Q1 2019 Edition
© 2019 TRANSWESTERN transwestern.com
A Message from
From lenders to corporations and consumers, it seems decision makers have eased off the accelerator and are scouring the roadway ahead for hazards. Caution is an appropriate response to a slowing global economy, and prudent investors remain vigilant in vetting development projects.
Yet those same investors know that the U.S. economy is growing and that interest rates, while climbing, are rising more slowly than expected and remain near historic lows. In contrast to the previous real estate cycle, supply has stayed in step with demand in most markets.
Every phase of the economic cycle brings real estate opportunities, including those calling for construction and development. With the appropriate care and attention to detail, now is a time for selective investment and strategic value creation.
In this issue of Insights, we approach development from several angles. Our cover story looks at structured parking as a tool to enhance urban shopping centers, including design improvements to allow eventual repurposing to retail, office or other uses. Sharing some of what we’ve learned through decades of development and asset management, we discuss strategies to extend the life of parking garages.
A speculative industrial project in Florida illustrates the redevelopment potential at one of the hundreds of closed golf courses scattered across the country, and how prudent planning could offer inroads for ecommerce or other uses in high-density metros. And finally, we clarify a federal program that imports billions of dollars in low-cost investment capital annually, much of it available for commercial real estate projects.
We hope these insights inspire you to consider a wide spectrum of possibilities in your own real estate endeavors.
As retailers stake claims in today’s densely populated urban communities, providing adequate parking presents an increasingly costly challenge.
Unlike suburban shopping centers, where customers often park directly in front of their destination, urban retail centers may require visitors to park on the street, in a remote lot or, increasingly, in a parking structure. Not only multitenant properties but also freestanding stores such as large grocers are turning to structured solutions to satisfy their parking needs.
In an industry focused on customer experience, garages have evolved to include reception areas, parking assistance technology and services designed to remove the perceived drudgery of searching dark corridors for a free space.
At the River Oaks District mixed-use project in Houston, for example, vehicles drive up a spiral ramp with automated displays indicating which floors offer available spaces. Once the driver moves to one of the parking decks, LED lights mark open slots, showing green for available or blue for handicap parking. The lights turn red when a car takes the space. The sensors also collect data about lengths of stay, occupancy and usage.
Many parking structures today offer valet parking and designated areas for shoppers to wait for ride shares or taxis. Some offer other automotive services, such as electrical vehicle charging or auto detailing.
People feel safer when they can see their surroundings clearly, so modern garages tend to offer better lighting than their older counterparts. Monitored cameras can help to increase security, and the conspicuous placement of cameras may deter crime.
The growing popularity of ride-sharing and the prospect of autonomous vehicles collecting and dropping off passengers in the future suggests that parking requirements will diminish over time. With that in mind, forward-thinking developers are adjusting the design of new parking structures to be more easily converted to other uses when the time comes.
Responsible, flexible development can save thousands of dollars in reconstruction costs. Most noticeable are level floors rather than graded parking decks, which will require less work to refinish as office or retail space. Architects can design the building shell for future window placement and integrate open shafts or chases in the interior to later house wiring and ductwork. Ceiling heights more in line with standard offices or stores not only simplify adaptive reuse but provide greater visibility and natural light penetration while the building remains a parking structure.
Up, Down or Sideways?
Like other types of commercial real estate, parking is a function of demand, opportunity, benefits and cost. The landlord or owner should first calculate how many vehicles the property will attract at peak hours, and then weigh the available options for meeting that demand.
Land costs aside, a surface lot is an easy, low-cost parking solution. But land acquisition for surface parking is often prohibitively expensive, particularly in busy retail districts where real estate prices reflect the revenue-generating potential of store space. Just as an office or apartment developer mitigates high land costs by stacking floors, a parking structure increases the usefulness of a tract that would otherwise provide only a few surface spaces.
Particularly in dense urban environments, land constraints may preclude purchasing any adjacent tract for parking. Developers in that situation may opt to place parking above or below their commercial space; each entails unique challenges.
Retail and office tenants generally prefer street-level entrances to their space. If parking must also begin on the ground level, one solution is to place garage levels behind street-facing tenant space. Another is to build one or more rooftop parking decks. In addition to the engineering and construction costs to provide rooftop parking, developers considering this option should take weather into account. In markets subject to extreme heat, cold or seasonal rains, customers may shun vehicle spaces exposed to the elements.
Can You Dig It?
Subterranean parking can be an excellent solution that hides vehicles from view and protects pedestrians from the weather as they walk to and from their cars. The cost of below-grade construction varies widely, however. One location may allow easy excavation while another site requires blasting into solid bedrock. In markets with a high water table, such as Houston or New Orleans, subgrade construction grows exponentially more expensive beyond the first level.
In extremely saturated soil conditions, such as those in Miami, where the water table is often within 10 feet of the surface, developers employ a range of strategies to build underground. A common approach is to sink retaining walls to establish a perimeter, excavate the space between the walls, and then pour a concrete base or plug that hardens underwater in the flooded cavity. This halts further infiltration, so the site can be pumped out for construction.
Determination and engineering can overcome most parking challenges. For property owners and developers, the hardest task may be identifying a solution that also fits their budget. That’s where sound financial analysis and a vision for future adaptive reuse pay off.
Nearly every parking structure will require repair within 10 years of its construction, but a maintenance program will slow deterioration and head off many problems that might otherwise require major reconstruction down the road.
Storms, seismic activity or even vehicles larger than a structure was designed to carry can damage parking decks and support structures. In northern markets, salt and harsh de-icing treatments can eat away sealants, connecting hardware, gaskets and exposed steel. Along the Gulf Coast, heat and heavy rains conspire to widen cracks over time, accelerating the breakdown of internal components within concrete. Design is another risk factor: The more exposed steel used in construction, the faster wear and accidental damage will cause those parts to corrode and eventually fail.
Transwestern advises landlords to include parking structure maintenance as an annual budget item. The place to begin is with an engineer’s assessment, ideally performed before acquiring the property. The owner can then base future maintenance and inspections on the engineer’s findings.
Expending $10,000 annually to address problems early—sealing cracks, replacing worn gaskets and painting exposed steel—can extend the structure’s life for years or decades. Deferring maintenance will allow deterioration to occur and accelerate until the landlord must undertake a full-scale renovation, which can easily cost millions of dollars and disrupt tenants for the better part of a year.
Importantly, tenants who are used to sharing ongoing maintenance and repair fees will take the cost of preventive measures in stride. Property owners who delay action until the structure requires a renovation will be facing a large capital outlay, which is generally considered an expense of the landlord alone.
A short drive southwest from Orlando, Transwestern Development Co. and partner Crow Holdings Capital Real Estate are redeveloping a former golf course into the largest speculative industrial project in Florida’s history.
Bridgewater Distribution Center will provide as much as 1 million square feet of space, beginning with a 713,000-square-foot building that broke ground in January. The space is being marketed to e-commerce firms that will appreciate the building’s 36-foot clear heights for racking, large truck courts and access to 19 million consumers within a two-hour drive.
Correction and Opportunity
An ongoing correction in the supply of golf courses represents a growing opportunity for developers. The U.S. has some 14,794 golf facilities or 45 percent of the global supply, according to the National Golf Foundation (NGF), which tracks the industry. Since 2006 when closures began to outnumber new course openings, the nation has been recovering from a 20-year run of unsustainable construction that added more than 4,000 golf courses and increased overall supply by 44 percent, NGF reported.
More than 200 U.S. courses closed permanently in 2017 and about 15 new ones opened. NGF projected a similar trend in 2018, and the correction is likely to continue.
The former Golf Club at Bridgewater was part of a massive mixed-use development, also called Bridgewater, and rests on a reclaimed, open-pit phosphate mine that was filled in.
A previous developer built the golf component in the 2000s to complement the high-end residential neighborhoods nearby. The course closed in 2009, however, soon after the financial crisis and after only a few years of operation. Ownership of the 183 acres eventually reverted to the lender.
The site’s proximity to an adjacent business park and excellent access to Interstate 4 made it a good candidate for industrial use, but neither of two developers that had placed the asset under contract with the bank over the years succeeded in obtaining the necessary rezoning.
Be Good Neighbors
Any redevelopment proposal has the potential to ruffle feathers in a community, but golf course conversions deserve extra diligence when planning and communicating with residents. In many instances, access to local golf may have influenced homeowners’ choice of residence. If the same firm developed both the course and nearby homes, homebuyers may feel entitled to access the course as a promised amenity. Developers who take the time to learn how community members will likely react to a redevelopment proposal and take any concerns into account will have a greater chance of securing local approvals.
For Transwestern and its partner, Crow Holdings, rezoning was top of the agenda after placing the site under contract. The team worked with the city of Lakeland to create a development that would satisfy city leaders and address neighborhood concerns.
Concessions to the community included wide setbacks and construction of a landscaped, earthen berm to shield residents from buildings and truck courts. City leaders approved the proposal and rezoned the site to a planned urban development for industrial use.
Avoid the Traps
Picturesque fairways and putting greens may capture nature’s beauty and still harbor environmental hazards sufficient to sink a redevelopment. The longer a course operated, the more it was probably exposed to insecticides, fertilizers and other potentially harsh chemicals that may linger in the soil.
Fortunately, Bridgewater only had a trace of caustic mineral deposits, which will be removed without limiting the property’s use. If a tract contains high levels of certain contaminants, federal or state regulations may require more intensive remediation and/or deed restrictions to preclude uses such as daycare that might expose children to dangerous materials.
Soil can present other types of hazards that limit suitability for redevelopment. Bunkers and other topographic features are designed to support foot traffic and lawnmowers, not buildings and vehicles. As in any industrial due diligence, a developer should conduct extensive geologic testing to determine soil composition and the expected cost of shoring up any weak spots to support anticipated loads.
As a former mining site, Bridgewater’s base was fill dirt rather than original strata. Testing showed the resultant mix is more than stable enough for an industrial park.
Water features deserve careful attention. Ponds at Bridgewater are protected wetlands, and it took 16 months of filing applications and working with the Army Corps of Engineers before they could be disturbed. A comprehensive solution involved creating high-quality and better-managed wetlands elsewhere on the site, and the purchase of mitigation credits that went to support offsite wetlands management.
While a golf course conversion can present unique challenges, patience and creativity pay off. With land in high-density metros in short supply, the blank slate offered by acres of open land is an exciting opportunity for an innovative developer.
Previously set to expire in 2015, the popular EB-5 Immigrant Investor Program owes its continued existence to a series of short-term extensions. In 2019, global economic headwinds are fueling renewed interest in the program by driving wealthy individuals to seek refuge in U.S. residency and attracting American investors and developers to EB-5’s low-cost capital.
Although the program has been around for decades, it gained little traction until after the Great Recession. Today, EB-5 pumps billions of dollars into the U.S. economy annually and has become an important source of equity capital for commercial real estate, funding portions of such high-profile projects as Related Cos.’ Hudson Yards development in Manhattan and Lennar Urban’s Hunter’s Point Shipyard in San Francisco.
EB-5 stands for “employment-based, fifth preference,” which is the category of visa or green card it provides. Congress created the program under the U.S Immigration Act of 1990 to stimulate job creation by foreign entrepreneurs. To qualify for visas for themselves and immediate family members, an EB-5 applicant must invest a minimum of $1 million in the U.S. and create at least 10 jobs in the process.
If the investment is made in a government-designated target employment area, the minimum investment is only $500,000. Not surprisingly, most applicants choose the latter option. And since 2009, the U.S. Citizenship and Immigration Service, which oversees the program, has counted temporary construction jobs toward the employment creation requirement.
Most EB-5 investors work with one of several hundred third-party EB-5 Regional Centers that have formed throughout the country to connect applicants with investment opportunities and pool contributions from multiple applicants to fund larger projects. Each project must produce at least 10 jobs per EB-5 investor.
Each year the immigrant investment system can issue approximately 10,000 EB-5 visas, with no more than about 7 percent of that amount going to applicants from any one country. After a cutoff date each year, any remaining, unissued visas can go to a waiting list of applicants beyond their country’s 7 percent allotment, until the overall number of EB-5 visas issued reaches 10,000 for that year.
The China Effect
EB-5 struggled for participation until 2008, when conventional lending sources were largely unavailable following the onset of the financial crisis and borrowers recognized EB-5 investors as an alternative equity source. In the same year, members of China’s rapidly growing population of wealthy individuals began applying to the program in large numbers. EB-5 visa issuance has maxed out at about 10,000 each year since 2014, chiefly to Chinese applicants.
Then in 2018, China-born immigrants accounted for only 48.3 percent of investment visas, down from more than 90 percent the previous year. In part, fewer approved visas for this group reflects pressure from their home government to retain capital in-country and shore up the slowing Chinese economy. But the ranks of program applicants from other nations are growing as well, which leaves fewer visas for China.
Working with EB-5
More than 90 percent of EB-5 applicants work with a Regional Center. These third-party organizations can serve as intermediaries with domestic developers to bring qualifying EB-5 investments to fruition. Compared with capital from other sources, financing from the program carries additional requirements and risks.
For example, the developer will usually be expected to own or control the project site during a year or more of fundraising, which doesn’t fit the operational model for many developers. There is also the risk the program could be discontinued while the project is still in the planning stages.
The advantage for developers and co-investors is a low cost of capital, explains Michael Snodgrass, an Executive Managing Director on the Structured Finance team at Transwestern. “Financing with EB-5 investors takes a lot of up-front work,” he observes. “But if you can work out the details, it offers the cheapest cost of capital in the market today.”
A conventional mezzanine lender will demand hefty annual returns of as much as 20 percent to compensate for their elevated risk, since they take a secondary position that puts them first in line for a loss if the borrower ceases to perform.
By contrast, EB-5 investors are motivated to secure visas for their families. They are more likely to require enough return to keep pace with inflation and eventually recover their investment. That would put the developer’s cost in 2019 dollars at perhaps 5 percent interest.
The outlook for EB-5 is politically cloudy, however, and its most recent extension was set to expire Feb. 15, until Congress’ federal funding bill extended the program until Sept. 30, 2019. EB-5 will undoubtedly come under scrutiny as the White House pursues immigration system reform. But a program that injected more than $5 billion into the U.S. economy in each of the past two years may draw bipartisan appeal.
With strife mounting in many foreign economies, wealthy individuals seeking to relocate both capital and their families to the U.S. will certainly apply for EB-5 visas while the program is available. And with lenders tightening leverage requirements to 65 percent or even 60 percent of asset value on long-term commercial real estate loans, look for demand for EB-5’s lowcost capital to grow as well.