in a thoughtful way. You want to invest in what will sustain and endure. In the areas where we own real estate, the markets are clearly changing around us, and we have to change with it. You have to continue to reinvent yourself — adding residences or offices, adding entertainment, reconfiguring, or just bolstering curb appeal.”
In Jacksonville, Fla., retail REIT Regency Centers Corp. is scrutinizing its portfolio of roughly 425 properties, including some California shopping centers acquired in the Equity One deal of last year. One of the more successful properties is Market Common Clarendon, in Arlington, Va., a mix of retail and residential. There, Regency is redeveloping a former office site into mixed-use office and retail. The firm is also entitling a group of properties in California, from San Diego to San Francisco, for mixed-use.
“Successful retail still has to be driven by the attributes of premier location, such as population density and income levels, not just the fact that it is in a mixed-use development,” said Rafael Muñiz, senior vice president of mixed-use development in Regency’s Los Angeles office. “As a firm, we are very focused on being grocery-anchored, so our projects are going to have this feature. When you add residential, it is a big plus. You don’t have to have a full-size supermarket — you can go to a small grocer like Trader Joe’s, or a medium grocer like Sprouts. Other features on the retail level include a variety of restaurants and services, such as dry cleaners, pet stores or nail salons. Fitness uses, both full-service gyms and boutique offerings like cycle and yoga, have become very popular.”
Revel is a 110-acre, ground-up project in Georgia’s Gwinnett County
Although mixed-use has certainly gained the attention of developers and investors, the strategy is not necessarily easy to implement. These projects are more complicated than, say, a straightforward retail center, and with such complications always come risks. Among retail companies that want to redevelop existing shopping centers, in particular, almost everyone acknowledges that mixed-use development will not save every failing retail property.
“For high-quality centers, those that are driving traffic with good retail tenants, the goal is to create a place where people want to sleep, work and play — in effect, little communities,” according to Matt Kopsky, a REIT analyst at St. Louis–based Edward Jones. “It takes a good location, for starters,” Kopsky said. “For some of the ‘B’ and ‘C’ centers, whether it is a strip center or a mall, adding mixed-use is not going to be a solution that will save them. You have to provide capital for those big projects, and that would be difficult.”
“It is a big risk to take on a major project like mixed-use, and there is no guarantee for success”
If mixed-use is to work, it is necessary to have the demand to support it, observes Melina Cordero, CBRE’s head of retail research for the Americas. “If you have an ailing mall in a more rural area, or where the population has declined, building apartments or offices is not going to solve that problem. It really depends on the demographics of the location.”
Should a developer decide to add apartments to former retail space, that could take several years to build and to lease, and an economic downturn could ensue in the interim, observers say. Thus, there is a lease-up risk, which is occurring in certain residential markets at present, and added to this are construction risks and the challenges of raising capital, observers note. “It is a big risk to take on a major project like mixed-use, and there is no guarantee for success,” Kopsky said.
Counterintuitive as it might seem, some say, a ground-up development is often easier than the redevelopment of an existing shopping center. “The challenge for a ground-up is finding the opportunity and tying up the property,” said Muñiz. “When you have an existing property, the good news is that you don’t have to compete for the dirt. On the other hand, the challenge is that you have to deal with in-place tenants that might have long-term leases. Even at some of our best centers, we might not be able to get at redevelopment for 10 years or more, and in the meantime, you have to be sure you are making the right lease decisions as you plan for the future.”
In a lot of instances, existing tenancy and lenders are big hurdles, says Toro. “If you need a department store or other tenant to approve an addition or other uses, that can be a problem,” he said. “If you have debt on the property, [that] may also require approval of existing lenders. You would think everyone would be OK with changes, but if the property has a securitized loan, it’s very complicated to work through the approval process.”
The success of a mixed-use development depends on the synergy of all the pieces — retail, residential, office, entertainment — working together to empower the other asset classes, which is why rent levels are higher and there is a premium to these developments. Getting there, however, is the test, and that is what Cordero calls the chicken-or-egg problem. “You need the retail on the ground floor to attract and charge higher rents for the multifamily units above,” she said. “You can’t charge a premium on the rent if there is no retail on the ground floor. At the same time, retail is not going to want to come in if there is no one living there yet. So what happens? Developers offer rent discounts to get retail onto the ground floor early. What we are seeing are a lot of creative leases, whether it is temporary leases, percentage increases or landlords contributing to tenant improvements.”
“People who have gotten mixed-use right have invariably been retail developers”
Not every developer has expertise in all asset classes, so the way mixed-use is typically constructed and managed is through partnership. A Green Street Advisors study of mixed-use and strip center REITs reports that “mixed-use projects are difficult; partners may help, but some control is lost.” Indeed, says Mulvee, “most deals are through partnering. The projects are often led by retail developers and operators. They bring in the best experts for multifamily, office or hotel.” Kimco brought in a local residential developer as a partner on its Lincoln Square project in Philadelphia, and Bozzuto Development on its Pentagon Centre.
North American Properties has taken a different tack. It is developing in-house expertise in asset classes besides retail. “We do the retail, multifamily, loft office and even single-family developments,” said Toro. “What we have yet to do is development of class-A office buildings, but we are developing capabilities in leasing and management.”
As the Green Street study notes, “mall REITs have been active in mixed-use for years; shopping center REITs not so much. Only three strip center REITs are engaged in major mixed-use projects. It is unclear if future mixed-use projects of significant size will be undertaken by the [strip center] REITs.”
If strip center REITs decline to leap into the mixed-use playing field, well, that could be unfortunate. “The most successful mixed-use projects are retail-centric,” said Mulvee. “You have to get the retail right first.”
By Steve McLinden
Contributor, Shopping Centers Today