With anchor and small shop tenants going dark, many neighborhood and community center owners are attempting to redevelop properties to attract new blood. It's a smart idea. But as with much else in the retail real estate business, redevelopment now comes with a few new challenges.

Redevelopment efforts are often being stymied by the difficulties owners face in lining up financing. And even if an owner has enough cash on hand to fund a project, the gruesome tenant landscape, with many chains contracting and few growing, means that owners are only moving ahead if they have some retailers in hand. Speculative redevelopments are not taking place. As a result, much of the redevelopment occurring on smaller centers (500,000 square feet or less), are being completed by owners with strong balance sheets and deep pockets who have tenants locked in place.

In Tucson, Ariz., for example, Holualoa Arizona Inc. is redeveloping Campbell Plaza, a 200,000-square-foot neighborhood center just one mile from the University of Arizona's main campus. The firm, also based in Tucson, is self-funding the more than $5 million redevelopment because it was unable to obtain funding from its primary lender, according to Holualoa's senior vice president Mike Perlman.

Anchored by a 45,000-square-foot Albertson's grocery store, Campbell Plaza was 25 percent vacant when Holualoa hired Nancy McClure, a first vice president in CB Richard Ellis' Tucson office, to revamp the center. Despite its infill location, it had lost a number of small shop tenants—primarily mom-and-pop operators—and had very few credit-worthy tenants.

With McClure's help, Holualoa signed leases with Staples and Ross for 21,000 square feet and 30,000 square feet, respectively. The new stores, which will serve as junior anchors for the center, required the firm to relocate an 18,000-square-foot Ace Hardware, terminate leases with several small tenants, and demolish several thousand square feet of small shop space. The center also has benefited from a minor façade renovation.

Today, Campbell Plaza is 100 percent leased, primarily to national credit tenants. "The redevelopment has increased the center's NOI, credit-worthiness, and overall value," Perlman notes. But, the redevelopment wouldn't have been possible if Holualoa's lender hadn't approved the project and the firm hadn't been able to pay for the construction out of its cash reserves.

"Sometimes just slapping on a coat of paint or putting on a new façade isn't going to be enough," McClure says. "We've taken this neighborhood center in the heart of Tucson, where there is no more land for new development, and turned it into a mini-power center."

Projects spur lender anxiety

The biggest factor shaping the redevelopment landscape is debt. Obtaining funding for redevelopments is almost as difficult as obtaining capital for new construction, according to Duane Stiller, president of Woolbright Development Inc., a Boca Raton, Fla.-based firm that specializes in redevelopment of neighborhood and community centers.

Banks, pension funds and life insurance companies are all wary of lending on most retail projects, regardless of whether they have the capital to do so, Stiller says. Lenders see too much risk in the retail sector and instead are far more interested in increasing their exposure to other commercial property types such as multifamily, health care and self-storage.

Many owners with redevelopment projects in the works have been forced to fund their projects out of their own pockets or by drawing on already established lines of credit. Woolbright, for example, is negotiating with Ross and Bed, Bath & Beyond to backfill a vacant Winn-Dixie in one of its Orlando shopping centers. Stiller expects redevelopment to cost $3 million—money Woolbright will have to spend itself rather than lining it up as financing.

However, while owners may prefer to fund redevelopment through debt, a cash infusion could have the added draw of proving to tenants an owners' commitment to a project. "Retailers are looking for the owner to put the capital in because they don't have a lot of excess capital," Stiller says. And, he's willing to make the investment because the prospective tenants will just go somewhere else if he doesn't. "In Orlando there are a whole lot of empty boxes they can choose from," he adds.

The conservativeness of lenders extends beyond their willingness to finance redevelopments. In some cases, lenders are even preventing owners with existing mortgages from modifying centers. Owners may make the case that redevelopment could increase occupancy, NOI and the value of properties. But in the short term lenders see redevelopment as a risky proposition because of the up-front costs and how it could destabilize a property during construction. This is especially the case for redevelopments that would require small shop space to be demolished to accommodate larger tenants. Lenders also see the process of reconfiguring small shop space and shifting the tenant mix as part of a redevelopment project as risky. Even if a new anchor has committed to the center, existing tenants may have to be relocated and re-leasing the space could be difficult.

Stiller points to a recent redevelopment Woolbright completed in Lantana, Fla. The firm backfilled a vacant Publix box with a T.J. Maxx and HomeGoods combo store and expanded the center by 12,000 square feet to accommodate the new anchor. At the same time, Woolbright signed a 28,000-square-foot Ross to backfill an empty Walgreens space. The firm bulldozed the 15,000-square-foot Walgreens and part of the small shop space to make room for the new Ross. In today's climate, however, Stiller doubts the redevelopment would have taken place because of lenders' attitudes towards redevelopment. "If we had to start the process today, no lender would go for it even though it would be in their best interest," he says.

Expansions, location drive redevelopment

Many shopping centers across the nation are struggling with rising vacancies. The ongoing recession has taken a toll on even the strongest of retailers, forcing many retailers to close stores, seek bankruptcy protection or, worst, liquidate entirely.

Retail vacancies have been rising for several quarters, even at well-located centers. On a national basis, the vacancy rate for community and neighborhood centers was 10.0 percent at the end of the second quarter 2009—the highest it's been in 17 years according to Reis, a New York City-based research firm. The vacancy rate is expected to increase over the next four years, reaching 12 percent in 2012 before it drops to 11.2 percent in 2013.

Many shopping centers are going through transformations because they've lost anchors and small shop tenants. Owners with empty space often believe expanding and reconfiguring the center is the only way to preserve value, yet few of them are tackling speculative redevelopment projects because the current economic environment has stalled retail expansion. They are waiting until they have lease commitments in hand.

But, there are fewer retailers to backfill empty space, especially big box space vacated by retailers such as Linens 'n Things, Circuit City, and Winn-Dixie. Even growing retailers continue to be cautious about their expansion plans, committing to fewer store openings in 2010 and negotiating favorable leases.

"There are fewer redevelopment opportunities because retailers are being very cautious with their capital," says Don Casto, a partner with Casto, a Columbus, Ohio-based retail owner and developer. The firm is focused only on redevelopments that are driven by expanding anchors. "When the capital markets were easier, we did 'defensive' redevelopments—if you build it they will come—but we don't do that now," Casto says.

Casto is certainly not alone; in fact, much of the redevelopment activities today are tied to anchor tenant expansion. In Boulder, Colo., for example, Regency Centers Corp. is in the middle of a redevelopment for Crossroads Center, a 133,139-square-foot neighborhood center anchored by a Whole Foods and Barnes & Noble.

Whole Foods' desire for a newer, larger store was the catalyst for the center's redevelopment, according to Matt Booth, vice president and regional manager for Regency Centers. "Whole Foods was already extremely successful in the center, and the Whole Foods team thought it could be even more successful in a larger format," he explains.

To accommodate Whole Foods' expansion from its existing 39,000-square-foot location to a 65,000-square-foot store, the Jacksonville, Fla.-based REIT relocated Barnes & Noble to a freestanding building within the center's footprint. It demolished an old movie theater and liquor store for the new bookstore, which will occupy 30,000 square feet, a 50 percent increase over its old store. The newly expanded Whole Foods is scheduled to open in October 2010, while the Barnes & Noble will open in August 2009.

In addition to Crossroads Center, Regency Centers is tackling a far more complex redevelopment project in Brea, Calif. The 229,000-square-foot center, Brea Marketplace, is situated across the street from Brea Mall in a dense, infill location within Southern California, according to Erwin Bucy, senior vice president of investments of Regency Centers.

Bucy says Regency Centers was willing to move forward with the redevelopment of Brea Marketplace, which was only 60 percent occupied prior to the redevelopment, because of its unique and desirable location. "Tenant demand is stronger for infill locations," he says.

Regency Centers was able to sign Target, Sprouts and Beverages & More! as anchors for the center and demolished about 70 percent of the existing center to make way for the new tenants. Target will open a podium store this October, while Sprouts and Beverages & More! already are open.

At 358,000 square feet, the redeveloped center is much larger than its original footprint. Moreover, the center should be 100 percent leased shortly after Target opens, Bucy notes. "The goal is to make a B asset into an A asset by increasing the credit quality and increasing the strength of the tenant mix," he says.

Even tenants are taking a leap of faith when they commit to a center that is scheduled for redevelopment. "Our regional and national retailers want to make sure that, as a landlord, you have the ability to continuously re-invest in the centers," says Jodie McLean, president and chief investment officer at Edens & Avant. The Columbia, S.C.-based retail property owner and developer has several properties under redevelopment currently and is funding most of them through cash or existing lines of credit.

Although the capital crunch makes it difficult to fund projects, many owners feel the current environment is ideal for redevelopment. "It's foolish not to look at your assets and figure out how to create more value," says Regency's Bucy. "A lot of centers are encumbered with older leases with low occupancy costs and by redeveloping assets, you can increase income and improve value. Even today, there are very clear financial reasons for redevelopment."