Shopping center landlord Tri-Land Properties has pulled off two minor miracles over the past few years in its $22.4 million effort to rejuvenate Cherokee South Plaza. The 118,000 sq. ft. strip center built in the early 1960s and located in a mature suburban neighborhood of Kansas City, Mo. had become tired and mostly vacant.

The first miracle occurred in May 2008, when Westchester, Ill.-based Tri-Land convinced the city of Overland Park, Kan., to award it $3.5 million in tax increment financing (TIF), the first development subsidy the city had ever granted. The redevelopment tool allows developers to capture new taxes generated within a TIF district to help pay for improvements within the district.

But once Overland Park and Tri-Land finalized the development agreement in October 2008, the capital markets were in freefall. A frequent user of public incentives to help finance its shopping center repositioning strategy, Tri-Land couldn't issue bonds tied to the TIF to secure construction financing.

“The whole project was at risk,” recalls Richard Dube, founder and president of Tri-Land, which owns and manages roughly 2.6 million sq. ft. of shopping centers primarily in the Midwest.

Creative solution

That set up the second minor miracle, which occurred in the summer of 2009. Tri-Land's investment bank, Minneapolis-based Dougherty & Co., structured notes using the TIF incentive as security and sold them to an Overland Park bank and 41 individual investors. In contrast to a 23-year term of a typical TIF bond, the Tri-Land TIF notes featured three-year maturities with three, one-year options.

The private offering raised $2.8 million, and Tri-Land coupled it with $7.4 million in conventional construction financing to launch the project. The company expects to complete the redevelopment this summer. A Walgreens opened in March, and Tri-Land has a high level of interest for the remaining 40,000 sq. ft. in the project, Dube says.

“We were happy about getting the first TIF in Overland Park only to find out there was a big hole in the bottom of it. Nobody was willing to monetize our achievement,” Dube says. “But at the end of the day, we went into high gear and found a way to do it.”

Still, Tri-Land is paying a much heftier price for the alternative financing compared with what it could have fetched in the bond market. The bank that bought the Cherokee South notes is receiving annual interest of 7.5%, Dube said, and it is secured by the development's incremental real estate tax stream, or the amount of taxes in excess of the existing real estate taxes.

The individual investors, meanwhile, are subordinate to the bank. Tri-Land is paying investors annual interest of 8% in addition to a 4% “kicker” on the loan balance when Tri-Land retires the debt, Dube says.

An improving bond market could allow Tri-Land to pay off the notes as early as 2011. At that time, Tri-Land will issue traditional TIF bonds, which will contribute to the project's bottom line.

Tri-Land originally estimated that it could earn an internal rate of return of around 12% with the TIF compared to about 3% without it. “Unless the market changes significantly, the interest rates will be cheaper on the long-term bond,” Dube says.

Test case

Tri-Land's Overland Park TIF odyssey began in 2004 when it purchased Cherokee South from a local family for $7.6 million. The then 42-year-old shopping center suffered from crumbling infrastructure and a rundown facade. The property had been leaking tenants, and a supermarket anchor was leaving, too. Eventually vacancy topped 60%.

Cherokee South nonetheless was in a promising spot. Annual household income within a three-mile radius averages $84,000, and the older, dense neighborhoods surrounding the center are beginning to gentrify, Dube says.

In 2004, a CVS drug store across the street was generating extremely high sales — about $11.5 million a year. That was about double the annual average of sales per CVS store at the time, according to revenue and store information in the company's 2004 annual report.

What's more, Cherokee South's location at the busy 95th Street and Antioch Road intersection has become even busier. A new interchange at Antioch and Interstate 435 that opened in late 2008 transformed Antioch into a major commuter thoroughfare.

“The population and residential densities have always been very good around that area,” says Bill Shackelford, a vice president with commercial real estate firm RED Brokerage in Kansas City.

Cherokee South and retail centers on adjacent corners were neglected for years, he adds, just like other shopping center properties in older Kansas City suburban areas. “Now finally owners are starting to put money back into them,” he says.

Yet the same year Tri-Land bought the property, Overland Park passed a zoning ordinance to guide the redevelopment of properties totaling 25,000 sq. ft. or more in infill locations.

Essentially, the city wanted developers to incorporate architectural, pedestrian and landscaping enhancements to create more of an urban look within existing suburban centers. The ordinance requires that developers add elements such as courtyards to foster public gatherings.

To pay for the extra costs associated with the ordinance, Tri-Land began lobbying the city in 2006 to help it pay for the rehab. “We told the city that we were happy to adhere to the ordinance, but that we couldn't achieve it without some kind of incentive,” says Dube. “The TIF was really designed to make sure that the property's completion was in line with the zoning law.”

Although city officials knew that tax breaks for redevelopment were inevitable, they hardly rushed to write Tri-Land a check. Overland Park hired a financial analyst to help it determine the incentive Tri-Land would need to earn a market-rate of return.

Eventually the company and Overland Park agreed on a $3.5 million TIF, even though $9.6 million in costs were eligible for reimbursement. All told, the negotiations and public hearing process took about 18 months.

“The city council knew that whatever it did would begin to set the basis for how we approach TIF and redevelopment in the future,” according to John Nachbar, Overland Park's city manager.

Enhanced value

The fact that Tri-Land was Overland Park's TIF guinea pig of sorts didn't discourage the developer. The company generally assesses whether a property will qualify for government incentives as part of its acquisition process, although it recognizes that some communities won't provide them, Dube says.

The rough economy has made communities more hesitant to provide incentives such as TIF, he acknowledges. But TIF projects still provide cities with at least current property tax revenue as well as potentially more sales tax revenue from increased traffic.

Real estate and sales taxes could dwindle if a property continues to lose value because it hasn't been redeveloped, Dube adds. At Cherokee South, the city and Tri-Land are projecting that sales tax collections will total more than $292,000 in 2013, a 400% increase over estimated sales tax revenues in 2009.

Thus far, at least, Overland Park's TIF bet and Tri-Land's redevelopment wager appear to be worthwhile risks. Tri-Land needs to fill only 7,000 more sq. ft. in the next few years to at least break even, he says. In addition to Walgreens, the developer has signed Jimmy John's Gourmet Sandwiches and Paul Mitchell Hair School and Salon to the project.

“We had the opportunity to do something new and to attract people to a much better environment,” Dube says. “But if it wasn't for the TIF, it wouldn't have been financially feasible.”

Joe Gose is a Kansas City-based writer.

Cherokee South Plaza Funding Breakdown

Equity Investment $3.5 million
Walgreens Capital Investment $2.3 million
Acquisition Loan $5.7 million
Construction Loan $7.4 million
TIF $3.5 million
Total $22.4 million

Source: Overland Park/Tri-Land TIF agreement