TEN YEARS AGO, the Rodney King beating sparked the riots that savaged South Central Los Angeles and made the economically depressed neighborhood the decade's symbol of urban blight — displacing the South Bronx of the 1980s. On April 28, 2002, Jerry Katell, president of Los Angeles-based Katell Properties LLC, was scheduled to preside over the official grand opening of Chesterfield Square in the heart of South Central.

The debut of the 285,000 sq. ft., $50 million shopping center — South Los Angeles' largest commercial project in more than a decade — signals not only an economic rebound for South Central, but also an emerging trend of retail development in inner-city districts around the country. Chicago's Cabrini Green and New York City's Harlem also have received attention as developers and retailers re-evaluate areas they once fled. As suburban sprawl slows, and shopping centers built in the 1970s and 1980s in outlying areas drag down portfolio returns, some real estate investors have identified inner-city projects as a frontier for freash development.

“Chesterfield Square is a traditional development in a non-traditional area,” Katell says. “It's a project that needed to be built. But I wasn't doing this out of charitable motives. If I didn't think this was going to make money, I wouldn't have done it.”

CHESTERFIELD SQUARE: INVESTING IN COMMUNITY

Chesterfield Square has attracted big anchors such as Home Depot and Ralph's Food 4 Less to an area formerly shunned by name-brand retailers. McDonald's, Radio Shack, IHOP and Starbucks fill out the in-line tenancies. “In a suburban location, you might have had competition among tenants to get in,” Katell says. “We didn't have that. We were pushing pretty hard, fighting the inner-city perception.”

A 1998 report by Boston Consulting Group and the Initiative for a Competitive Inner City (ICIC) estimates that 7.7 million households in America's inner cities account for $85 billion in annual retail spending power. That amounts to nearly 7% of total retail expenditures in the U.S., most of which takes place outside the inner city. It is a market that has been largely overlooked.

But it took a new vision to see the possibilities of areas long ago abandoned by major retailers. There were 1.1 million residents living within a 5-mile radius of the site, but almost no mainstream retail because the demographic statistics were so grim: Median household income was $30,131 — $12,000 less than the $42,000 national median recorded by the U.S. Bureau of the Census. Still, these residents were spending some $900 million a year outside of South Central, says a report by Pepperdine University in Malibu, Calif.

That, says Katell, convinced him that retail development could succeed in the area. But getting retailers to buy into that vision was another story.

First, Katell estimated land acquisition and construction costs of about $50 million. He figured he could make the project work if he could sign solid anchors. “We look for a return of no less than 10%, and preferably 11% or higher,” he says.

Katell then purchased the land for $13 million with partner Chris Hammond, president of Los Angeles housing developer Capital Vision Equities. Katell personally guaranteed loans with 18% and 21% interest from the Los Angeles Community Development Bank, which directs federal money to inner cities. “The interest rate was high,” Katell says. “It made me feel like I was sticking my neck out.”

The development bank's loan covered 90% of the cost of acquiring the land. Typically, a bank loan for a land acquisition covers only 50% of the land's total cost, requiring substantially more in equity and some form of co-investment.

Katell says he preferred the high interest rate over giving up ownership interest to another equity partner. “We paid an extra 9% interest for one year, but we got to keep our equity interest,” he says. “It was well worth it.”

After signing for the loan, Katell turned his attention to signing up tenants. At the time, Home Depot was evaluating sites and appeared to be holding out for another location. With the help of then-city councilman Mark Ridley Thomas, Katell persuaded executives to sign for 11 acres at Chesterfield Square.

Home Depot's commitment enabled Katell to obtain a construction loan from Bank of America, which paid off the Community Development Bank loan. “Once we had Home Depot, the process became easier,” Katell says. With the property 93% leased, he closed a permanent loan with Nationwide Life Insurance Co.

How is the center faring? The April grand opening, scheduled to coincide with the 10th anniversary of the riots, is really a formality. Home Depot and Food 4 Less opened in July 2001, McDonald's in September and Starbucks on March 26. Home Depot spokesman Chuck Sifuentes says the store is operating 10% ahead of the $50 million in sales projected for its first year. Food 4 Less calls its Chesterfield Square opening the best-ever for the chain.

For Katell, too, the project is a source of pride. “I've done mostly suburban development,” he says. “People tend to like my projects when they open. But in the beginning, people don't want retail development, and I feel like public enemy No. 1. This was the opposite. The community really wants this.”

RETAIL CHICAGO: A TEAM EFFORT

Through a program called Retail Chicago, the Windy City has promoted retail development in its under-served communities since 1994. Perhaps the most striking change — in both housing and retail development — has occurred around Cabrini Green, a 1950s public housing project in west Chicago that came to symbolize the failure of that era's “urban renewal” strategies. Several of the complex's 16 high-rises have been demolished. “There were no services in this area,” says Frances Spencer, director of Retail Chicago and assistant city commissioner. “Today, there is a shopping center and new housing.”

In the mid-1990s, Chicago issued a request for proposals (RFP) for low-rise housing on a 7-acre site near Cabrini Green. A half-dozen developers responded, including MCL Cos., which owned 20 acres nearby. Most proposals focused on the limited residential development defined by the RFP. MCL, however, teamed up with DePaul University and local housing groups to propose a master plan for the square mile area surrounding the site. The plan included retail and housing, setting aside a percentage of private housing developments for low-income tenants. “Our concern with the original housing parcel was that no one would jump onto an island surrounded by public housing high rises with a reputation as a shooting gallery,” says Dan McLean, president of MCL. “You need to build a neighborhood first.”

MCL built five projects with more than 300 homes, and a $14 million, 85,000 sq. ft. shopping center. Offers on the property began rolling in while MCL was negotiating permanent financing. “We put the property out through a broker and received 20 bids,” McLean says. The property ultimately was sold to Principal Financial Group in Des Moines, Iowa.

HARLEM: NON-PROFIT TO PROFIT

The return of retail to Harlem — an area where no significant development had taken place for 25 years — has been significantly aided by the non-profit sector. The Retail Initiative (TRI), an early urban retail pioneer, has developed shopping centers in the undeserved inner city for 10 years.

Local Initiative Support Corp. (LISC), a non-profit group, formed TRI in 1992 to raise capital to invest in grocery-anchored shopping centers in inner cities. In 1994, TRI raised $24 million to stimulate 13 projects. “Each of these developments serves areas with low to moderate incomes as defined by the U.S. Census Bureau,” says Oliver Wesson, president of TRI.

According to the Census Bureau, low income is defined as 50% of the median income in the metropolitan statistical area (MSA). Moderate income is defined as 50% to 80% of median household income in the U.S. — $42,000 in 2000.

One of TRI's most successful projects financed the development of a 50,000 sq. ft. Pathmark grocery store combined with 5,500 sq. ft. of satellite retail operated by discount retailer Lot Stores at the corner of 125th Street and Lexington Avenue.

When the project began in the mid-1990s, research showed a population of 156,000 within a 1-mile radius of the site with an annual median household income of just $18,000. That was a number no developer would warm up to without the help of non-profit development groups and government agencies.

In the case of the Harlem Pathmark project, state participation proved essential. The New York Empire State Development Corp. provided grant funding and secured a construction loan to facilitate development. “A traditional bank construction lender had the first position on the construction loan, but the public sector made it work by taking a second position,” says Lamont Blackstone, vice president and CIO with TRI.

The project has spurred more development nearby. On FDR Drive, Syosset, N.Y.-based Blumenfeld Development Group Ltd. is transforming the former Washburn Wire Factory into the $87 million East River Plaza. The 400,000 sq. ft. retail complex features big-box tenants such as Home Depot and Costco.

In addition, Forest City Ratner Cos. of New York broke ground this spring on Harlem Center, an $80 million mixed-use project at 125th Street and Malcolm X Boulevard. The development features 300,000 sq. ft. of space. Marshalls, CVS and Dime Savings Bank have pre-leased retail space, and the Gap has built a 23,000 sq. ft. store on the property.

So how can developers and retailers justify entering markets with median household incomes as low as $18,000? According to the Boston Consulting/ICIC study, the business potential of these areas is a function of income density, not household income. In Harlem, for example, the demand for food and apparel per square mile is an estimated $116 million, compared with $53 million across all categories in the rest of the New York metro area.

“Inner-city areas can possess up to six times as much buying power per square mile as surrounding areas,” says the report. “Impressively, inner-city demand per square mile for basics such as groceries and apparel can exceed retail demand across all categories in surrounding locations.”

THE NUMBERS DON'T LIE

Such demographic data is leading developers and retailers to view inner-city communities around the nation not only as growth opportunities, but as a chance to create a vibrant retail environment that is welcomed by the community.

“Over 37 years in the business, I've developed 6 million sq. ft. of property, and I haven't often done projects that communities really want from the beginning,” says Katell of Katell Properties. But in the case of Chesterfield Square, he knew residents, like other inner-city dwellers around the nation, were looking forward to finally having a shopping center in their neighborhood. “Because of that, I think this will be the project I will look back on with the most pride.”

Mike Fickes is a Baltimore-based writer.

SEARCHING FOR PROFIT

Retailers collide with the inner-city stigma

After a decade of experimentation, inner-city development has proven successful. But some developers still hesitate to commit to an inner-city location. Why?

According to a survey by the International Council of Shopping Centers, 80% of the companies polled cited 11 factors as significant obstacles to operating stores in these areas. In order of importance, these factors are:

  • Crime/perceived crime;
  • Insufficient concentration of the retailer's target customer;
  • Lack of consumer purchasing power for the retailer's product;
  • Shoplifting and employee theft;
  • Higher rental rates;
  • Build-out/rehabilitation costs;
  • Difficulty in identifying and assembling a site;
  • Inadequate parking;
  • Higher operating costs;
  • Higher construction and development costs; and
  • Lack of amenities to attract employees from outside the neighborhood.


But the question remains: Are these real obstacles or simply misconceptions about the inner-city community?

The Brookings Institution Center on Urban and Metropolitan Policy explored this question in a 2001 discussion paper entitled, “Exposing Urban Legends: The Real Purchasing Power of Central City Neighborhoods.”

The paper concludes that retailers ignore some of the strongest markets in metropolitan areas because of misconceptions about central city income status, persistent “urban legends” about the absence of workers in inner-city neighborhoods, racial and class-based stereotypes, and the emphasis on average household income promoted by commercial marketing firms. Anecdotal evidence also argues that commonly cited objections to urban development miss the mark.

Southgate in East Los Angeles, an apparently poor Latino area of the city, is a case in point. “In this area, you will find a Target, Sam's Club and other big-box retailers,” says Ken Lombard, president of Johnson Development Corp. — founded by former basketball star Earvin “Magic” Johnson — in Beverly Hills, Calif. “These stores report revenues in the top 5% of their sales district. The demographics say one thing, but the big-box business says another.”

While soliciting grocery store tenants for the recently opened Chesterfield Square center in South Central Los Angeles, developer Jerry Katell, president of Los Angeles-based Katell Properties LLC, asked several grocers about their objections to locating in the center. Why would they avoid an undeserved market with solid demographics? “It didn't make sense to me,” Katell says. “They will build new stores in suburban locations with competitors all around. Here, there is no competition.”

The grocers told Katell that inner-city stores typically suffer from too much employee-related theft.

When Ralph's Food 4 Less signed a lease at Chesterfield Square, Katell questioned the manager, relaying what other operators had told him. “The manager told me Ralph's understood how to manage the problem,” Katell says. “If one company can manage the problem, why can't others?”

In the end, separating fact from fiction is the key to success in the inner-city retail market. As Lombard says, “There is a huge disconnect between demographics and reality.”
Mike Fickes