There usually are no second acts in real estate. If you develop a property and it does not pan out like you thought, usually another firm gets a chance to clean up the mess. That’s what makes the case of the 305,303 sq. ft. Woodbury Lakes open-air lifestyle center in Woodbury, Minn., a bit unusual.

Woodbury Lakes opened in 2005 as a joint venture project built by RED Development and Opus Northwest. The joint venture sold Woodbury Lakes to Cornerstone Real Estate Advisers the following year.

Then things turned sour. The property became one of many lifestyle centers to face significant challenges during the Great Recession. Ultimately, the project ended up 25% vacant, and Cornerstone turned over the property’s keys to its special servicer, LNR Partners Inc.

But that’s where the story takes a twist. In July, RED re-entered the picture. It teamed up with Fortress Investment Group to buy back the property. Now, RED is already beginning to turn things around and is getting a second chance to succeed with the center.

Unraveling of a center

Today, RED believes it would have been wise to keep the center in its portfolio rather than sell it, according to Michael L. Ebert, managing partner in the Phoenix office of RED. But Opus, a merchant builder, was not in the business of holding properties.

So the joint venture took the center to market. It was 85% pre-leased to tenants including Gap, Ann Taylor Loft and Victoria’s Secret. Linens ’n Things and Z Gallerie served as de facto anchors. In 2006, Opus Northwest also added a 12,500 sq. ft. Trader Joe’s to the site.

What came next is indicative of the industry’s go-go years. The property, which cost the joint venture $67 million to build, fetched $99 million from Cornerstone just one year later — a price that works out to $324 per sq. ft.

In order to finance that acquisition, Cornerstone took on an $80 million loan — which works out to an 80% loan-to-value ratio that was fairly standard practice in the industry at the time.

This was the first problem. The acquisition price was based on pro forma sales that were entirely too optimistic, according to Tom Commerford, an investment sales broker with Grubb & Ellis | Northco Real Estate Services.

After the acquisition, things started to unravel. As the economy began to turn and retailers stopped expanding, Cornerstone could not find tenants to fill the center’s remaining space, says Bob Pounds, senior vice president with Welsh Investment Services, a Minneapolis-based real estate firm that managed the property for the lender while it was in REO.

In early 2008, Linens ’n Things filed for bankruptcy and eventual liquidation, closing all of its stores. In the spring of 2009, Z Gallerie followed suit, closing a number of stores, including the one at Woodbury Lakes.

The closings not only increased the center’s vacancy by about 40,000 sq. ft., but also triggered co-tenancy clauses for a number of Woodbury Lakes’ remaining retailers. Some of the leases had clauses that gave tenants automatic rent discounts if the center’s occupancy fell below 80%.

In retail leases, co-tenancy clauses allow a retail tenant to either switch to lower rent or exit the property if occupancy drops below a certain level, or if a preferred co-tenant closes shop. Some of the leases at Woodbury Lakes had clauses that gave tenants automatic rent discounts if the center’s occupancy fell below 80%. A few had co-tenancy clauses that were tied to Linens ’n Things.

In addition, the vacancies left the center without a clear traffic draw, according to Deb Carlson, director in the Minneapolis office of brokerage firm Cushman & Wakefield. Up to that point, Z Gallerie served as Woodbury Lakes’ star tenant. It was the retailer’s first entry into the Minneapolis market.

The rest of the center’s tenant roster was made up of the usual national chains that could be found throughout the metro area, says Carlson.

Woodbury Lakes “is really located on the very eastern edge of the metro area, so you have to have a reason to draw people in from other parts of the city or from across the river in Wisconsin,” Carlson says. “I really believe that a way to attract people to a center like Woodbury would be to bring in some unique retailers that would increase its trade area.”

By 2009, the property still had $65 million of debt left on it, which meant that sales had to reach at least $200 per sq. ft. to cover the debt service, according to Commerford. But Cornerstone couldn’t service the debt, according to Pounds.

When the center was appraised, its value turned out to be significantly below the value of the loan. Cornerstone’s loan was non-recourse. In September 2009, the firm agreed to a deed-in-lieu of foreclosure and gave up control of the center to LNR.

RED re-enters the picture

When Pounds and his partner, Tim Prinsen, took over the management of Woodbury Lakes in the fall of that year, they found it to be a beautiful, upscale center that was drawing a healthy amount of traffic, even during Minnesota’s cold winter months.

The center’s main problem was the vacancy rate, which was higher than the average for the metro area. “Physically, the property is in very good shape. It’s a class-A property by every measure,” Pounds notes.

Pounds and Prinsen put the center up for sale in the spring of 2010 at the request of the lender. The seller of Woodbury Lakes received 13 bids from a number of local, national and international investors.

Among those bidders was RED with backing of its new partner, Fortress. RED’s management continued to believe in the viability of the project and wanted to get Woodbury Lakes back on track.

“We liked the price and the reason we liked the price was we knew the asset well,” Ebert says. “We liked the tenants that were in place and sales were relatively strong, which is key in the lifestyle center business. We were very confident that we could fill the center’s vacancies and keep the existing tenants, continue to grow sales and be successful.”

RED and Fortress ended up winning the contract not because they had the highest bid (theirs was second highest), but because they were already familiar with the property and its complicated leasing structures. They also could not claim ignorance of the center’s issues after the sale, according to Pounds.

The bid amounted to $35 million, or $114 per sq. ft. The price was just more than half what Woodbury cost to build and about one-third what Cornerstone had paid for the same asset at the peak of the market.

For their part, RED executives were convinced the center’s sales performance merited re-investment. In 2010, sales at Woodbury Lakes averaged more than $300 per sq. ft., an increase of 6% compared with the year prior, according to Ebert. RED eventually hopes to bring the center’s average sales to $400 per sq. ft. with a combination of marketing and leasing efforts.

Those efforts have already started paying off. Since taking possession of Woodbury Lakes in July, RED has brought in a 10,157 sq. ft. Charming Charlie along with Designer Marketplace, Kinichi restaurant and Lakes Tavern & Grill.

RED gets to work

RED also is currently negotiating deals with some women’s apparel chains and restaurants, according to Ebert. When it acquired the property, Woodbury Lakes had an occupancy rate of 75%. Today, Ebert says the center’s occupancy is approaching 90%. Increasing occupancy resolved the co-tenancy clause issues and forced some tenants to go back to paying their full rents.

It remains to be seen how much time it will take for Woodbury Lakes to completely stabilize. Today, overall retail vacancy in the Minneapolis metro market averages 7.27%, according to Welsh. In Southeastern Minneapolis, however, where the center is based, the vacancy rate is significantly lower, at 4.16%.

Retailers have started talking about expansion again, but it likely will take six to 18 months for occupancy at Woodbury Lakes to move past 90%, according to Pounds. In the meantime, RED has been trying to simplify its lease agreements as it negotiates transactions with new tenants. RED will try to avoid co-tenancy clauses whenever possible, Ebert says.

“We have seen how devastating those could be,” he notes. “The tenants are becoming much more receptive to it as a result of the development community starting to push back. I think they now see that they can’t necessarily rely on named co-tenants because in 2008 and 2009 many of those tenants either went out of business or lost importance in [new] projects.”