The city is hot again. With the U.S. population expected to swell by another 70 million people over the next 25 years, the real estate community and municipalities nationwide are focusing on “smart-growth” approaches to urban development to best accommodate all these new residents.

Rather than merely sprawling beyond today's suburbs — lengthening already stressful commutes, carving up precious open space and further degrading the environment — we are beginning to redevelop underused urban sites, taking advantage of existing infrastructure to create lively, “18-hour” neighborhoods where people can live, work and play.

At the same time, retailers and retail-property investors are awakening to the largely untapped potential of urban consumer markets. And not just in gentrified areas. Low-income neighborhoods with predominantly minority residents and limited shopping options are drawing attention and attracting investment as one of retail's last frontiers.

Together, these two trends are shining a spotlight on urban real estate and the key role that retailing plays in urban revitalization. When conceived well and managed properly, retail outlets — neighborhood centers, entertainment-oriented venues, retail components of residential/commercial mixed-use projects — enhance a neighborhood's character and facilitate urban renewal.

Smart growth means using — and reusing — land more efficiently, such as by redeveloping underused sites (e.g., surface-parking lots, obsolete commercial buildings) into neighborhood-friendly, mixed-use projects featuring streetscape retail, restaurants and high-density housing; or by building a mix of commercial and residential space around public-transit stations.

By its very nature, the smart-growth movement is encouraging people to live more densely in existing cities. However, it is not the only catalyst that is prompting urban renewal. According to the Census Bureau, the share of the U.S. population represented by Hispanics and other racial minorities is expected to grow to 50 percent in 2050 from 31 percent in 2000. Since these demographic groups tend to live in urban neighborhoods, their growth will translate into additional demand for urban properties in the coming years — even as some relocate to more suburban settings.

Another factor behind the urbanization trend is the desire of older, empty-nester couples and young Echo Boomers to experience an urban lifestyle full of daytime and nighttime entertainment options, a myriad of retail choices and ethnically and culturally diverse neighborhoods.

Downtown Los Angeles, for example, is undergoing a dramatic transformation as people flock to live in recently built condominiums and apartments and be a part of a burgeoning cultural and entertainment scene. Reversing a long-standing pattern, the population downtown is growing more quickly than the Los Angeles metropolitan area as a whole.

Retailers are following the rooftops, looking more closely at urban locations that they may have bypassed not long ago. Big-box chains that dominate suburban roadways, such as Home Depot and Best Buy, are setting up shop in higher-density areas. Sears has introduced two off-mall, mid-size store concepts — Sears Grand and Sears Essentials — that are well-suited for densely populated, urban neighborhoods. And Borders Books & Music made headlines in late 2003 when it opened a store in downtown Detroit, long a retail ghost town.

In some cases, the obvious synergies between retail and other land uses achieved in upscale mixed-use development projects such as Bethesda Row in Maryland are drawing retailers to urban sites. In poorer urban neighborhoods, meanwhile, the significant imbalance between potential retail demand and the existing supply of space is too great for retailers to ignore.

Steady population growth among minorities, paired with the high population densities of urban neighborhoods, create significant aggregate demand for retail products and services — even in areas with the lowest income levels. Yet, these consumers often have few quality retail outlets in their own neighborhoods. The disparity between demand and supply is stark. Inner-city residents represent an estimated $85 billion in unmet retail demand, according to a 1998 Boston Consulting Group study.

Before we launched our urban real estate venture with the California Public Employees' Retirement System in 1995, we researched retail supply/demand fundamentals in California's major markets and discovered minority neighborhoods within Los Angeles and the San Francisco Bay area that had as little as 2 square feet to 5 square feet of shopping-center space per person. At the time, the national average was 19 square feet per capita.

Real estate investors are beginning to realize that there's money to be made from retail properties and other projects that help revitalize urban communities. Pension funds, for one, are increasingly looking to invest in the retail, residential and mixed-use projects that cities large and small want to pursue in order to revive downtrodden districts and create vibrant urban neighborhoods.

The Right Mix

Several investment managers now offer programs dedicated to urban real estate, a strategy virtually unheard of 10 years ago. Back then, we were considered pioneers venturing into unknown — and, from an investment perspective, perhaps frightening — territory. Even if we made money, critics charged, it would not be enough to compensate for the risks we undertook.

However, our performance and that of other firms over the ensuing years has proved that urban real estate investments can generate attractive risk-adjusted returns while, at the same time, providing community benefits in the form of housing, jobs and improved retail services.

Our urban investments traverse a broad spectrum of retail formats: Ladera Center, a grocery-anchored center serving a primarily African American and Latino neighborhood in Los Angeles; Bay Street Emeryville, a mixed-use community near the eastern approach to the San Francisco-Oakland Bay Bridge that features a 365,000-square-foot lifestyle center, residential condominiums and both market-rate and affordable apartments; and the Shops at Columbus Circle, the upscale retail venue at the Time Warner Center in New York City that is proving that vertical retail configurations can make it in Manhattan.

Each retail investment is bringing much-needed shopping and dining experiences to its surrounding environs, adding momentum to local efforts that lead to a broader neighborhood revitalization. Ladera Center has become a community center and popular nightspot for residents of the Baldwin Hills and Ladera Heights districts of Los Angeles. Bay Street is transforming a once-contaminated and abandoned industrial site into a full-fledged urban village. And the Shops at Columbus Circle is serving as a key link between Times Square and the Upper West Side.

By no means are we the only ones making these investments. CIM Group, Urban America, Canyon Capital/Johnson Development, Thor Equities and other firms are raising millions of dollars in equity capital from pension funds and other institutions that are earmarked for projects that contribute to urban renewal.

Although such investments are just a small slice of the overall real estate capital market, they show that investors are overcoming misconceptions about urban areas and minority neighborhoods. Indeed, the supposedly risky realm of urban projects is converging with the long-accepted world of “core” properties — that is, stabilized, income-producing assets — which constitute the majority of pension real estate portfolios. We are finding that the very same urban projects we built or redeveloped are now coveted by core investors.

Over time, as the smart-growth and urbanization movements gain traction, and as retailers meet the demands of underserved urban markets, we anticipate that urban-focused investment strategies will become a more common component of institutional real estate portfolios. And retail properties, as an integral part of the urban experience, will have played an important part in that process.

Founder and managing principal of MacFarlane Partners, the leading U.S. minority-owned real estate investment management firm with $1.75 billion in investor equity and $6 billion in properties completed and under construction