Could the 300,000-square-foot Los Angeles Fashion Center (or L.A. Face) be the future of retail development? Located in the city's Downtown Fashion District, the six-story enclosed mall will feature women's clothing wholesalers, a food court, upper-floor parking and banks.

What makes it unique is the 196 condominium units, where the individual retailers own and control their 1,200-square-foot space. L.A. Face will be one of the largest retail condo projects in the country and only the second in the area.

“If this condo thing sells at a fast clip, I think you are going to see a lot more of these things in the future,” says Mark Tarczynski, a senior vice president for CB Richard Ellis in L.A.

While retail condo ownership has always languished in the background, it has gained popularity as condo ownership increases in residential properties, as well as office and industrial spaces. According to Real Capital Analytics, $1.1 billion in retail condo transactions were recorded in 2004 and 2005 combined, up from $120 million in 2002 and 2003.

“I have heard from a couple of investors that they are looking at this [retail condo] inventory as a concept,” says Hessam Nadji, senior vice president and director of research for Marcus & Millichap. “Given that we have seen a lot of office and industrial condos lately, there is a possibility that they could be doing this as a concept next.”

Historically low interest rates, while expected to rise, are also feeding the trend. And an emerging market for retail condos is taking shape in urban centers nationwide as developers convert old apartment buildings, offices or hotels into condominiums. In 2005, a total of $28 billion worth of apartment units were bought for condo conversion versus $2.6 billion in 2003, according to Real Capital Analytics.

“When anyone converts a building into condos, the whole things becomes converted, even the ground-floor retail,” says Barry Farchi, vice president of New York-based Itzhaki Properties. For the first time, many urban markets will have a supply of retail condos about to come on-line, say market analysts.

The buyers of retail condominiums fall into two general categories: mom-and-pop stores that buy smaller, individual spaces and investors interested in big urban spaces that can be leased out to multiple tenants.

National chains tend to avoid individual ownership because it ties them down to a neighborhood's rising, or falling, fortunes. “If the market turns soft, it's not just a lease you have to get out of, but you have to find a buyer for your property,” says Jay McIntosh, director of retail and consumer products for Ernst & Young.

Also, with space for a individual retail condos averaging 1,000 square feet to 5,000 square feet, ownership makes more sense for small retailers such as the local dry cleaner, barber shop or jewelry store, says Dan Martin, senior investment advisor for Sperry Van Ness.

For example, Vienna, Va.-based Atlantic Realty Cos. is developing the 165,000-square-foot Eastgate Business Center in Jessup, Md., which will have about 60 retail condos. Built in a former Burlington Coat Factory warehouse, most units are between 1,000 and 3,000 square feet. Buyers already signed on are largely local retailers including a florist, a Mediterranean grocer and a Vietnamese restaurant. The project also includes a few larger parcels ranging from 11,000 square feet to 25,000 square feet. Carl Taylor, Atlantic senior leasing director, says the company is negotiating with a few national retailers, but that those parcels will be leased. Plans are to then sell them to an investor.

“There's a whole litany of reasons why we chose to do this,” says Taylor. “We were able to present the opportunity to own for local businesses and make this a valuable product for our investors. So it's a win-win.” The units will sell for $180 to $220 a square foot. Typical rents for a triple net property in the region range from $13 to $20 a square foot.

The big guns

For big investors who think like developers, big condo spaces that they could rent out to a number of tenants are becoming more popular.

“Like everything else in real estate, they are looking for appreciation,” says Roxanne Betesh, vice president of New York-based Sinvin Realty Corp. This is especially popular in urban areas where there is little greenfield property.

Retail condos are an attractive investment in emerging neighborhoods with growth potential, where they can provide an easy, low-maintenance point of entry. Investors may include 1031 exchangers who are looking to sell their apartment buildings for a retail condo, which may require dealing with only one tenant rather than multiple apartment tenants, says Erez Itzhaki, CEO of Itzhaki Properties.

In a more mature retail condo market such as New York City, investors are paying top dollar for space in a good location. Recently, Ponte Gadea S.L., a Spanish real estate holding company, paid $107 million for a 38,000-square-foot retail condominium at the UJA-Federation's headquarters on 59th Street. It is turning around and leasing the space to Banana Republic and Gap stores. As a major national tenant, Gap Inc. does not want to tie its capital down into real estate. But for a private investor like Ponte Gadea, the condo investment provides a steady cash flow.

Most retail condo properties in New York sell at a 6 percent cap rate, says Betesh. And rents in New York in certain retail districts have climbed as much as 32 percent over the past year, according to the Real Estate Board of New York.

“They are so attractive that anytime there is something on the market there could be 100 bidders,” says Faith Consolo, chairman of the retail leasing and sales division for Prudential Douglas Elliman.

Retail condos come in different shapes and sizes. For example, last year Vornado Realty Trust purchased a 17,000-square-foot, street level retail condo on Madison Avenue for $113 million, which works out to $6,647 a square foot. The unit, part of the former Westbury Hotel on Madison Avenue that was converted into residential condos, includes luxury retailers like Cartier, Chloe and Gucci.

But in general, large REITs or developers don't usually get involved in the condo market. Madison Marquette, with 21 retail condos, is an exception. It purchased properties in late 2004 from Starwood Urban for about $120 million. Most are located in the downtown district of South Norwalk, Conn., or SoNo.

That critical mass of retail attracted the company, because it now had enough control to determine merchandising mix and maximize value. “In most of the areas you will find them [retail condos] fragmented,” says Jake Farver, investment associate with Madison Marquette. “You can get a piece here or a piece there, but not enough to have a strategic plan.”

Madison Marquette has been able to provide more daytime retail opportunities for an area traditionally known for its nightlife. Since purchasing the retail condos, Madison has brought in more home goods tenants such as local retailer Klaff's.

Ownership of a large number of retail condos is still rare. One problem: Large companies are unfamiliar dealing with apartment owners in a condo association. For example, if Madison Marquette wanted to build a dividing wall and create two properties out of one retail condo, it must first get approval from the condo association.

It also has to charge tenants additional costs related to the capital improvement program of the condo association. “It's something that you don't have control over as an owner,” says Farver. “But it's just sort of a nuance of urban retail and buying urban retail that you wouldn't find, say, in a power center.”

In many cases, a condo developer may choose to hold on to the retail portion of his development. “When you ‘condo’ the whole building, the cherry at the top of the pie is the retail,” says Farchi. “If you put a lot of money into converting the property, a lot of your profit is in the retail.” Or a developer can sell the retail condos.

How does a condo converter decide whether to sell the space to an investor or retailer or keep it for himself? “It depends on each developer's goal,” says Timothy L. Bower, first vice president, CB Richard Ellis, Beverly Hills. “In some instances he is trying to hold onto the retail for cash flow. In others, he wants the money right now so he can move onto the next project.”

For the market to grow unabated, some of the property has to change hands to prove that there is a liquid market. “Certainly the idea has a tremendous amount of promise,” says Kenneth Balin, president and chief executive of real estate investment company AMC Delancey Group Inc.

“With a 1031 market exploding right now and other things like tenant-in-common, it shows that there are a lot of private investors that are looking for good, stable retail properties. Remember also that 25 years ago condominiums in general were a relatively unheard of concept [outside New York] that people didn't understand.”