Business Direct Weekly
6.24.2004
Zeroing in on downtown
BY PAULA GARDNER
pgardner@bdwbiz.com
Downtown residential growth is a target of Ann Arbor city officials as
developers plan new projects that could bring several hundred new
housing units and multiple retail opportunities to the heart of town.
These projects and others in the pipeline - ranging from 13 condos
approved for East Liberty Street to the massive Lower Town development
in the works just blocks from the city center - forge a clustering of
potential change for the city.
At the same time, public debate on policy that could affect height of
new buildings and housing density begins in July, when recommendations
to reduce barriers to downtown growth will be discussed by City Council.
Some 2,000 new housing units are sought from private developers.
In coming months, the Planning Commission also will vote on two major
redevelopments recently submitted for approvals - Morningside Group's
plans for the Eaton factory at First and William streets, and a
two-tower condo project led by Toll Bros. at the former Greek Orthodox
church on North Main Street - as well as on the residential task force's
recommended zoning changes.
Business Direct Weekly real estate reporter Paula Gardner recently
invited five area developers to discuss downtown: what it takes to
build, the risks, the costs and the direction.
Do you support more residential units
- either condos or apartments -
downtown?
Ed Shaffran:
I remember in mid-1980s the city got involved, saying "We've got to
create housing." I find this very funny that it keeps coming up. It's
always been my belief that housing is neat downtown, but it's a very
small market. I find it humorous that they think 2,000 people could be
moving into downtown in the next 20 years. It doesn't make sense. I
don't think there's that kind of demand. I don't think there's demand
for 500. Our base construction costs in the $130-$140 per square foot
range. Then add in soft costs, marketing, selling, paying tax on sales -
you're probably around $210-$225 per square foot. Now, if you want to
make some money - imagine that, being a capitalist in Ann Arbor - you're
in the $325 range.
So now you have a 1,000-square-foot
unit and you think it's going to
sell for $325,000 with one parking
space?
Bill Kinley:
Buying a shell is cheaper per square foot, then building within that
shell, not having to do anything with site work and being able to bring
it on the market at a rational price. Challenged projects are the ones
that go down to the ground.
Chris Grant:
Especially with city regulations. It's not just the new construction
costs; it's trying to get something through the site plan approval
process.
Jerry Spears:
The funny thing about everything you read right now is somehow this is
all going to stop urban sprawl, too. Come on: 500 units downtown?
Grant: Insignificant.
Spears: And the people who are coming down here are not the people who
want to be in the suburbs.
Tom Fraerman:
We're developing a large project in Royal Oak, and maybe it's the herd
mentality, but Morningside Group has had tremendous success in
developing condominiums in that downtown and they were selling for $250
and up per square foot. I'm assuming he made money … but that's a fairly
healthy number and he presumably bought the land cheaper.
Why do we think we can't build in downtown? Ann Arbor is probably one of
the greatest downtowns in the country in terms of ambience and The
University of Michigan and everything else.
We're in a number of suburban downtowns in the Chicago area, and some
ways those have gotten kick-started is we have tax increment financing
available. The city either owns the land or buys the land and subsidizes
it heavily, maybe buying parking that's adjacent. All of that helps
buy-down our costs and make it a more affordable product.
Kinley: There's an answer.
Fraerman: It works, and I think it starts to build, and more
market-rate product can come on line because you have generated activity
and demand.
Shaffran: You're talking about communities in reality. You're dealing
with the last communist state in the world here.
Fraerman: We're in Madison (Wisc.) as well. They are seeing condo
development downtown and they are similar in some ways to what we're
seeing in Ann Arbor.
Spears: The reality is we have a community that doesn't support those
types of developments. Until lately, it's probably been 180 degrees the
other way. It was, "Don't knock down that old house, or three old
houses, to put up condominium project." It's just in the last six months
that we're seeing pictures of buildings 15 stories high.
Grant: But that's different from City Council (approval).
Kinley: And they're not approved yet.
I'm on the Downtown Residential Taskforce and the point is to show there
is movement toward opening up more development downtown. What you're
going to see, I think, is a restructuring of the zoning that would allow
that. It's not saying someone is going to come in and do that.
Spears: Isn't the Historic District Commission doing that also in the
same areas?
Kinley: We're staying away from historical areas. The idea is to bring
some new consistency - but say there's a new envelope, then stand back
and have all the developers decide they can fit within that. I think
there's a crack in the door of more acceptance and maybe support from
council.
What about prices per unit and market
demand?
Fraerman: We had our failed project with the DDA at First and
Washington, and part of that was the height issue. To get the return to
the developer, you needed another floor, another two floors.
Shaffran: That's being a capitalist.
Fraerman: Height is important because that allows you to recover some
of your costs.
Grant: That's a two-edged sword because there's not the demand for
that many units. We've had market studies done of downtown. There's not
a large demand in today's market for 150 units. Absorption goes out to
five years.
Kinley:It's relating demand to what people are actually going to need
to pay for that - when it's $300-350 a square foot ….
Grant: There's no demand.
Kinley: If you're offering the same units at $200, there's a huge
demand.
Shaffran: But how do you make money? I don't care if you got the land
for free. You can't make it work.
Kinley: There's demand at some price.
Grant: $275 per square foot is the price that we've heard.
Fraerman: That's what we would think, too.
Shaffran: The difficulty is how big is your project and how big is
your time frame. It's that graph: money and time. When they meet, you're
dead because the numbers don't work.
Spears: Bill's point is right, though. The two projects that we see
going ahead - Eaton and maybe the Greek Church - that's a significant
discount. It's not subsidized by the government.
Shaffran: It'll be interesting because we hear they're at $55 per foot
on raw square footage. When you do the math … what does it cost to
renovate? It's got to be $120 per square foot for residential, so now
you're at $175, and then add in the incidentals and you're at $200 and
you're going to sell at what? How much time can you have if you're going
to have gross profits of $75 a foot before that thing starts falling
back the other way?
Kinley: You've got four (local) folks here who'd love to be shown by
Freed or Toll Brothers or anybody else how it's done.
Fraerman: You've been in this community a long time; we've had
experience in other communities where it works and where it continues to
work. We struggle with market studies and so-called objective criteria.
Sometimes developers just leap in and all of a sudden you've got a
success. Ann Arbor has the right characteristics to be a real lifestyle
city.
Spears: If you look at condos in this town, none have really done
well. Condos in and around town have sold, and they stay flat….
(appreciating) at 1 percent a year and the housing market is going up 7
or 8 percent.
Shaffran: If you're paying $300 per foot for a condo, do you know what
kind of house you can buy on the periphery? And you can actually park
your car.
What do you determine a successful project? I determine success
by how
much cash goes into my pockets.
Fraerman: We're looking for what's the appropriate profit margin on
gross sales - is it the mid-teens? It should be when you're taking that
kind of risk.
Shaffran: I don't disagree.
Fraerman: There are certain developers out there with very slim
margins and they do it with other people's money. That's a different
game.
What about the projects that seek to
add retail to downtown? Downtown
rents continue to escalate and
existing retailers feel the pressure from
regional and national chains that can
pay more for their spaces.
Fraerman: Where we find retail is a challenge in the downtown is you
really need mass. You can't do one shop here and there. … If you want to
create real retail down here, it's got to be a bigger project.
Shaffran: If you have that project, who's going to come downtown? Take
a snapshot in your mind of what Main Street looked like 10-12 years ago.
There were two or three restaurants. Today, what?
Spears: Forty-two in six blocks.
Grant: With more coming.
Shaffran: The mom-and-pop independent retailers can't afford the rents
of a new project that would come in.
Spears: You'll see some spread to the periphery of downtown when more
franchises come in. Businesses that can't pay $35 per square foot will
be forced around the corner.
Kinley: It's tough to figure out where you can do a critical mass of
retail. … You need a big enough chunk. (First Martin has) the block you
need to make mega retail.
Grant: Let me give you the history of our first three buildings, from
1972, 1974 and 1977. Bicycle Jim's on the corner of South University:
Retail lower level, partially below grade, Community News Center; good
restaurant; two floors of office. It will be all office in six months.
Liberty Center, corner of Liberty and Maynard: Burger King, Radio Shack,
Musicland, with one floor of office. With both of those projects, the
city came to us and said will you do this instead of putting a Burger
King on it or something else. Michigan Square, Liberty and South
Division. Four stories … all office now.
Mixed use - you don't need it. And there's no residential in those
buildings. The only reason there's residential in One North Main is that
was a way to get a profit out of it. And it still went belly-up.
Kinley:All of those examples that you gave are examples of what we're
talking about: There was not a critical mass. You need a grouping.
Grant: There was a critical mass in the 1960s. And it went away.
Fraerman: You could say that's true for a lot of downtowns. So can
there be a critical mass again? Can it be incentivized? You do have
other retail close by, so you do have to be careful. Can the downtown
have its own retail where people will come and shop?
There are a fair number of people downtown, there's good daytime
population - that's a characteristic that's important that a lot of
downtowns don't have. … The entertainment does well down here in terms
of the restaurants (at nighttime).
Shaffran:Let's face it; you have to accumulate a hell of a lot of land
to have a good-size project - to have that footprint.
Kinley: That's the Brown Block. (First Martin's property leased to the
city for parking).
Grant: Then there's no parking.
Fraerman: Then you have to build parking.
Grant: But then people aren't going to drive to Ann Arbor to park in a
three-level underground parking structure to go up to Crate and Barrel.
They're going to go to Somerset (in Troy). It's only 50 minutes away.
Kinley: And you have more demographic critical mass.
Grant: And you can stop in Birmingham on the way back.
Kinley: We're sounding awfully negative here, aren't we?
Grant: We're the realists.
What do you see happening with tenants
for downtown space, both office
and retail?
Grant: The only vacant office space we have in our portfolio is
downtown. Plymouth Road is 100 percent occupied, but we have our small
vacancy of 8,000 feet downtown.
Shaffran: When we did our project on Main, we battled not to have
restaurants. In all of our buildings, I have two restaurants, and I
don't want any more. On Main Street, I can't tell you how many people we
had pounding on the door for restaurants. So we created four or five
spaces simply for small retail. In some respects you could say we
subsidize it, simply for the amount of the rent we could have received.
I gave away one-third of the first floor for common area.
Kinley: We had the same experience in the Schwaben Building. The first
floor we have a great retailer - Three Chairs, fabulous. But I could
have got probably 50-80 percent more for a restaurant. We decided that
for the office users and what we wanted for the building was to get the
right retailer.
Spears: That's what we're doing.
Kinley: Good restaurants can seem to be able to afford the rents that
one would like to have … but then the mom-and-pop retailers can't, and
there's not the demand from the name retailers for only 4,500 square
feet on a (typical downtown) first floor.
Spears: We had a sign hanging on Main Street for a year and we were
getting five calls a week, and every one of them was a restaurant. Like
many of these guys, we try to turn them away. But you have to be a
realist, too, when you're carrying a project. The truth is, that's where
the demand is. And they won't all be successful. If you look at the best
block, from Liberty to William, five restaurants closed there last year.
So what's attracting you to downtown?
Spears: I think I'm a lot like these guys: There's a lot of romance to
be down here and to be part of the community. It feels good. We have
some projects on the south side of town and we give them attention, but
they just don't seem to be as fun. At some point you pick and choose
because you can, and you pick and choose the ones that seem the most fun
even though they don't seem to be the most profitable. Most of the guys
in this room are long-term investors. We may not make as much as we want
in the first couple of years, but this is a long pull. Rents are going
up and if we don't get the margins we want up front, two or three years
down the road (we should).
A recent building of about 1,400
square feet sold downtown for about
$330 per square foot. What does that
say about property acquisition
downtown?
Shaffran: You explain to me how you make money on $330 per foot. That
doesn't even make sense for owner occupied.
Fraerman: Some of that, though, which is starting to change, is the
low interest rates and the fact that real estate is a hot commodity.
Shaffran: But not $330 per foot!
Fraerman: That's crazy, but you probably have a hard time buying in
today's market. There are people in the market who are overpaying all
the time. Property is very hard to find.
Grant: And you can't use interest rates for today. It takes you 2.5
years to develop a project. You have to use a 7.5 or 8 percent interest
rate to make it work.
Shaffran: Do we dare talk about some people who are going to be on the
south side (of profitability) soon?
Fraerman: That's opportunity for you. Some people who've been on that
low interest rate get into trouble when the increases come. That's just
cyclical. You see it every time.
Spears: And that's why you'll see some slowdown. There are a lot of
people who bought into these projects at really cheap money and they
won't be able to get out because they can't get out. The value has to
come down when the debt service goes up. It won't make sense. They won't
sell. We'll see a slowdown. I don't think anyone in this room that
doesn't believe that in the next few years they'll probably do fewer
projects.
Fraerman: It's really an interesting puzzle. You guys are in love with
downtown Ann Arbor. We share it as well. And yet you're so pessimistic
about future development.
Grant: No, we're realistic.
Fraerman: But there's a certain pessimism about it.
Spears: I think the four of us are happy to sit on the sidelines and
watch you do it.
Fraerman: Sometimes it takes that. It takes a developer to leap into
the market and say, "We think we can do something different." That's
what we did with Arborland.
Shaffran: You guys did a great job.
Fraerman: And the rents are now (showing it).
The latest projects are from outside developers.
Shaffran: I have a feeling we're all waiting for opportunities, but
then we have the fair-haired boy from Chicago coming in and saying
"We're going to do this now" and throwing down money for these
buildings. At least in my world, if I go back to conventional wisdom of
25 percent down, 75 percent financing, I have to ask what kind of return
can I get? In the 1990s we didn't do anything for two or three years. We
were waiting for an opportunity for people to either go belly up so we
can buy a project. I can't compete with a Morningside. I don't want to.
… They're too big for what I want to do.
Fraerman: We need to do bigger projects. It doesn't make sense when
you have an organization that you've built up. They need to be 40-50
units as a minimum.
Kinley: Show us that you can do a brand-new building and make it work.
Shaffran: It will be interesting to see the numbers (from all of the
projects). Where are those people going to come from to fill that many
units? I fail to come up with the numbers to make it work.
Spears: There's a difference in scale. They can afford to have a
couple of failures. It comes out of our pockets. We can be wrong a
little, but we can't fail.
Fraerman: We're closer to you than to national builders.
Spears: It's easy for us to watch. I'm OK being second or third, I
don't have to be a groundbreaker.
The St. Nicholas Place proposal calls
for two towers - 10 and 11
stories - but it has yet to go through
the city approvals. What do you
predict will be the approved heights?
Kinley: Ten and 11 stories.
Shaffran: Six and seven.
Spears: Six and seven. The politics are going to change it.
Shaffran: Get enough (residential opposition) out there and they'll
beat it to death. Now it's simply down to politics.
What about the future of downtown?
Fraerman: I think Ann Arbor has the potential to change. It's a
community with so much ambience, though some obstacles are more unusual.
You'll need patience to get through it.
Kinley: I think we all consider Ann Arbor a wonderful community and
want the opportunity to create development. It remains to be seen in
five to 10 years whether the expectations of more density will happen.
Shaffran: I'm a firm believer in the free market. If there's money to
be made, a project will be built and money will be made eventually.
Grant: Ann Arbor is a wonderful community, but it's difficult to do
new development anywhere near downtown. The numbers don't make sense.
We'll sit on the sidelines and wait.
Spears: The only thing that's constant is change and it's going to
change - and it'll change by the guys in this room. We're all niche
players, and there's business for everybody. We won't see 15 story
buildings ever. There will be backlash, but you'll see some progress.
There's tremendous opportunity all over downtown for housing. We need
City Council to be wiling to tear down shacks for nice units. Developers
are not the enemy. The city needs tax revenue and we can redevelop
downtown. The city needs development.
Paula Gardner covers real estate for
Business Direct Weekly.