From the Carolinas to California, the mixed-use fever that is sweeping through the shopping center industry shows no signs of breaking anytime soon. Now even stalwart neighborhood shopping center owners such as Columbia, S.C.-based Edens & Avant are turning their attention to mixed-use development.

The privately held Edens & Avant, whose portfolio includes 170 centers in 18 states, is currently working on several mixed-use projects. The firm's first project, Davidson Commons, will be completed next fall. Located in Davidson, N.C., the Harris Teeter-anchored development will feature 90,000 square feet of retail and office space, as well as five residential units.

“We're being driven more by market demand. Residential and retail in particular are becoming more aligned with the consumer,” says Jodie McLean, president and chief investment officer at Edens & Avant. The company's decision to include mixed-use projects in its portfolio complements Edens & Avant's continued expansion into urban areas such as Boston and Washington, D.C. More people want to live in urban settings, and retailers in turn are chasing those consumers, McLean adds.

Edens & Avant is among a growing contingent of developers adding a complement of office, residential and other uses to its retail developments. An exclusive research survey conducted jointly by National Real Estate Investor and Retail Traffic magazines this fall revealed that mixed-use is the dominant retail property type when it comes to both new development and redevelopment projects. Among the 329 respondents surveyed, 80% are currently active in retail, and 77% are active in two or more property types [Figure 1].

Slightly more than one-quarter of respondents (28%) indicated that they had developed mixed-use properties during the past 12 months. An equal percentage of respondents also said that they developed freestanding/single-tenant properties over the past 12 months. The next most frequently cited development niche was non grocery-anchored strip centers (25%) followed by lifestyle centers (18%).

Mixed-use projects ranked even higher in developers' plans. Among respondents who indicate plans for new development in 2007, 52% say they will develop mixed-use properties, followed by freestanding, single-tenant properties (36%), non-grocery-anchored strip centers (32%), grocery-anchored strip centers (30%), downtown urban centers (29%), and lifestyle centers (28%).

Obstacles become opportunities

Mounting challenges to retail development — such as land costs and availability of building sites — may also explain why developers are drawn to mixed-use projects. Increasing project density with mid-rise or high-rise housing, hotels or office buildings helps to increase square footage and boost developers' financial returns.

“Over the last several years, everything has gotten more difficult, from entitlement to land costs to construction costs,” observes Jeff Fuqua, president of development for Sembler, a retail development firm based in St. Petersburg, Fla. Certainly one of the chief stumbling blocks for developers is scarcity of affordable greenfield sites, prompting retailers and developers to pursue opportunities in urban markets. Oftentimes, those infill sites are more expensive to develop due to high land costs, as well as added costs associated with site cleanup or demolition.

In order to combat those challenges, veteran mixed-use developers such as Sembler are placing even more emphasis on mixed-use projects. Sembler officially launched its residential division in May. Incorporating a mid-rise or high-rise use such as residential enables the developer to take advantage of “vertical” development to increase the density of a real estate development. Sembler currently has eight mixed-use projects underway that feature a combined 4.5 million square feet of retail space and 8,000 residential units.

“Residential does so much better inside these retail projects, because people really like to live around the activity and have all of their services and goods in close proximity,” Fuqua says. An added benefit is that urban communities are increasingly looking for “smart-growth” projects that minimize sprawl by creating a live-work-play environment, Fuqua adds.

And developers are cashing in on that synergy. For example, Sembler recently completed construction on the $280 million Perimeter Place in Atlanta. The project features 500,000 square feet of retail space, 328 apartments and 230 condos. The condos were sold out prior to completion, and the apartments are renting fairly quickly — at about 40 to 60 units per month — and are renting about 15 cents per square foot higher than other comparable properties in the area.

Although Fuqua concedes that returns on mixed-use projects are comparable to other types of retail developments, one of the advantages of mixed-use developments is that, by nature, they tend to occur in mature markets. As a result, those projects tend to be more insulated from competition, which in turn can boost sales performance.

Slower growth ahead?

Overall, shopping center construction has been moving forward at a healthy clip in recent years. The question is whether that pace is sustainable — particularly in light of a slowing residential market. Retail construction starts are expected to reach 300 million square feet in 2006, which would be a slight decline from the 306 million square feet reported in 2005, according to “Construction Outlook 2007,” a report produced by McGraw-Hill Construction.

Slowing residential growth coupled with less robust expansion from big-box retailers are expected to create a drag on construction activity in the coming year. Construction is projected to drop 7% in 2007 to 278 million square feet — the lowest level since 2002 when construction activity totaled 257 million square feet, according to McGraw-Hill Construction.

Despite those predictions, developers are moving forward with existing development plans. Survey respondents anticipate construction levels for 2007 that are on par with 2006. The largest group of respondents (33%) indicates that it will break ground on less than 50,000 square feet in 2007. Yet, a closer look at the data shows 28% plan to break ground on at least 200,000 square feet, while 17% anticipate breaking ground on more than 500,000 square feet [Figure 3].

For their part, construction lenders such as Cleveland-based KeyBank Real Estate Capital report a steady stream of projects across the country. Through the first 10 months of 2006, the bank's retail origination volume registered $2.01 billion compared with $1.78 billion in originations during the same period a year ago, a 13% increase. “Retail clearly remains a major force in our lending activity,” confirms George Valko, KeyBank's senior vice president and southwest regional sales manager.

That retail activity is being driven by a number of factors such as a shift in consumer shopping patterns. “Mixed-use and lifestyle centers are showing up where they haven't in the past,” Valko says. Even traditional big-box power centers are being built with a portion devoted to the lifestyle tenants such as restaurants and entertainment features, he adds. At the same time, demographic shifts and significant population growth in Sun Belt markets such as Phoenix and Las Vegas are fueling demand for basic retail, ranging from supermarkets to drugstores.

Expansion of dominant retailers such as Target, Kohl's and Wal-Mart will continue to fuel development. For example, Kohl's management has said that the retailer plans to add 500 new stores in the next five years. Other factors driving construction include changing formats as retailers and shopping centers alike strive for a competitive edge. JCPenney, for example, has announced that it plans to renovate 250 existing department stores and construct 170 new freestanding locations by 2009.

Despite the optimism, there are signs that demand for new space is not keeping pace with the current construction activity. For example, the 6.6 million square feet of new community shopping center space that was completed during the third quarter helped to push vacancies up 20 basis points to 7%, according to New York-based research firm Reis.

Dirt anything but cheap

Developers are pushing forward with new construction despite mounting challenges including rising costs, diminished returns and concerns regarding fallout from the slowing residential market. Slightly more than half of respondents (52%) cite rising land costs as the biggest factor likely to impact development activity over the next 12 months. Respondents also are likely to be influenced by the overall health of the economy (45%), cost of materials (43%), and availability of land (40%) [Figure 4].

Land prices that have doubled or even tripled in the past 18 months have curbed buying activity for some developers. “On the land side, we are probably at a standstill at the moment. We are not actively pursuing land acquisitions today,” says Michael A. Pollack, president of Michael A. Pollack Real Estate Investments, a real estate owner and developer based in Mesa, Ariz. Pollack does not anticipate making any additional land buys until the fourth quarter of 2007 when he hopes that by that time land pricing will have started to drop.

As Pollack waits for pricing to adjust, he is focusing the firm's efforts on development, redevelopment and renovation opportunities within its existing portfolio. For example, Pollack owns three of the four corners at the intersection of Arizona Avenue and Elliot Road in Chandler, Ariz. Although Pollack has already redeveloped two of those corners, the firm is preparing to start its third and final phase of the Pollack Business Park North.

The 70,000-square-foot development will feature a combination of retail, showroom and light industrial space. In this case, Pollack purchased the land several years ago. “Buying infill at today's costs would have been much more challenging,” he says. In fact, the one-story development would not have been feasible at today's prices, he adds.

Redevelopment gains favor

High land costs and scarcity of appropriately zoned greenfield building sites may be prompting developers to focus on redevelopment, renovation and expansion opportunities. More than half of respondents (58%) currently have redevelopment, renovation or expansion projects underway, and 42% indicate that they plan to initiate retail redevelopment, renovation or expansion activity in 2007.

The largest group (21%) has plans to redevelop, renovate, or expand properties under 50,000 square feet [Figure 5]. Grocery-anchored strip centers and non-grocery anchored strip centers are the most likely properties to have been redeveloped, renovated or expanded in the past 12 months.

Redevelopment is a constant for owners such as Edens & Avant because retail is always evolving and reinventing itself as consumer tastes and store formats change. “We truly believe that if we are starting with the right piece of real estate, that 20% of our portfolio at any given time should be in redevelopment or be repositioned,” McLean says.

Currently, Edens & Avant is redeveloping or repositioning 20 of its 170 retail properties. For example, Rio Pinar Plaza in Orlando involves the construction of a new 45,600-square-foot Publix. The new store features the grocer's new prototype, and the former 73,000-square-foot store is being reconfigured to accommodate new retail space. The $12 million project, which is slated for completion in the first quarter of 2007, also includes new landscaping and facade updates.

Pushing for higher returns

Certainly, one of the biggest challenges for developers is generating returns in an environment where prices for land and building materials continue to climb. Higher construction and land costs have dropped returns about 200 basis points in the past two years. The price of construction materials alone has increased 22% over the past three years, according to McGraw-Hill Construction.

Return expectations certainly play a key role in what types of projects are being built. The largest group of respondents (46%) cited mixed-use properties as the shopping center category that yields the highest returns, closely followed by grocery-anchored centers (44%) and lifestyle centers (35%) [Figure 6].

The fact that lifestyle centers made the top three list is not a big surprise to some industry experts. “The consumer has voted and they love this product, and it's likely to be a very viable product for many years to come,” says Terry McEwen, president of Memphis-based Poag & McEwen Lifestyle Centers.

Poag & McEwen opened two new lifestyle centers in 2006, and is currently constructing The Promenade Shops at The Spectrum in Pearland, Texas. The 615,000-square-foot lifestyle center is part of a larger mixed-use development that also includes a 100-room hotel and 350 residential units. Construction of a Bass Pro store is currently under construction, with additional construction expected to start next spring. Bass Pro will open in October 2007, followed by the rest of the project in spring 2008.

In addition, Poag & McEwen has nine new lifestyle centers and four major expansions either planned or in early development. “I don't see demand for lifestyle centers slowing down. In fact, it's the opposite. It's continuing to increase,” McEwen says.

Impediments to expansion

Certainly, two of the biggest influences on retail expansion are consumer spending and the overall health of the economy. By and large, respondents do not expect major changes in the U.S. economy over the next year. Nearly half of respondents (47%) expect to see moderate growth, while 16% expect no change and 29% expect a moderate decline [Figure 7].

Yet some economists are predicting slower economic growth in the coming year due to a combination of a decline in residential refinancing activity, lower volume of home sales and anticipated increases in interest rates. The gross domestic product is expected to grow at an annualized rate of 3.5% for the year, and that rate is expected to slow to 2.5% next year, according to Scott Anderson, vice president and senior economist at Wells Fargo & Co. in Minneapolis.

Although respondents have mixed expectations regarding consumer spending, most do not expect major changes in either direction over the next 12 months. Some 40% of respondents believe that consumer spending will increase slightly over the next year, while 25% believe that consumer spending will remain the same, and 28% anticipate spending to decrease slightly [Figure 8].

In the short term, fuel costs that dropped after record high prices earlier this summer have buoyed retail spending. But that activity may be short lived as the housing market cools, Anderson notes. The national median existing-home price is expected to rise 1.6% to $223,000 for all of 2006, according to The National Association of Realtors. At the same time, the median new-home price is projected to decline 0.2% to $240,500 as builders cut prices to sell existing inventory, according to the association.

Stabilizing home values are already having an impact in the retail sector. “People are not using their homes as ATMs (automatic teller machines) anymore,” Anderson says. Home refinancing activity is down more than 50% from a year ago. “So the concern is that this will weigh into consumer spending plans,” Anderson says.

On the upside, factors that could bolster spending are continued improvement in the stock market and job growth. Although employment figures were lower than expected in October, the creation of 92,000 jobs helped to reduce the unemployment rate to 4.4%, according to the U.S. Department of Labor. “I believe that consumer spending is going to be pretty constant from where it is today,” McEwen predicts. “The housing slump is going to be offset by business profitability, growing employment and lower energy prices.”

Snapshot of Survey Respondents

Data for the Retail Development Survey was collected between Sept. 14 and Sept. 29. E-mail surveys were sent to National Real Estate Investor and Retail Traffic subscribers listed as either builder/developer or owner/manager.

The purpose of the survey was to determine which segments of the shopping center industry that subscribers plan to be the most active in during the coming year on the development front, and to gauge their views about the short-term economic outlook. A total of 329 usable surveys were collected.

The majority of respondents are executives at their companies, with over half of respondents holding a top-level position. An additional 30% carry the title of either vice president or director. On average, respondents hold properties in their portfolios for 10 years.

Respondents plan to begin construction on an estimated median of 86,206 square feet of new retail properties by Dec. 31, 2007. The data also shows that respondents plan to begin renovation, redevelopment or expansion on an estimated median of 52,778 square feet of retail property by Dec. 31, 2007.