When chefs Joe Truex and Mihoko Obunai decided to open their first restaurant, they were searching for a site with a unique, urban vibe. The husband-and-wife team considered several leased spaces before settling on a 3,000-square-foot retail condo at Ponce Springs, a 112-unit, mixed-use building with roughly 10,000 square feet of retail space in Atlanta's Ponce de Leon neighborhood.

“We never thought about buying space — it wasn't something that we even knew we would have an option to do,” Truex says. Realizing they could buy space changed Truex and Obunai's strategy. It gave them additional peace of mind to know that underlying their restaurant concept was a good piece of real estate that they could control. So even if the eatery flopped, they would have the option to lease the retail condo to another business.

With a $480,000 loan from the Small Business Administration, Truex and Obunai opened Repast in early 2006. The restaurant has since garnered acclaim as one of Esquire's best new restaurants in the country. “We're thrilled to own our own space because we don't have to worry about a landlord jerking us around,” Truex says. “The condo really gives us peace of mind.”

Truex and Obunai represent a new breed of entrepreneurial retailers who are bypassing leasing in favor of owning. They've been turned off by large retail developments and national landlords, preferring to be in the driver's seat when it comes to their space.

National retailers still prefer to lease space, but many local and regional retailers are increasingly interested in owning their space.

Jerry Miller, a principal of Miller-Gallman Developers LLC, which developed Ponce Springs, says that the quality of retailers interested in the project increased dramatically when he switched from for lease to for-sale. “We really started to attract people who had a vision for the project — people who wanted a stake in the future of the neighborhood,” he says.

Easy exit strategy

In 2006, sales volume of retail condos exploded, increasing 43 percent to $930.3 million from $655.1 million in 2005, according to Real Capital Analytics Inc. Similarly, the number of retail condo deals jumped 43 percent to 1.1 million units compared to 764,444 units in 2005. On average, the price per square foot for retail condos last year was $859, just $2 more per square foot than in 2005. More than half of these deals are still in Manhattan, but use of the structure is growing nationwide, according to Real Capital data.

“They are becoming more prevalent in other markets as more mixed-use projects with residential condos pop up,” says Robin Abrams, a broker with The Lansco Corp., a New York City-based retail brokerage firm.

Marquette, for example, is developing Fry's Landing District, a mixed-use residential and retail condo project in Lemont, Ill., a small town located about 30 miles southwest of Chicago along the historic Illinois and Michigan Canal.

Fry's Landing District, which will include four buildings with 82 loft residences and 24,000 square feet of retail space, is part of the $250 million Lemont Downtown Redevelopment Project that encompasses 10 city blocks, bringing 150,000 square feet of new commercial space, 400 new residences and 750 structured parking spaces to the downtown area.

As part of the planning process for Fry's Landing District, Marquette interviewed several prospective retailers and found that most of them preferred to own rather than lease space, Ryan says.

“We have plenty of experience with for-sale condos in housing, but we had never done retail condos,” Ryan says. “But, we researched it and found that retail condos are becoming more popular, especially with local retailers.”

Marquette offered the ground-floor retail space for sale and for lease. To date, the firm has sold two retail spaces at $275 per square foot and has leased one at $22 per square foot. (Marquette has retained ownership of the retail condo space that was leased).

Local flavor

Most of the retail condos that exist today — and those that are under development — are part of mixed-use buildings. Retail condos typically occupy the ground floor of vertical mixed-use projects, usually when the space above is structured as retail or office condos. In most cases, the spaces are small — less than 5,000 square feet.

The appeal is strongest for local or regional retailers just starting out. For them, there are more questions about owning vs. renting than a national chain, who may only look for space they can lease.

“There are a lot of benefits for operators who own their own space,” says Nick Ryan, managing director of Marquette Cos., a Naperville, Ill.-based firm that is developing retail condos. “They know there won't be future rent increases, they'll have certain tax benefits and they're creating value in the real estate that they can borrow against to expand.”

Melton Goodwin, sales manager for KUBIK, a 299-unit residential loft project with roughly 40,000 square feet of ground floor retail condo space in Miami, agrees: “Today, the small business owner is more educated and has realized that by purchasing space, they not only will have their business, they'll also have an investment.”

Retail condos in KUBIK range from 1,219 to 9,169 square feet, and all except for one sold within two months of being on the market, Goodwin says. (The largest space — 9,169 square feet with outdoor patio space of 2,564 square feet — is still available and is zoned for restaurant or food market use.)

Ryan says that Marquette is taking the same approach to tenant mix for Fry's Landing District as it would for a project that is 100 percent leased. “We want to create a mix of retailers and users that is going to continue to thrive,” he says.

BlueSky's Vargosko admits that he's turned down buyers and uses that don't enhance his projects. “With mixed-use projects, the tenant mix is very important because you're selling a lifestyle,” he says. “It's a challenge because we could have the space pre-sold right away, but we have to think about the best use for the space.”

Knowing the rules

One common misconception is that if the residential space above is structured as condos, then the retail portion has to be as well. There is certainly correlation in that owners may find it easier to structure the entire building as a condo. But they are not compelled to do that. Owners can market the retail (and office) as separate elements by structuring the building to have “vertical subdivisions,” according to Brian Kozminski, chair of the real estate group at Levenfeld Pearlstein, LLC, a Chicago-based law firm. Most mixed-use buildings that have rental components, for example, are also structured this way so the different pieces can be sold off independently.

Condominiums, regardless of the type, are created by invoking a state's condominium property act, which create the framework of rules and regulations related to condo associations and management of common areas.

“It can be kind of tricky to sandwich retail and office condos into the condo property act because it was created for residential condos,” Kozminski says.

From Ryan's perspective, retail condos provide a more efficient process when it comes to exit strategy. “Selling retail condos gives us a return of about 8 percent,” he says. “If we sold all the retail space to one investor, we'd probably get a cap rate of 7 percent, so we're giving up a little bit of yield. But, we also don't have to deal with the risk of leasing it up and then trying to find a seller.”

Charlotte, N.C.-based BlueSky Developers LLC's decision to sell the retail space in its mixed-use projects is also connected to its exit strategy, says managing partner Eric Vargosko. “From a residential standpoint, our exit strategy has always been to sell,” he says. “When you add retail, it just seems logical to sell off the whole building as condos.”

Right now, BlueSky has two mixed-use projects under construction in Charlotte with nearly 50,000 square feet of retail condo space: Fat City Lofts and 2525 South. Retail condos in both buildings are selling for $200 per square foot to $250 per square foot, Vargosko says. On a marketwide basis, prices for retail condos range from $160 per square foot to $325 per square foot.

Board meetings

Of course one of the twists to having retail condos, is that retailers end up on the building's condo board. That means that as an owner, you have to be willing to take that step as well. BlueSky Developers say they have no problem doing that as a price of leasing space to national retailers that refuse to purchase retail condos.

By sitting on the condo board, retailers gain some power over determining a building's tenant mix, since they can then vote up or down on whether or not to accept who else buys space in the building.

KUBIK's developer, Miami-based Lab Group Developers created very strict rules and regulations for retail condo owners to address these concerns, says principal Jose Camilo Lega. Provisions govern the type of uses allowed in the building to prevent any overlap. Additionally, the condo association oversees and approves all signage.

Despite the restrictions, demand for space in KUBIK was so strong that pricing escalated to $625 per square foot, Goodwin says, a 30 percent to 40 percent increase over other space in the market. The buyers included: an interior designer who plans to open a home décor store; a fashion designer who will open a high-end boutique; an art gallery; and an upscale Caribbean restaurant called Kazbah.

“The guidelines make me feel confident that the building is going to be maintained to a high standard,” says Kazbah's business manager Doreen Stephens.“We're making a huge investment, and 10 years from now, we don't want the building to be falling apart.”

“We looked for two years before we found a retail condo that was right for us,” Stephens says. “Our goal was to own rather than rent because we didn't want to be at the mercy of a landlord and have to sign a new lease every few years. But it was difficult to find space than we could buy.”

Even with a $2.8 million price tag, Stephens says it was less costly to buy Kazbah's 3,492-square-foot space than lease it. She estimates that leasing would have been almost 50 percent more expensive. Moreover, she is reassured by the fact that she has a say in how the building is managed and the provisions enforced by the condo association.

NATIONWIDE RETAIL CONDO SALES
  YEAR
DATA 2004 2005 2006
Sum of Price $649,777,700 $655,077,733 $930,331,716
Sum of Units 1,057,086 764,444 1,083,525
Average of Per Unit $615 $857 $859
Source: Real Capital Analytics

Center Pieces

Developers carve up traditional retail formats

Although most retail condos are situated on the ground floor of mixed-use projects, a couple of developers are building retail condos in traditional retail formats. Jacksonville, Fla.-based Business Condos USA, for example, is selling space within unanchored strip centers, while Boca Raton, Fla.-based Silver Cos. is building an enclosed mall in suburban Washington D.C. that offers retail condos rather than leased space.

Business Condos USA has retail condo projects underway in Houston, Nashville, Jacksonville, Fla., Los Angeles and Tampa, Fla. The company launched its retail condo development program after several years of developing office and industrial condos, says president Larry Walshaw.

“We realized that ownership doesn't just have to be segregated to office and industrial and determined that there was a need for an unanchored strip center-type product of 40,000 to 55,000 square feet,” Walshaw says. “Most developers and landlords pay attention to the national retailers, leaving the small business owners out in the cold. So, our retail condos are for retailers that can't get in with the big boxes, or for those that don't want to be with the big boxes.”

Walshaw says that about 85 percent of Business Condos USA's retail condo buyers are local entrepreneurs, while the rest are national chains. The company often leases retail condos to national retailers and then sells them to investors. “Our centers have the same retailers you would find in a typical center,” he notes, pointing to jewelry stores, restaurants, dry cleaners, tanning salons and nail salons.

Similarly, Silver Cos. and partner WorldStreet Development are pursuing smaller retailers for its 700,000-square-foot World Street project, says president David Mignatti. “We wanted to create a showcase of products from around the world, and ownership is the preferred model for these international entrepreneurs and vendors,” he notes. “Many of them are coming to America for the first time, and ownership provides security for them.”

Mignatti explains that WorldStreet Development initially discovered demand for retail condos after speaking with local and regional retailers in the United States.

“These operators have been disenfranchised from the big regional malls, and they're embracing retail condos because it's a new home for them,” he says.

Retail condos in WorldStreet are selling from $300,000 for 500-square-foot boutiques to several million dollars for larger spaces. Condo association fees are similar to the common area maintenance (CAM) charges in regional malls, Mignatti says. Additionally, retail condo owners don't have to pay percentage rent. “The beauty of our model is the landlord isn't in the tenants' pockets, which is a major issue in malls today,” he says.

Mignatti concludes: “I believe that a lot of retail condo projects that are similar to traditional retail centers will pop up across North America.”
JP