Filling in the Blanks
[July/August 2002]
By Michele Lerner
As suburban sprawl spreads, residents and developers have headed back to the city. But how long will this urban renewal last?
The urban lifestyle is making a comeback as an increasing number of suburbanites, weary of long commutes and overcrowded roads, are migrating back into cities across the country. Also supporting this urban renewal are environmentalists trying to stop development of far-flung office parks, retail centers and housing communities, as well as developers and city planners looking to promote smart growth, a concept often linked with urban infill development.
Urban infill, a loosely defined term which refers to development projects on vacant urban land or the redevelopment of a blighted building or neighborhood, is currently in vogue as the solution to sprawl and one of the leading investment opportunities for real estate companies.
“Sprawl is everywhere, and that type of development can’t be sustained forever,” says Fred Stemmler, partner for development and operations for California-based Hopkins Real Estate Group, developers of shopping centers in urban infill and redevelopment areas. “My feeling is, if you’re not doing infill development in the next 10 years, you won’t be doing development at all. Developers who don’t get on this bandwagon will be left behind. I think infill projects are rapidly becoming one of the most important games in town.”
According to Bill Hudnut, senior resident fellow for public policy at the Urban Land Institute, “In general terms, infill is very important because it serves as an antidote to sprawl. It is a wise use of land, it brings a tax base to an area that needs it, and it adds value to city life. Generally speaking, infill projects refer not only to urban projects, but also to projects in areas close to a city. A lot of the nation’s first-string suburbs around a city are deteriorating, such as some of the close-in suburbs of Cleveland.”
Most infill projects tend to be residential multi-housing developments, because that is where the greatest need is, Hudnut says. “Developers of these types of projects should always think in terms of mixed-use projects, though. Just putting up residential housing in an area without services such as grocery stores and dry cleaners won’t help revitalize the neighborhood,” he says.
Filling in Demand
The seeds for this wave of infill development were planted back when the initial migration to the suburbs began. Mass production of suburban housing began after World War II when traditional nuclear families represented the majority of the market. Families seeking refuge from the hustle and bustle and high costs of big cities quickly gravitated to the suburbs.
However, changes in demographics from the 1970s into the 21st century have meant that the traditional nuclear households—with a working father, stay-at-home mother and two or more children—now constitute less than one quarter of all households. Single-person households now account for a quarter of the total, and longer life expectancies are creating a larger aging population. The rising number of singles, working parents, single parents and elderly indicate a growing demand for higher density infill housing located close to services, jobs and transportation.
“Two trends are making residential infill projects more attractive to developers. First, a number of cities have seen a resurgence in population in the past few years which is changing the trend of previous decades,” says Mark Obrinksy, vice president of research and chief economist for the National Multi Housing Council. “Second, there’s an increase in the number of people who want to live in the close-in suburbs, which tend to be older and in need of infill projects themselves.”
Obrinsky says most new development is still taking place in the farther suburbs where there’s more land. But a counter-trend is occurring, with people wanting to be in the city. “Obviously this doesn’t include every city, but it does particularly include Boston, New York, Washington, D.C., Chicago and San Francisco, cities that are more desirable to people than they were 10 years ago,” he says.
According to Obrinsky, “The mix of demand for these infill projects is coming from classic urban renters, young professionals who are in the early stages of their careers and looking for middle-income housing, and empty-nester baby boomers who tend to have more disposable income. The baby boomers are fueling demand for upscale apartments and condominiums in or near major cities now that their children are grown or are finishing college. In the short term, in terms of demographics, there will be more and more of these empty nesters for at least the next 10 years or so looking for multifamily housing.”
Unique Development Challenges
Demand for infill projects may be rising in some cities, but there are challenges for infill developers that are different from those of more traditional developments.
“The primary challenge we face is assembly,” Stemmler says. “If you take the stereotypical strip shopping center in an infill area which needs to be redeveloped, you’ll often find fractionalized ownership. By the time a shopping center is ready for revitalization you could have 10 different owners and a bunch of tenants with long-term leases. If you want to take down the shopping center you need to satisfy all these people, including legal occupants and legal owners. That’s where the public-private partnership works best, with the power of eminent domain or the threat of that power.”
Trammell Crow’s The Proscenium in Atlanta is an example of a public-private infill success story. |
In addition to acquiring the land for an infill project, the condition of the land can be a problem.
“If other people and companies have been using or abusing the land for decades or longer, there can be environmental issues and costs associated with a clean-up,” Stemmler says. “It is essential that companies go through an environmental inquiry before investing in a development site, because if they don’t do it and there is an environmental problem later, the company can be held liable for damages even if the problem is an old one.”
The first step of the inquiry, Stemmler recommends, is conducting a historic, user-focused inquiry. Ideally, he says, a company discovers the land is untouched and has never been used for agricultural or commercial use. The bad news would be that a pre-World War II gas station was on the site, or even worse, that the site was a former Marine Corps air base. The second phase would be to test the soil.
Financing Hurdles
Once a suitable site is discovered, infill developers can run into a third challenge: financing. “One of the reasons infill projects can be more difficult to undertake is that lending institutions are more likely to lend money for traditional projects, which they see as less risky,” Hudnut says. “There’s also an often fallacious assumption that infill projects are for lower-income people, which ignores the fact that people who want to move into the city are often affluent.”
Companies new to infill development can face an even harder road in obtaining financing, says Alfred Neely, executive vice president and chief investment officer of Charles E. Smith Residential, a division of Archstone-Smith. “Lots of capital is available if you have a proven track record. It’s just a question of investors knowing who they’re dealing with,” Neely says.
When Trammell Crow first became involved with midtown Atlanta revitalization projects, they found financing difficult simply because of the timing.
“We were starting at a time when there wasn’t much capital available for any type of project,” says John Whitaker, managing director of Trammell Crow in Atlanta. “Investors will follow market dynamics and investment returns, and the fact that something is being built in an urban market doesn’t necessarily bear on that. We had to demonstrate market validation of our product, which we did through pre-leasing agreements. For the right projects there’s plenty of money out there.”
Mack-Cali Realty Corporation, developers of Harborside on the Hudson River in Jersey City, NJ, found financing the infill project and similar ones to be a little more complex than traditional projects, but not an impossible obstacle.
“It’s definitely tougher to do infill (development) than buying an isolated piece of land and building a single asset,” says Mitchell Hersh, CEO of Mack-Cali. The challenges of this type of development vary according to the project. It’s often physically challenging and therefore more expensive to work in an urban setting. At Harborside, we had to do all the work from barges in the river, which was definitely a challenge.”
Benefits of Public-Private Partnerships
Hopkins Real Estate Group’s Stemmler works with an alliance of members of the International Council of Shopping Centers in an outreach to the public sector to encourage their cooperation in redevelopment efforts.
“Public-private partnerships have become a battle cry for redevelopment, and we’re working on state-by-state alliance programs to bring developers and redevelopment agencies together,” Stemmler says.
According to Hudnut, “Most local governments are in favor of redevelopment projects and there are lots of ways they can help developers. They can offer tax abatements, tax-increment financing and money for community development projects. Sometimes a local government will assemble the land for redevelopment and then turn it over to a private developer.”
When a local government wants an area to be redeveloped, they can streamline the permitting process as an incentive to the developer, Obrinsky says. “Local government incentives to redevelopment run the gamut from active involvement and encouragement to limiting their opposition if the developer agrees to include a certain number of units for people with low to moderate incomes,” he says.
Trammell Crow’s experience when developing The Proscenium building in Atlanta is an example of a successful public-private partnership.
“About 10 years ago, leaders of the Atlanta business community and residential areas began brainstorming sessions, talking about how buildings should relate to the street, how traffic flow should work, etc., and the result was the ‘Midtown Blueprint’,” Whitaker says. “The Blueprint is a collaborative effort between the occupants of the commercial buildings in midtown Atlanta, owners, residents and the government. Some of the things we did were voluntarily done because they were things the community wanted, such as putting a retail component on the first level of our parking structure so that there would be activity on the street.”
When Mack-Cali worked on Harborside, the company emphasized the benefits to the city of this commercial development and the link to the history of Jersey City as a port town.
“We wanted to be sure that residents of Jersey City saw Harborside as part of their city, that there was no bifurcation between the two communities,” Hersh says.
Community Relations
Working with community groups during the planning stages of a project can be an additional challenge for infill developers, particularly when those groups oppose redevelopment. However, in many cities there are community groups eagerly seeking redevelopment projects, some of which can help streamline the permitting process.
“The Greenbelt Alliance supports development that occurs in already developed areas, even if it’s on vacant land. This development should be compact, with higher density than suburban development, at around 20 units per acre,” says Janet Stone, livable community project director of the Greenbelt Alliance in San Francisco. “We support mixed-use developments, too. People recognize that the old style of developing single use areas, with only housing in one place and only commercial development in another is not livable. The third element of appropriate development is that it occurs where public transportation already exists or in an area that is pedestrian friendly.”
The Greenbelt Alliance also encourages a mix of housing choices and options for a variety of income levels, especially affordable housing for low to moderate-income families.
“Displacement of low-income families and gentrification of a neighborhood is a problem that can be avoided if a municipality makes it clear that they favor a mix of housing types and won’t welcome just any kind of development,” Stone says. “Municipalities can also give incentives to developers to include affordable housing as part of their project.”
Tapping the Investment Potential
The short supply of appropriate urban infill development locations adds to the financial viability of these projects.
“While there’s lots of supply and plenty of sites which haven’t been developed, that doesn’t necessarily mean that each one of these sites is economically viable,” says Dale Anne Reiss, global industry leader of the real estate practice for Ernst & Young LLP. “You really cannot generalize about infill projects because by nature each is unique, with its own environmental, location and title challenges.”
The key thing for REITs is to look for a project that generates the highest returns with an acceptable level of risk for their investors. “Yes, redeveloping our cities is an important goal, but this needs to be done with the best interests of the shareholder in mind,” Reiss says. “If an infill project works, then it’s good for everyone. From a macro perspective, infill projects make sense, as they frequently have the ability to generate a high return on investment.”
It is that lure of high returns that has many developers exploring infill projects. “The ability to grow rents in infill markets is greater than in other markets,” Neely says. “The high-rise and high-density projects we develop offer a more stable investment, in part because it’s not likely that other projects will open in the same area. They are supply constrained.”
Mack-Cali’s Hersh agrees that the financial benefits of infill projects outweigh the challenges. “These projects allow us the ability to have deep penetration in markets where replication is impossible,” Hersh says.
“Ten years ago, if I had been asked about urban development I’d have given a different answer,” Whitaker says. “At that time there was a feeling that downtown markets were being abandoned in favor of the suburbs. Now that feeling is flipped around, as people realize that they like to live in a city environment. It’s clear to us that urban development is here to stay.”
While areas currently ripe for infill projects may slow, Stemmler says that doesn’t mean overall supply will diminish. “I think there’s an unlimited supply of urban infill sites, mostly because this isn’t a static opportunity,” he says. “For one thing, there’s what I call filtering, which means that neighborhoods change over time. Keeping up with redevelopment is like the boy with his finger (plugging a hole) in the dike. When one area is fixed, another will open up and need work.”
Michele Lerner, a freelance writer from Washington, D.C., specializes in real estate-related articles.
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