Twin Cities Developers Push Back On Mandated Storefronts In Apartment Buildings

[M II A II R II K]

'Nobody Wants It.' Twin Cities Developers Push Back On Mandated Storefronts In Apartment Buildings


August 10, 2020

By Jim Buchta and Dee DePass



Read More: https://www.startribune.com/twin-cit...ngs/572045262/

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With rising commercial vacancy rates in the Twin Cities, developers are imploring city planners to let them build more apartment units on the street level where commercial space is now required. While planning departments try to make cities more livable with such mixed-use projects, developers argue vacant commercial space increases rents at a time when renters can least afford it. Plus lenders are less willing to finance such projects.

- Minneapolis City Council Member Andrew Johnson said developers have a responsibility to make neighborhoods more active and said he regularly gets calls from small businesses seeking affordable spaces. So he said he often “pushes back” when apartment developers complain they can’t find retail tenants. — “Developers can make a profit,” he said, suggesting that they need to re-examine their commercial rent levels and work harder to find small local businesses that would benefit the community. He also suggested they forgo luxury lobbies that go largely unused and invest instead “in a little coffee shop.” — Jeffrey Herman, president of Urban Anthology Commercial Real Estate in Minneapolis, said COVID-19 has essentially “destroyed” the inner-city commercial market and the prospects for a recovery are uncertain. And while developers would love to land a neighborhood coffee shop or locally owned service business, many of those merchants can’t afford the kind of new space that’s getting built. “If you put in a neighborhood florist you almost have to pay them to be there because they don’t make any money,” he said.

- Mixed-use zoning is a long-standing concept that’s aimed at incorporating a variety of uses into a single development. It’s supposed to enable people to live, work and shop in high-density areas. It’s seen by cities as a more efficient use of land and resources. — Developers say such requirements often have unintended consequences. With demand for commercial space waning and demand for rental apartments raging, they want more flexibility. — Ted Abramson, senior vice president of multifamily investment properties for CBRE Inc., said he recently sold a 118-unit apartment building in St. Paul where 70% of its apartments rented within seven months of opening in November. But the first-floor retail space is empty. — He said it’s increasingly difficult to get such projects financed because lenders understand the growing demand for housing but remain leery of retail, especially because it’s hard to land those sure-bet anchor stores such as Target, Cub Foods or Aldi. — “The underwriting and the credit that a lender is willing to give toward the retail component on those mixed-use developments is heavily scrutinized,” Abramson said. “Even pre-COVID-19.”

- David Daly, a CBRE senior vice president of retail properties, said city rules can create a big risk for builders even if the deal gets financing. A housing developer could build out its first floor for a restaurant only to wind up with a fitness center tenant instead and a significant renovation bill. Drew Johnson, senior vice president of development at Oppidan Investment Co., said mixing restaurants with housing is particularly costly because developers have to install industrial kitchen “odor scrubbers” or grease exhaust vents that can add $250,000 in costs. — Oppidan thought it had a home run of a plan for the city to approve when it presented its 2018 plan for 150 market-rate apartments upstairs, anchored by a Cub Foods on the first floor of its Hiawatha Avenue and 46th Street project in Minneapolis. The city, however, wanted more. It asked for small storefronts along the 46th Street side instead of just a solid wall or a window into Cub’s meat section. — Oppidan complied and built a series of storefronts. But 20 months later, the 4,000-square-foot commercial space, which cost $1.2 million to build, has never had a renter. If occupied, the space could have generated $100,000 a year in rent.

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[PoshSteve]

Can someone help me understand this? I hear developers talk about how the local shops who want to rent space, can't afford the rent they would charge. Then they turn around and say they are losing out because they have all this empty retail space. Wouldn't it be better to rent that space out to a local shop for something (even if less than you would prefer) than to make zero by it sitting empty? Is there some tax benefit they get to write off by keeping the space empty? It just defies all common sense...

[Centropolis]

Originally Posted by PoshSteve

Can someone help me understand this? I hear developers talk about how the local shops who want to rent space, can't afford the rent they would charge. Then they turn around and say they are losing out because they have all this empty retail space. Wouldn't it be better to rent that space out to a local shop for something (even if less than you would prefer) than to make zero by it sitting empty? Is there some tax benefit they get to write off by keeping the space empty? It just defies all common sense...

yeah ive seen this for years. they try to hold out for a chain (or high end concept) and i’ve seen them hold out so long that dust collects on the inside of the glass of new retail spaces...

yeah i think its also tax related but i’ll let someone else chime in on that...

[ardecila]

Any potential tax writeoffs are part of it, but it's a complicated topic.

Professional developers don't usually build with their own equity. They build using Other People's Money - banks that issue debt, and outside investors who contribute equity. It is competitive to get this financing, so developers have to show strong performance on the project at hand and (ideally) a track record of similar financial performance in the past. To ensure strong financial performance (increase returns or reduce risk), banks and investors will often make demands on developers that they have to comply with. In a really red-hot market, sometimes developers can get a pass to do whatever they want, but in a weaker market (which is most markets) banks and investors can make demands concerning the size, type, financial plan, sometimes even the architectural style of new buildings.

When it comes to retail spaces, that means developers don't always have the ability to just lease the space to whomever they want... the banks and investors that actually finance new buildings often set rent targets that the developers must comply with, for both residential and retail spaces. To reduce risk, sometimes they even require national credit tenants (i.e. chain stores).

TL;DR, developers don't always have the latitude to rent their retail spaces at a discount, or to give preference to local or independent businesses (which are objectively very risky tenants with a high likelihood of failure).



The article also alludes to another issue, which is that commercial leases usually have a tenant improvement allowance (TIA) - the landlord/developer agrees to spend a lot of money renovating the space to the tenant's specifications. Developers are understandably hesitant to do this for a small or independent business if they think the business is likely to fail before the cost of TIA is recouped. It's not that independent business is bad per se - most developers would love to land an independent business if it brings cachet or buzz to their project, but only if they have a proven strong track record at another location.

[M II A II R II K]

I guess financing would be less of an issue if there were more apartments, and particularly more floors to compensate for the ground floor being used up.

[Qubert]

Originally Posted by PoshSteve

Can someone help me understand this? I hear developers talk about how the local shops who want to rent space, can't afford the rent they would charge. Then they turn around and say they are losing out because they have all this empty retail space. Wouldn't it be better to rent that space out to a local shop for something (even if less than you would prefer) than to make zero by it sitting empty? Is there some tax benefit they get to write off by keeping the space empty? It just defies all common sense...

What I'm curious about is wither this law applies only on buildings being built along retail corridors or citywide. Not even Brooklyn is dense enough to support retail on every. single. street of the city.

[mhays]

The planners just aren't grasping reality here.

Storefront retail was always a loss leader in most neighborhood business districts, at least since shopping shifted to supermarkets and malls. The internet has made it worse, and Covid worse still, mostly by shifting long-term trends toward more internet. Rents haven't justified the development costs for a while. The exception is the strongest districts that attract people from elsewhere, and the places that manage to balance supply and demand by having less retail space.

The US has 40 square feet of retail per person. I'd guess a neighborhood business district would often get maybe 10 square feet of that, omitting supermarkets. In a mixed-use district, office workers would contribute too...let's say another 5 if you're lucky.

Now multiply that by a building with 200 units and 300 residents. Maybe 3,000 square feet of retail is merited. That's a single smallish retail space. If the block has 15,000 square feet, that's way too much.

What happens when several buildings all build retail without bringing enough demand? Lots of vacancies. My city is full of them too.

Development lenders have always assumed retail would go at a loss, even in strong economies. Today is a huge question mark, and a big hurdle on any development.

The idea of simply renting more cheaply is myopic at best. Retail is a zero-sum game. Subsidizing businesses doesn't add customers on a net basis. They're simply not shopping somewhere else. And you're making the residents (actually all of the region's renters, ultimately) provide the subsidy.

We need to get beyond the idea that every multifamily frontage needs to be active. Allowing townhouse units on the perimeter is a start.

[C.]

Tax laws and the financing structure make it more beneficial to keep the commercial space vacant in hopes of attracting a deep pocket tenant than it would be to lower the rent.

Land-use planners have met their match here. Only so much they can do to promote this type of development.

Here is a radical idea that might work if this was a condominium development (instead of rental): sell the commercial space as condos. Whoever buys would be strictly in the business of leasing out the commercial property and their financing would encourage 100 percent occupancy instead of being a tax write-off.

Out of curiosity, are there any examples out there of a vacant property tax that encourages landlords to keep their space occupied or face a higher tax rate? Not sure if this exists or would work but just curious if anyone has tried it.

[The North One]

It is really stupid to force retail in an effort to bring in more mixed use development, you're just gonna have a city with a ton of empty retail.

Units that directly face the street are also great, no reason it has to be retail.

[iheartthed]

Originally Posted by The North One

It is really stupid to force retail in an effort to bring in more mixed use development, you're just gonna have a city with a ton of empty retail.

Even if it is empty, that's better than permanently taking away that space from potential retail, especially on major thoroughfares.

[Doady]

You Americans think mandated anything is "really stupid". That's why so much sprawl, transit ridership is so low, no universal healthcare, 160,000+ dead from coronavirus. Now even the idea of mixed-use retail is too much for you people. What concept will be next to come under attack? Public public postal service? Just the same old, same old. USA never changes.

[PoshSteve]

Originally Posted by ardecila

Any potential tax writeoffs are part of it, but it's a complicated topic.

Professional developers don't usually build with their own equity. They build using Other People's Money - banks that issue debt, and outside investors who contribute equity. It is competitive to get this financing, so developers have to show strong performance on the project at hand and (ideally) a track record of similar financial performance in the past. To ensure strong financial performance (increase returns or reduce risk), banks and investors will often make demands on developers that they have to comply with. In a really red-hot market, sometimes developers can get a pass to do whatever they want, but in a weaker market (which is most markets) banks and investors can make demands concerning the size, type, financial plan, sometimes even the architectural style of new buildings.

When it comes to retail spaces, that means developers don't always have the ability to just lease the space to whomever they want... the banks and investors that actually finance new buildings often set rent targets that the developers must comply with, for both residential and retail spaces. To reduce risk, sometimes they even require national credit tenants (i.e. chain stores).

TL;DR, developers don't always have the latitude to rent their retail spaces at a discount, or to give preference to local or independent businesses (which are objectively very risky tenants with a high likelihood of failure).



The article also alludes to another issue, which is that commercial leases usually have a tenant improvement allowance (TIA) - the landlord/developer agrees to spend a lot of money renovating the space to the tenant's specifications. Developers are understandably hesitant to do this for a small or independent business if they think the business is likely to fail before the cost of TIA is recouped. It's not that independent business is bad per se - most developers would love to land an independent business if it brings cachet or buzz to their project, but only if they have a proven strong track record at another location.

Thank you, this helps. I never really considered that aspect before.

[Pedestrian]

Originally Posted by C.

Tax laws and the financing structure make it more beneficial to keep the commercial space vacant in hopes of attracting a deep pocket tenant than it would be to lower the rent.

Land-use planners have met their match here. Only so much they can do to promote this type of development.

Here is a radical idea that might work if this was a condominium development (instead of rental): sell the commercial space as condos. Whoever buys would be strictly in the business of leasing out the commercial property and their financing would encourage 100 percent occupancy instead of being a tax write-off.

Out of curiosity, are there any examples out there of a vacant property tax that encourages landlords to keep their space occupied or face a higher tax rate? Not sure if this exists or would work but just curious if anyone has tried it.

You can depend on the PRSF (Peoples' Republic of San Francisco) to be way ahead on this and everything:

Supes delay storefront vacancy tax until 2022
JOSHUA SABATINI
Jun. 9, 2020 4:30 p.m.

After the coronavirus pandemic shuttered San Francisco many businesses and sent the local economy into a tailspin, the Board of Supervisors voted Tuesday to delay implementation of the voter-approved vacancy tax on empty storefronts.

The unanimously approved one-year delay was proposed by Supervisor Aaron Peskin, who had introduced Proposition D, the storefront vacancy tax for the March ballot. The tax will now go into effect in 2022, not 2021.

The measure was seen as one strategy to address a proliferation of vacant storefronts in San Francisco neighborhood commercial corridors, despite a strong economy. The vacancies were blamed in part on landlords asking for exorbitant rents.

“I think we all agree that this global pandemic definitely is in the category of severe and unforeseen events that is throwing a wrench into the proper functioning of this voter approved tax,” Peskin said. “I want to reassure everybody that in time this vacancy tax will work precisely as intended when our economy recovers.”

https://www.sfexaminer.com/news/supe...ax-until-2022/

Meanwhile, as far as I know the Planning Dept. is still strongly inclined to force developers to include ground floor retail, even in districts where a lot of it already sits empty and chains are banned by city ordinance.

[0214685226]

Originally Posted by Doady

You Americans think mandated anything is "really stupid". That's why so much sprawl, transit ridership is so low, no universal healthcare, 160,000+ dead from coronavirus. Now even the idea of mixed-use retail is too much for you people. What concept will be next to come under attack? Public public postal service? Just the same old, same old. USA never changes.

You should avoid NJ, NY, CT, MA, RI at all costs due to Covid, the worst places in the WORLD. You would be much safer in Texas, Florida, California, Missouri, North Carolina. Stay safe, bro.

[Pedestrian]

Originally Posted by 0214685226

You should avoid NJ, NY, CT, MA, RI at all costs due to Covid, the worst places in the WORLD. You would be much safer in Texas, Florida, California, Missouri, North Carolina. Stay safe, bro.

This is the wrong thread but I have to object to the near-universal (by outsiders) lumping of all California together. The COVID pandemic in urban southern CA bears little resemblance to that in the Central Valley which is very different (and much worse) than that in northern California.

On your list, northern CA belongs in the listing with the northeast as much as the Central Valley belongs with the southeast.

[Centropolis]

a past coworker of mine from bakersfield who now lives in los angeles described the central valley as texas (or south texas) wrapped by...california. or something like that, it was more clever.

[0214685226]

Originally Posted by Pedestrian

This is the wrong thread but I have to object to the near-universal (by outsiders) lumping of all California together. The COVID pandemic in urban southern CA bears little resemblance to that in the Central Valley which is very different (and much worse) than that in northern California.

On your list, northern CA belongs in the listing with the northeast as much as the Central Valley belongs with the southeast.

You're right. It is the wrong thread. Perhaps you should lecture Doady and not my self. I was responding to an incorrect (Doady's) post.

[Pedestrian]

Originally Posted by 0214685226

You're right. It is the wrong thread. Perhaps you should lecture Doady and not my self. I was responding to an incorrect (Doady's) post.

Not lecturing. If you aren't from CA you probably don't realize which is not your fault since the media makes the same mistake every evening. Anyway, just trying to clear up a misconception that I think is important--for everybody who isn't a Californian, not just you.

Originally Posted by Centropolis

a past coworker of mine from bakersfield who now lives in los angeles described the central valley as texas (or south texas) wrapped by...california. or something like that, it was more clever.

That's very apt. Even the geography is largely right. I do think the Hispanic citizens of Texas are treated less serf-like, though.

OK, so anybody have any comment on SF's tax on vacant storefronts? And since our terribly liberal Supes rarely have an original idea, they must have got it from somewhere so are we alone in having this?

[Northern Light]

Originally Posted by mhays

The planners just aren't grasping reality here.

Storefront retail was always a loss leader in most neighborhood business districts, at least since shopping shifted to supermarkets and malls.

Sincere question, not snark.

Why not prohibit superstores and malls and power centres?

Its been done, and not just in Europe........but in the U.S.

Turlock, CA, prohibits stores over 100,000 square feet that devote more than 5 percent of their space to groceries

Ireland restricts stores in the Dublin area to 3,500 square meters (38,000 sq. ft.) and applies a 3,000 square meter (32,000 sq. ft.) limit to the rest of the country.

Doing that and banning drive-thrus can change the dynamic in favour of 'main street retail' over time.

Similarly, imposing maximum parking on retailers, and requiring it be hidden behind stores that have entrances fronting the main street essentially outlaws the typical power centre or mall.

What happens when several buildings all build retail without bringing enough demand? Lots of vacancies. My city is full of them too.

Toronto doesn't have very many stretches of mainstreet retail that sit vacant.

You get the odd bit here and there; but its more the exception that the rule.

Retail is not imposed on streets that are entirely 'side streets' or residential in character.

But it is typically required anywhere on a mainstreet that is already predominantly retail; (even when replacing single-family homes).

Collector roads are a bit more nuanced; some many have retail, and others not.

But in general its the norm in any hirise construction and most midrise fronting a major road.

[Commentariat]

Originally Posted by PoshSteve

Can someone help me understand this? I hear developers talk about how the local shops who want to rent space, can't afford the rent they would charge. Then they turn around and say they are losing out because they have all this empty retail space. Wouldn't it be better to rent that space out to a local shop for something (even if less than you would prefer) than to make zero by it sitting empty? Is there some tax benefit they get to write off by keeping the space empty? It just defies all common sense...

Dunno how it works in America but here in Australia we have the same issue and it’s all about cap rates/multiples.

Let’s say a store typically brings in a 6% yield. The capitalized value is then about 16 times the rent. So if the store is renting for $100k pa, the value is $1.6 million.

Now let’s say it’s vacant, and the landlord decides to reduce the rent to $75k to get a tenant. The capitalized value is now 16 times $75k or $1.2 million. That’s a (paper) loss of $400k. The owner would be better off keeping the property vacant for years to find a tenant who will pay $100k instead of $75k.

The loss in value also has financing implications, eg the bank might lend up to 75% of the value of the property, so if the new valuation is $400k less then you are going to have to to stump up more equity. If you are forced to sell, then there might not be any equity left.

It’s probably a bit different in the US where you have more institutional ownership of large portfolios of properties (as compared to Australia, where the individual stores would usually be sold to small investors). But the same underlying concepts will be relevant to some extent.