Secondary markets are, in fact, afforded secondary status by most developers. But, one, Red Development, has made smaller markets its primary target, and, in so doing, has built a 12 million-square-foot business in 11 years and helped spotlight the growing value of second-tier locations.

The success of Red's 735,000-square-foot Summit Woods Crossing in Kansas City suburb Lee's Summit, Mo., proved that particular area was under-retailed, says Dan Bourk, senior vice president at Grubb & Ellis/The Winbury Group in Kansas City, Mo. Poag & McEwen, for example, followed with Town Center Plaza in Leawood, Kan.

“People have started to realize that you can make money in secondary and other markets,” says Burke.

And Red, started in 1994 as a side-business by three real-estate buddies, Scott Rehorn, Michael Ebert and Dan Low, is among those, along with CBL & Associates Properties and GK Development, leading the way. The Red partners began by developing property where they lived — in Kansas City, Kan., and Scottsdale, Ariz.

After 11 years in business, Red reported gross revenue of $13 million in 2004, up from $860,000 in 2001. A private company, Red doesn't reveal profit.

Over time, Red's achievements have also shown that second-, and even third-tier, markets can accommodate more sophisticated retail, such as Aeropostale, H&M and Tommy Hilfiger, which are headed for the 850,000-square-foot Legends at Village West in Kansas City, Kan., along with an AMC theater and Jimmy Buffet's Cheeseburger in Paradise.

It's not all smooth sailing, however. Tertiary markets tend to have more mortgage defaults, a fact which can make lenders wary of financing projects, says Tony Butler, vice president and senior CMBS analyst with Wachovia Securities. Rehorn says that's hasn't been a problem. It has developed good relationships with three or four lenders for construction financing, including KeyBanc Capital Markets.

It also often shares cost, by creating joint ventures to develop properties. Red is working with Westcor on the 2 million-square-foot Prasada in Surprise, Ariz. Rather than compete head-on in some territories, it embraces partnerships. “Red is not a big fan of banging heads with other developers,” says Rehorn. “It's a tough business as it is and even tougher when you have to compete.”

Joint ventures also let Red enter unfamiliar markets, and richer markets. Opus Northwest LLC, a member of the Opus Group, and Red have completed two open-air, lifestyle centers around Minneapolis/St. Paul. This year, the pair opened the 400,000-square-foot Woodbury Lakes in Woodbury, Minn.

Red's strategy is to hold on to properties and manage them, though it has sold some when partners decided to cash out. It intends to continue to operate as a private company to avoid Wall Street expectations.

Some question the profitability of building in less-populated regions, where rents and sales-per-square-foot generally are lower. Retail rents in the Kansas City metro region, for example, average about $18.50 a square foot versus $37.50, say, in, Washington, D.C., according to Grubb & Ellis. And GK Development, which owns 4 million square feet of regional mall space in such markets las Grand Forks, N.D., averages about $250 to $280 a square foot in its malls versus $300 to $400 in a primary market, according to company president Garo Kholamian.

But there are exceptions. Red is one. Rehorn says Red's 450,000-square-foot South Pointe Pavilions in Lincoln, Neb., takes in $375 a square foot. CBL & Associates Properties Inc. is another. Stephen Lebovitz, CBL president says the company's 1-million-square-foot Fayette Mall in Lexington, Ky., earns about $500 a square foot. “Being the only mall or the dominant mall in town helps you to deal with retailers because you are not competing with the mall three miles away,” says Lebovitz, whose firm has a long history embracing secondary markets. “If the retailer wants to come to a mall, they come to you.”

Anyway, says Matt Williams, vice president of Grubb & Ellis/Paramount, lower operating costs can compensate for lower sales numbers. Williams estimates that land in Grand Rapids costs on average about $90,000-a-square-foot for a triple-net lease, compared with more than $100,000 in the Detroit area.

Big Names

Red also has helped prove that these second- and third-tier markets can handle more sophisticated retail. Its 850,000-square-foot Legends at Village West in Kansas City, Kan. — which is opening in stages — is part of an entertainment district know as Village West which also includes Nebraska Furniture mart, a baseball stadium and the NASCAR Kansas Speedway. The open-air lifestyle center, an evolution from Red's start in power centers, will be an entertainment destination, with national retailers including Aeropostale, H&M and Tommy Hilfiger signing on.

“The people read the same magazines and see the same ads as anywhere else and they long to have retail in their towns like the big cities have,” says Rehorn.

But just what is a secondary market? The definition is fluid. “It's just an investor's thought process,” says Dan Fasulo, director of market analysis at Real Capital Analytics, Inc.

Real Capital, however, has tried to delineate the differences. Based on 2000 U.S. Census figures it has specified 11 primary markets, in total populated by about one-third of the population. They are Atlanta, Boston, Chicago, Dallas/Ft. Worth, Washington, D.C., Houston, Los Angeles, New York City tri-state area, Philadelphia, San Francisco and South Florida.

Metropolitan areas with fewer than 3.8 million residents, according to Real Capital's calculations, fall into the secondary category. That list names about 19 locales, including Denver, Cleveland, Memphis and Phoenix. (See box on page 20.)

After that, the distinctions become murky. All MSAs with between 2.6 million and 3.8 million people are considered secondary, according to Real Capital's definition. But some areas, with as few as 1.3 million residents, are labeled secondary if they're growing fast. After that come tertiary markets.

The Red style

Red collaborates with its retailers to create centers where demand is ripe. Take South Pointe Pavilions in Lincoln, Neb., for example. The project began when AMC Theatres and Gap decided they wanted to be in Lincoln, Neb, which has a population about 225,000. They had a site, but needed a developer to create a shopping center. They turned to red

The deal usually comes to Red via a tenant interested in the locations, says Rehorn.

For example, Midwest department store chain Von Maur asked Red if it could help open a store in Fort Wayne, Ind. After researching the market, the company teamed up with CDK Investments, an investment manager for several pension funds, and built 600,000-square-foot Jefferson Pointe.

Rehorn says Red's close relations with tenants helps impress city councils when a development is pitched. When St. Joseph, Mo., issued an RFP for retail development on a piece of city-owned property, it eventually chose Red. That was in part due to Red's strong ties to national tenants, says Clint Thompson, director of planning and community development for the city of 80,000. The 753,000-square-foot Shoppes at North Village includes retailers new to the area, such as Target, Bed, Bath & Beyond and Chili's.

“One of the important things for us, because we were using taxpayer's money (through tax increment financing), was that the project would be completed and occupied,” says Thompson. “Red had a good track record with big-box stores and other tenants, so that meant a lot.” In order to reduce Red's overall costs and expedite the development process, the city issued $70 million worth of TIFs.

Normally, the city approval process for a TIF application takes about six to nine months to complete. However, in Red's case, the city shortened the process to four months so the development could be completed on time for certain key tenants, says Thompson. “I think there is probably more flexibility by local governments and by the staff to work with developers in smaller communities,” says Thompson. “This is something that could get lost in a bigger city through bureaucracy.”

Phoenix rising

While Red often locates in off-beat markets, it's big in the fast-growing Phoenix area. Nearly 4 million square feet, or one-fourth of its portfolio, is in that market. One of its two main offices is located in Scottsdale, Ariz., where Rehorn and Ebert originally operated their brokerage business. Because of its rich demographics, Phoenix is more competitive than other secondary market. Unlike in Fort Wayne, Ind., or in St. Joseph, Mo., Red faces other developers. It shares the market with other large players like Vestar Development Co. and Westcor, with which it has partnered to alleviate some of the competition.

Make new friends

For Opus, partnership meant a chance to get into lifestyle centers “We had some basic knowledge of tenant mixing from building grocery centers,” says Tim Murnane, a senior vice president and general manager at Opus Northwest. “But in a lifestyle center, there are certain nuances that are unique to that type of development and Red had a clear understanding of putting that together.”

The two companies are looking into possibly developing another lifestyle center in the region. However, the partnership is expected to sell Woodbury following Opus' business model of developing properties and selling them. Red also recently sold its Jefferson Point project in Fort Wayne after co-investor CDK wanted to cash out. It also sold the Shoppes at North Village to take advantage of a high point in the market.

On its agenda are more entertainment-destination centers. The company is currently working on another Legends project in Sparks, Nev., near Reno. The 800,000-square-foot Legends at Sparks Marina will be a retail and entertainment destination near a former gravel pit that the city has been transformed into a popular fishing spot.

“Red's big focus is not on a particular product type,” says Rehorn. “Whether it's lifestyle, power or destination centers, we just like good real estate deals.”

SECONDARY MARKETS

PROBLEM:

Primary markets are overcrowded, leading to fierce competition. And while sales potential may be higher than in secondary markets, expenses, such as land and labor costs, are also greater. In addition, retailers are in danger of oversaturating these markets and cannibalizing sales from surrounding stores.

SOLUTION:

Develop quality retail in secondary and tertiary markets with promising demographics. While rental rates may be lower, operating costs, such as CAM and land acquisition, are also lower insuring healthy returns.

BUZZ:

After conquering its initial markets, Kansas City and Phoenix, Red has expanded to other tertiary areas, such as St. Joseph, Mo., Lincoln, Neb. and Fort Wayne, Ind. and is expanding beyond power and lifestyle centers into entertainment destination retail.

DATA:

Red has developed its first entertainment destination retail center with the $250 million Legends at Village West in Kansas City, Kan., near the NASCAR Kansas Speedway. The company currently has about $2 billion worth of projects under construction in seven states including Nevada, Arizona and Kansas. When completed, these projects will more than double Red's portfolio to 12 million square feet.

Secondary Markets — For Now

Secondary markets, as defined by Real Capital Analytics Inc. using 2000 census data, include the following. Some cities will likely be redesignated primary markets when fresh population data becomes available.

  • Austin
  • Baltimore/Wilmington, Del.
  • Charlotte
  • Cincinnati
  • Cleveland
  • Denver
  • Detroit
  • Las Vegas
  • Memphis
  • Minneapolis
  • Nashville
  • Orlando
  • Phoenix/Mesa
  • Portland
  • Sacramento
  • San Diego
  • Seattle
  • St. Louis
  • Tampa

Source: Real Capital Analytics Inc.