Western Real Estate Business

AUG 2018

Western Real Estate Business magazine covers the multifamily, retail, office, healthcare, industrial and hospitality sectors in the Western United States.

Issue link: https://westernrealestatebusiness.epubxp.com/i/1012778

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Page 32 of 42

30 • August 2018 • Western Real Estate Business www.REBusinessOnline.com The forces shaking up retail are front and center in the Western United States — and so, too, are savvy responses by retailers and landlords looking to maximize the value of their real estate. Let's start with the challenges. While Seattle-based Amazon tends to take the blame for the troubles of brick-and-mortar re- tail, the truth is more complicated. According to the Commerce De- partment, e-commerce sales for the first quarter grew by an estimated 3.9 percent year-over-year. Daunt- ing as that might sound, keep in mind that total e-commerce sales in the first quarter of 2018 stood at about $123.7 billion as compared to $1.3 trillion for retail overall. Clearly, the "retail apocalypse" is about much more than Amazon. First and foremost, the United States is still overstored compared to other mature markets around the globe. It is a legacy of the aggressive retail rollouts that started in the 1980s and continued off and on until the 2008 meltdown. The Home Depot is a prime example: in 1989, the home improvement retailer operated just 100 stores; by 2005, that number stood at 2,000. After the Wall Street meltdown, weaker retailers with lackluster offerings began to fold in a process that is still ongoing. In many cases, private equity firms played a contributing role: they loaded up chains with debt, sucked out cash and skimped on reinvestment. For malls in particular, the shift among Millennials away from consumerism and branded apparel still stings. According to Reis, U.S. malls posted an 8.6 percent vacancy rate — the high- est since 2012 — in the second quarter of this year. West Coast mall owners like Westfield and Mac- erich are seeking a path forward amid this new nor- mal. Take the $1 billion remake of Westfield Cen- tury City in Los Angeles. The goal is to ramp up the experience in every way. Westfield has added 1.3 million square feet of traffic-driving retail and res- taurants, not the least of which is Eataly — a mas- sively popular food hall concept with lines out the door several days a week. Entertainment is a major focus as well with a Steven Spielberg virtual reality complex (coming soon) and an outdoor event space called the Atrium. In image-conscious L.A., fashion still matters, of course. However, Westfield has add- ed all kinds of experiences and services to Century City. These include fitness tenants Gloveworx, Equi- nox and Peloton, as well as UCLA Health and Cen- tury City Optometry. The new valet stations and on- line parking reservation system bring "frictionless" parking to the oasis-like mall as well. For its part, Macerich has put a premium on part- nering with digitally native retailers such as B8ta, Blue Nile, Dyson, Morphe, UNTUCKit and Warby Parker. By giving these startups affordable percent- age rents and allowing them to use its malls as a "lab," Macerich aims to court new customers — and find the next wave of clicks-to-bricks concepts with the potential to go national. As you may have noticed, both of these mall own- ers are focused on affluent, even rich shoppers. This highlights a reality about the U.S. economy that is particularly pronounced in West Coast cit- ies like Seattle, Los Angeles and San Francisco: In- come inequality is stark and growing. According to the federal government, a Bay Area family of four with an annual household income of $117,000 now qualifies as "low income." In urban areas across the region, this barbell-shaped distribution of wealth and household income means that the middle is the worst place to be. Successful strategies tend to focus either on luxury or discount. But even those retailers that do serve affluent shoppers need to offer something more. Back in the early 1990s, you had to drive to a specialty store to find the kind of outdoor apparel and recreation gear sold by Kent, Wash.-based REI. These days, such items are readily available online. REI's strategy? Invest heavily in the in-store experience as well as your salespeople. The retailer posted a record $2.62 billion in sales in 2017 (a year-over-year increase of 2.6 percent), so its approach may well be paying off. Real estate, too, is increasingly about the "haves" and the "have-nots." Retailers and landlords are ditching underperformers and sinking money into only their best properties and markets. Centers like Seattle's University Village, with its huge new Ap- ple store, are all about catering to millionaires from Microsoft and Amazon. It will be interesting to see whether traditional apparel tenants can shoulder the skyrocketing rents. In any case, count on prop- erties in these markets to keep on shifting toward non-traditional mixes heavy on food and beverage and novel "IRL" (in real life) experiences. Incentives for single-use devel- opers to jump into the mixed-use game are growing across the West- ern U.S. thanks to high land val- ues, the push for environmental sustainability and rising demand for live-work-play developments. Some of these projects aim to meet tech's specific needs. One Silicon Valley example is Ameswell Mountain View. The plans by Broadreach Capital Part- ners and Rockwood Capital call for a 255-room Ameswell Hotel, a Class A, LEED-Platinum office building with amenities geared toward the highly paid workforces of nearby Google, Amazon, Micro- soft, Apple and Intuit. The amenities include a park, bike trails, terraces and breakout areas designed to merge workspaces with nature. The Ameswell Ho- tel will feature creative, local design with an empha- sis on art and technology; meeting and event space; food and beverage offerings like a destination bar and restaurant and grab-and-go market; and out- door gathering spaces with a pool, fire pits, bocce ball court and large lawn. The total project cost is reportedly $250 million. The site is situated at the intersection of Highway 101 and Moffett Boulevard, the kind of place where, a generation ago, a developer might have plopped down a single-use project. These days, however, Western developers are looking for new ways to make projects pencil — not to mention pass muster among local communities and entitlement boards. Given skyrocketing costs, which shrink margins and amplify the need for leverage, mixed-use is a natural solution in dense Western markets. Ele- ments of these projects can be monetized quickly to deliver immediate returns to investors (condos, for example, can be sold early in the process). Traffic- driving projects with diverse uses also tend to be more insulated against risk, which appeals to lend- ers. These dynamics are translating into some ambi- tious investments. Take the $1.5 billion plan to rede- velop Westfield Promenade shopping center in the Warner Center neighborhood of Woodland Hills, Ca- lif. It follows on the heels of an ongoing plan to turn Warner Center, a business development dating to the 1960s, into a new mixed-use, transit-oriented down- town district by 2035. Under the plan, Westfield would build two hotels, 1,400 apartments, 244,000 square feet of retail, 629,000 square feet of office, and a 15,000-seat entertainment and sports venue. Single-use developers contemplating getting into mixed-use need to prepare for new sets of chal- lenges, however. This starts with the financial un- derwriting and modeling platforms, which are far more variegated in mixed-use than in single-use development. For these projects, creating a compel- ling, professional package for prospective lenders and investors is critically important. Pitch decks and financial projections need to inspire confidence. Some lenders might want rollup financials, for ex- ample, while others may ask for reports on individ- ual property types. Providing a clear explication of the deal structure, which can involve multiple sets of investors and construction loans, is likewise es- sential. Once the project is moving forward, it is important to consider how the different uses will work together in time and space. Mixed-use properties often open in staggered phases, with different uses coming on line sequentially. There is an art and a science to get- ting these timelines right. It is a process that typically requires modeling different iterations and scenarios to find the right blend and the right timing. Best prac- tices also vary by property type. The marketing team for the multifamily portion, for example, needs to be adept at reaching potential tenants in compelling ways. Retail leasing agents, by contrast, may need to have a good story (and data) for chef-driven restau- rants and national tenants. To contend with such challenges, some develop- ers are courting mixed-use veterans to fill C-suite positions. But the talent pool is so limited — and the salaries so high — that this tends to be an op- tion only for the largest companies. A more com- mon approach is to form joint ventures and bring in consultants with expertise in mixed-use to help with financial analysis, leasing, property manage- ment, marketing and/or operations. The key is to find those with a proven track record of maximizing value. Harris Lynch Graub MAKING THE LEAP TO MIXED-USE By Mike Harris, Managing Director, and Max Garbus, Vice President, CREModels RETAILERS, LANDLORDS EMBRACE DISRUPTION WITH ADAPTIVE STRATEGIES By Peter J. Lynch and Jon Graub, Principals, A&G Realty Partners MIX WELL FOR BEST RESULTS Adding a mix of uses to a project brings an air of diversity, attracting more people to the same place. Below, five mixed-use experts give their impressions of where this trend is headed.

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