When the Baldwin Hills Crenshaw Plaza center in south Los Angeles — long a poster child for the trials and tribulations of inner city retail — was put up for sale in late 2005, more than 20 firms were chomping at the bit to get the 20-year-old urban mall.

Included in the auction were some expected names — Johnson Development Corp., MacFarlane Partners and Capri Capital Advisors LLC — all of which have helped pioneer the idea that it makes good economic sense to invest in inner cities. But, more than a few traditional suburban mall owners also entered the fray, including Westfield Trust and General Growth Properties Inc.

Eventually, Capri Capital won out, paying $136 million on behalf of an institutional investor for the property in February 2006.

But the bidding war for a property that had sold three years prior for half what Capri Capital paid, shows just how far inner city retail has come in just a few short years.

“Inner city retail has become depeche mode,” says Bobby Turner, co-managing partner of Johnson Development Corp.'s Canyon-Johnson Fund. Canyon-Johnson used to have little competition in finding its deals, Turner says. But that's changed. “People are intrigued as they look for markets that are less competitive,” he says.

For Baldwin Hills, the sale was the culmination of a 20-year roller coaster ride. It started as a $120 million experiment to bring first-class retail to an underserved market. But it struggled for years to find stable footing, getting passed from owner to owner (see sidebar, p. 28). The turning point for the project was the addition of a three-story Wal-Mart in 2003, which generated interest from other tenants. Sales have grown from $200 per square foot to $500 per square foot — $150 above the national average.

Baldwin Hills — and other inner city successes like Harlem USA, and Gulfgate Center in Houston — are convincing a widening pool of players that investment in minority communities is a good bet. “It will increasingly become mainstream as retailers recognize that there are few other commercial real estate opportunities in this country of the magnitude these present,” says Capri CEO and Chairman Quintin Primo, III.

Meanwhile, the projects themselves are becoming more ambitious. Capri, for example, enlisted Skidmore Owings & Merrill to design its proposed Metropolis project in Bronzeville/Grand Boulevard neighborhood in Chicago, an area that has been ignored by national retailers.

The project calls for more than 1 million square feet of office, residential, retail and hotel space to be built. The $155-million first phase includes 150,000 square feet of residential condominiums, 330,000 square feet of retail space and 200,000 square feet of site improvements including an open-air park with fountain, a public library and underground parking.

By comparison, Harlem USA, which was built in 2000 and is credited for getting the latest wave of inner city development started, features 285,000 square feet of space and cost $66 million to build.

A lot of mainstream investors now want to be in urban in-fill locations, says Reza Etedali, whose firm created the RIG Urban Division to serve ethnic markets. Etedali brokered the last two sales of Baldwin Hills. “We're putting a huge focus on inner city in-fill, ethnically oriented properties,” he says.

General Growth, for one, is committed to aggressive inner city expansion. (Westfield did not comment and Simon Property Group Inc. said it has nothing in the pipeline.) Acadia Realty Trust, a REIT based in White Plains, N.Y., started an urban infill development program that has seven projects all around New York in the works in the Bronx, Westchester, Washington Heights, Brooklyn and Queens.

Chicago-based General Growth plans shopping centers in Baltimore, Detroit and the South Side of Chicago, says Lyneir Richardson, General Growth vice president of urban land development.

And it's looking for more opportunities. “We want to find areas where we can build 250,000- to 400,000-square-foot shopping centers anchored by a Target or Wal-Mart or a grocery store or JCPenney,” he says. General Growth also wants to take its traditional tenants with it into the urban core.

What investors have concluded is the inner city represents the next frontier. That's because most urban core markets are dense, yet lack enough retail to support residents' needs. These areas are begging for development, proponents say.

In 2002, the last year for which data are available, inner city shoppers went outside their neighborhoods to buy $42 billion in goods, or 25 percent of the total $122 billion retail demand of those consumers, according to a study for the Boston-based Initiative for a Competitive Inner City by Boston Consulting Group Analytics with Claritas Inc. That gap — bigger than the retail market in 44 states — was up from $25 billion a decade earlier.

“There is still significant leakage,” says Primo. “Millions of dollars have to be spent to stop the drastic flow of spending outside these areas.”

Toward that end, in fact, billions have been earmarked for inner city development. Much of that money will be spent on mixed-use projects that revitalize entire neighborhoods, according to developers. One company alone is set to raise $1 billion for urban projects and MacFarlane already has $2.2 billion to invest. Meanwhile, DLC Management Corp. has joined with G.L. Blackstone & Associates to form DLC UrbanCore LLC and is sitting on $100 million in capital.

Great benefits

For those that launch projects, the benefits can be enormous. DLC UrbanCore is meeting and exceeding its hurdle rates of 13 percent returns, according to G. Lamont Blackstone, a principal in UrbanCore. And Victor MacFarlane, CEO of MacFarlane Partners says the return rate for an initial $50 million (of a total $3 billion) invested by the California Public Employees' Retirement System was 30 percent in 1996.

There are other rewards. Harvard Business School professor Michael Porter, who founded the ICIC, told leaders at its annual conference in September that as inner city demographics better reflect the U.S. population, retailers who do business there early will be the best prepared for a changing population including more Hispanic and African-American shoppers.

“The suburbs are a dinosaur in terms of the future demographic of America,” Porter said. “It's the inner city that's mirroring the future demographic. If you're a retailer and can't figure this out, you're a dinosaur. You're going to be serving a shrinking market.”

So developers of all stripes are carefully scouting areas to determine where the combination of density and per capita income adds up to profits. Harlem, the Bronx, Boston and San Diego are among the proven markets, says Mark Bickenbach, a consultant with the Boston Consulting Group in Chicago. But even some of the biggest, most successful markets, like Harlem, require considerably more investment.

San Francisco-based MacFarlane Partners is considering investing in Seattle, south Florida, Phoenix, Dallas and Denver. Turner sees Texas and Florida as two of the prime areas for development. Specifically, he cites Phoenix, Tucson, Dallas, Fort Worth, Austin, Tampa, Miami, Fort Lauderdale and Jacksonville as growth cities. Grid Properties agrees on Jacksonville, but says it's hard to put together a large enough site. “We've been looking for 10 years,” says Greenwald.

Pittsburgh, Philadelphia and Detroit, meanwhile, are flat, says Bickenbach.

One issue that has kept mainstream developers and retailers out of African-American and Hispanic neighborhoods is that a primary concern in site selection is household incomes. But companies make a mistake when they consider just the per capita income of area families without considering the population density, says Turner. “You need to take the number of households and multiply that by income to figure out what the density of spending is,” he says. “That's a much more meaningful metric.”

Staples Inc. agrees and has changed its policy accordingly. “By looking only at the number of potential customers, we strip our demographic information of everything that has traditionally been used to justify under-serving markets,” says John Barton, executive vice president, real estate for Framingham, Mass.-based Staples. “This is an incredible advantage for us.”

“Inner city stores are among our top performers in the chain,” says Barton. “They operate at a faster pace because they serve high volumes of customers.”

So why isn't there more mainstream development right now? Retailer reticence is cited as the main holdback. Many national chains remain conservative about operating outside their comfort zones, says MacFarlane. Many perceive that there are greater security problems and higher pilferage in urban centers.

To be sure, developers and retailers can't just take their suburban model and plunk them down in urban centers. Too many retailers try to analyze inner cities with market analysis models that have been designed for suburban markets, Blackstone says. As a result, they don't understand the politics, safety issues, merchandising, operating systems and underwriting required in ethnic communities, he says.

The result can lead to mainstream companies and inner city residents “speaking different languages,” agrees MacFarlane. “No one has bothered to understand what buying preferences and needs are. It's just like if you're going to China, you try to understand the market needs there.” It helps to work closely with community leaders, he says.

One example of different spending patterns by race, discovered by Johnson Development, is that the average African-American consumer spends 1.5 times what Caucasian customers spend on food at the movies. That, says Turner, is because African-American families tend to eat dinner at the theater, while Caucasian theatergoers often dine before or after a movie.

Local businesses have an advantage because they are in sync with the communities. Top inner city retailers include Sneaker Villa in Pennsylvania, Redbarn Pet products in California, The Roasterie in Kansas City and Extreme Pizza in several states.

Another big difference, as Grid discovered in Jacksonvillle, is that there are no greenfield sites in built-up city neighborhoods. One San Diego project required the acquisition of 53 different parcels, which was accomplished through a public/private partnership and the use of eminent domain, says Blackstone.

Pioneers are adapting their models to fit limited spaces. Wal-Mart built its first three-story outlet at Baldwin Hills, which serves both affluent and inner city African-Americans and Payless Shoe Source and Staples are building two-story stores.

Adaptation, Blackstone adds, is key for both retailers and developers, in generating success in inner cities.

In all, 70 new projects will be planned or built in the 50 major inner city markets over the next 10 years, estimates Drew Greenwald, president of Grid Properties, which, in partnership with Gotham Development LLC, built Harlem USA on 125th Street in New York a decade ago.

“It is reasonable to think that there will be an average one-plus projects per market; more in some than others,” says Greenwald.

SOME BIG INNER CITY RETAIL DEVELOPMENTS PLANNED OR UNDER WAY
Project City Developer Retail space Opens
DC USA Washington Grid and Gotham 500,000 sq. ft. Early 2008
The Metropolis Chicago Capri 330,000 2010
Mondawmin Mall Baltimore General Growth Properties 600,000 Redevelopment
Shoppes at Gateway Detroit General Growth Properties 330,000 Spring 2009
The Cannery Chicago General Growth Properties 330,000 Spring 2009
Marlton Square South LA Keyshawn Johnson 100,000+ 2009
7 Urban Infill Projects New York Acadia Realty And P/A Associates 1.5 million total Various dates
Source: Company data

Baldwin's Journey

When Baldwin Hills Crenshaw Plaza was redeveloped in south Los Angeles 20 years ago, it was the largest enclosed mall in an urban area. Developer Alexander Haagen & Co. took the 41-year-old outdoor mall and transformed it with financial help from the city for about $120 million. But for the next two decades, it was anything but an argument for inner city retail.

What went wrong? A series of owners didn't keep up with the demographic changes as the neighborhood, then a mixture of Caucasians and African Americans, underwent a series of population shifts says Quinton Primo III, chairman and chief executive of Capri Capital Advisors LLC, which acquired the mall in 2005 on behalf of an institutional investor.

Retailer arrogance and developer disinvestment combined to reduce the mall's value, says Primo. Macy's came in and out of the property, opening in 1996 and pulling out in 1998. In 1995, the first Magic Johnson Theatre in the country was added to the property.

The property changed hands several times. Pan Pacific Retail Properties bought the property in 2000. It held the mall for several years and helped bring on board Wal-Mart. It sold the property in 2003 for $68 million to Hager Pacific Properties.

That marked the turning point. Wal-Mart opened at the same time that Hager took control of the property, opening a three-level store at the center. When Wal-Mart arrived, tenants were concerned that Wal-Mart would siphon business from them. Those concerns were swiftly quelled as sales jumped throughout the mall. Average sales per square foot rose to $500 from $200, with most retailers benefiting from Wal-Mart's arrival. Meanwhile, the vacancy rate fell from 20 percent to 5-percent. In fact, even Macy's is returning — taking over a Robinsons-May at the property.

Still, at the time of the sale to Capri, Hager Pacific said operating the mall was a daily management challenge and outside its comfort zone of industrial properties. Hager sold the mall for $136 million twice as much as it had paid three years earlier, finally bringing the property above its development price.

The residential mix is now 90 percent African American (both affluent and poor) and 10 percent Hispanic Primo says. Now, that demographic is increasingly Hispanic, a factor that must be considered, he says.

“It's no different from many urban shopping centers that did not change with the changing demographic of an area,” says Capri's Primo. “Traditional retailers attempted to sell in a style and strategy that did not reflect realities of a changing demographic.”

Capri now plans to spend an additional $100 million to de-mall it and add 300,000 to 500,000 square feet to the existing 860,000 square feet.

Primo says he is just beginning to talk to potential tenants. Ideal candidates he says would be Niketown and Target, which appeal to “cross shoppers” of all races and economic niches. He is planning to unveil a model of the redevelopment plan at ICSC's Spring Convention.

“Baldwin Hills has huge potential under Capri to take the property to the next level,” says Etedali.

Evolving Aesthetic

Much has changed since Harlem USA proved inner city retail could be successful. Opened in 2000 in the New York borough by Grid Properties with Gotham Developers LLC, the $66 million center will be dwarfed by projects planned for Chicago, Washington, D.C. and Brooklyn, among other areas, where the sophistication of the architecture will be as welcome to residents as the stores to the underserved markets.

For example, The Metropolis, a mixed-use development planned by Capri for Chicago's South Side, eschews concrete for sleek, undulating glass to reflect the jazz origins of the Bronzeville community where it will be located.

“The building facades recall the repeated musical patterns of blues and jazz and the residential unit layouts invoke harmonious rhythms and the ideals of freedom and flexibility,” says Ross Wimer, design partner at architects Skidmore, Owings & Merrill.

The Metropolis will cost more than $155 million in just the first (of three phases), which will feature 330,000 square feet of retail and 102 residential units. Future construction will include three towers dedicated to residential and hotel uses. “This project is important to the South Side,” says Primo, who notes that according to LISC MetroEdge, a Chicago-based retail consulting firm, about $671 million or more than two-thirds of the total $909 million spent by residents goes outside the community. “The numbers speak for themselves,” Primo says.

In the nation's capital, DC USA, being built by Grid and Gotham about 2.5 miles north of the White House, will “make a statement” with a glass-enclosed cylinder as part of its design, says Greenwald. A two-story Target will anchor the three-level, 500,000-square-foot complex when it opens in early 2008. Other tenants will include a Bed, Bath & Beyond, Best Buy, Marshalls and Staples. Citibank is investing $136 million in the $150 million project with partners Joseph Searles and the Development Corp. of Columbia Heights.

And, of course, noted architect Frank Gehry made an impact and stirred controversy with his design for Forest City Ratner Cos.' 22-acre Atlantic Yards mixed-use project. Gehry has said his goal is to create a community that looks contemporary, like it has grown over time. Some area residents take issue with that description, saying it will destroy the seasoned-over-time Brooklyn ambiance.

“Architecture is of extreme importance,” says Primo. It will cost more initially, but recoup the added expense through increased sales and a lower cap rate down the line. “Spend a nickel more and make a dime more.”
BK