Retail Center Redevelopment Process
As I sit down to write this article, NFL general managers are preparing for their annual draft of college players. Much like the general managers of a professional football team, retail developers searching for and executing property redevelopments must coordinate their staff in the constant search to unearth and mold raw talent into productive assets and future stars.
The process that developers go thru takes years of preparation before they can unveil their overnight success. The property scout must sift thru hundreds of prospects. The director of leasing must assess the property’s strengths and weaknesses as well as what tenants might be interested in locating in the redeveloped property. The construction manager must ferret out the physical strengths and challenges. The director of acquisitions must negotiate with the property’s agent for a price that can work under the developer’s capital structure and the finance department must make sure the project’s financial structure will not expose the development team to unnecessary risks. Just as the development of a football player is fraught with risk and uncertainty that good homework can mitigate, but not eliminate, the developer must spend many hours making sure he avoids the mistake that could bring significant harm to his financial position and reputation.
The first step is identifying the property. Developers find their redevelopment targets through many avenues. Scouts in the market may tip them off on a deteriorating partnership that has let a property lose value and tenants because of neglect or lack of appropriate funding. The property’s exclusive agent may present it to the development team or the developer may identify the prospect himself and recruit the owner for years until he is ready to sell the property.
In the case of Hillsboro Square Shopping Center in Deerfield Beach Woolbright Development had kept in touch directly with the property owner for over five years. The constant contact paid off. When the owner decided to sell, Woolbright was able to negotiate their purchase directly with the owner before the property was placed on the open market according to Michael Fimiani a Vice President at Woolbright.
Once a property is identified, the developer must make sure that he can create enough value to justify the transaction. He must confirm that the center’s viable tenants want to remain and what their vision of the center’s future is. Will they pay more in rent or expand their space? Would they consider moving to accommodate another tenant or user that will help them to increase sales at the location? Can the center be redeveloped to accommodate these new users or tenants under current land use regulations or will land use changes be required? Will the seller allow time for any required land use changes or will the seller’s price be low enough to justify the developer taking the land use change risk? Should the developer just tear down the entire project and start from scratch?
Robert Shapiro, President of Master Development in Miami believes that “it is often faster and cheaper to tear down existing, old boxes then to try and reconfigure them. The old box may need to have the roof replaced, numerous hidden mechanical problems, life safety issues, etc”. He looks at existing redevelopment opportunities if they are “vacant land.” Shapiro prefers to “create new centers using the existing site and improvements as raw materials”.
Once the center’s redevelopment and stabilized cash flows can be modeled, the developer’s finance department takes over. Can the project be financed with internal equity or will outside equity be required? Does the seller want a price that is so high that it can only be achieved by giving the seller a carried interest in the property? Should the developer go to a local bank, an opportunity fund, high net worth investors or a combination of all to structure his financing? Doest the project offer enough profit to make it worthwhile?
The Plantation Fashion Mall was recently acquired by a partnership between The Cameron Group of Syracuse, NY and a wealthy real estate investor. The partnership worked with the Miami office of Mellon United National Bank. Their loan officer at the bank is Bill Gallagher, Vice President, Commercial Real Estate. He indicated that while Cameron was from out of state, “they had very strong contacts with the decision makers of major national retailers across the country”. Cameron also had “teamed up with a strong equity partner” that had the financial strength to fund turn around costs such as leasing commissions, tenant improvements and whatever large scale redevelopment the mall required. In addition, “the Mall itself had excellent fundamentals because of the quality of the structural and interior improvements and its location in the heart of some of Broward County’s strongest demographics. Those are a few of the qualities that Mellon looks for in a retail redevelopment project.”
Once the property is selected and it is determined that there are new users and financing available, the developer must execute. Even though it may have taken years to identify and negotiate the property’s purchase, line up the tenants and secure the financing, this is the hardest part of the process. Many unforeseen events can still happen. A user or tenant may drop out of the deal during renovation. Economic conditions may change forcing the cost of the project’s capital to increase. Since floating rate debt finances most redevelopments a change in interest rates can cause significant problems in a project’s redevelopment budget. Unforeseen problems with the property’s existing physical structure may increase costs well beyond budget. While these can all be planned for in the contingency line of the redevelopment budget and hopefully identified by through due diligence, a project can only be successful within a certain variance of its initial cost budget.
Once the property has been redeveloped, the owner must decide to sell or hold. This decision typically depends on the project’s capital structure and should have been determined when the transaction’s capital structure is set at the start of the process. The developer must make sure he has the same goals as his capital partners or the entire transaction may be doomed from the start.
If outside opportunity fund capital was used a project may need to be sold to generate enough cash to pay off the fund. Another alternative is to refinance the property with a permanent mortgage. Most developers will not take on a redevelopment unless they know that they can “finance out” most, if not all of their equity upon competing the renovation.
So, as you track you favorite NFL team’s draft this year, remember that much like the redeveloped shopping center, years of preparation have only created a situation where the final results of the team’s efforts may not be know for two or three years.