Be warned. I have a bad pun coming up two paragraphs from now.

The automotive sector, which in recent years has been associated with bankruptcies, plant closures, and outsourcing, is once again proving an asset to some local economies. On Monday, Philadelphia Business Journal reported that Subaru of America was shopping for a new headquarters. Philadelphia’s increasingly popular Navy Yard business park is one of the locations under consideration, writes BizJournal’s Natalie Kostelni.

Does Philly have good enough “carma” to attract Subaru? The American subsidiary of Subaru (TYO: 9632) is seeking a replacement for its current headquarters, a seven-story building in nearby Cherry Hill, NJ. The Navy Yard is certainly a strong contender, having already attracted companies such as GlaxoSmithKline and Urban Outfitters, which established headquarters there. 

What market characteristics will attract a new corporate resident and its economic, employment, and real estate benefits? Obviously, location, community, economic conditions, tax climate, and workforce are all factors that bear on this decision. Ultimately, whichever city offers the best incentives will win Subaru’s presence. 

One possible incentive to move into the Navy Yard is it’s tax-advantaged location. Ms. Kostelni explains,

The Navy Yard is in a Keystone Opportunity Zone, which gives tenants who move there breaks on state and local taxes. It’s unknown if Subaru of America would qualify for those benefits. If the company went that route, a newly constructed headquarters would also be consistent with recent decisions made by other regional companies.

I discussed KOZs in a recent post, showing examples of how this and related tax breaks helped bring 21st century jobs and developments to dilapidated industrial parks and struggling neighborhoods. My conclusion, regarding KOZs, is this: we don’t know if the long-term economic benefits will justify the tax dollars being spent, but in the near term, the KOZ strategy seems quite effective.

Other areas have used similar incentives to attract corporate operations. In Kentucky, Subaru’s larger competitor, Toyota, took the state up on its offer of enormous tax incentives in exchange for an expanded automotive plant and significant job creation. Specifically, says Bloomberg, the automaker has been offered $146.5 million in tax incentives–but Toyota must invest over half a billion dollars and create 570 jobs in order to quality.

This is great news for the industrial real estate sector, which has seen the bulk of its deal and development activity focus on warehouse and distribution centers rather than heavy-duty manufacturing properties. Such investment isn’t unique to Kentucky, either. Farther south, in Huntsville, Alabama, Toyota announced it would expand its engine plant, an $80 million investment expected to produce 125 new jobs.

Wait… automakers are bringing business to the United States? It’s like the 1980′s playing out in reverse.

Since the financial crisis badly hit almost every nation (yeah, yeah, quit gloating, Canada), numerous corporate strategies have been drastically altered, including those of manufacturing companies. A different Bloomberg article explains why Toyota is boosting its presence in the States:

Toyota has been eager to bolster its Lexus brand in the United States, the automaker’s biggest overseas market, where luxury car sales now outpace sales of other autos. Toyota also wants to shift more production from Japan to overseas markets to better insulate itself from the currency gyrations that have wreaked havoc on its bottom line in recent years.

Also, in certain instances, it may be true that some cars can be made domestically with less expense than those shipped in from overseas. This article looks at how importing costs affect the bottom line for many manufacturers.

In the U.S., we’ll never see the manufacturing sector reach the level of activity it achieved in the 20th century, which suggests warehouse/distribution centers, not manufacturing plants, will remain the bread and butter of industrial real estate.

Though industrial properties’ square footage usually exceeds that of most corporate offices, any amount of development, tax revenue, and employment growth helps. Subaru’s new headquarters certainly won’t boost its market the way Toyota’s Kentucky auto plant helps its own market. Still, corporations tend to leap onto bandwagons; if one corporation moves its headquarters, others often follow it to the same market. Subaru’s relocation is just one of many.

This will probably be our last retail-focused Top 10 for a while–it’s time to look at some other asset classes. Since we already counted down the Retail Markets with the Highest Quoted Rents, let’s look at which retail markets are seeing the most improvement in their rents. Once again from Colliers’ 2013 Retail Outlook for North America (PDF), here are the Top 10 Retail Markets for Rent Growth:

10. Dallas/Ft. Worth, TX (1.83%)

9. San Jose/South Bay, CA (1.87%)

8. Omaha, NE (2.06%)

7. Houston, TX (2.18%)

6. Boston, MA (2.51%)

5. Boise, ID (2.65%)

4. Westchester County, NY (3.04%)

3. Miami-Dade County, FL (6.51%)

2. Little Rock, AR (9.97%)

1. Hawaii (16.4%)

The numbers above are year-over-year changes reported at the end of 2012. The Colliers data only covered the largest retail markets (except Manhattan), so this isn’t a definitive list. Still, like before, we have a clear winner: Hawaii is not only enjoying incredible rent growth, but incredibly high rents as well. According to data from NAI, Honolulu’s retail vacancies by asset class go as low as 1% (for regional malls). Impressive. 

Less surprising are markets like Westchester County–which is enjoying spillover demand from New York City–and energy/technology hubs like Houston and Dallas/Fort Worth, significant growth markets that withstood the recession better than most.

Rent growth can be a sign of economic strength or simply recovery, so we shouldn’t confuse this ranking with a list of the “healthiest” retail markets, though a few made it onto this list. Ultimately, all of these markets are doing something right–if you check out the report I linked to above, you’ll notice that most of the major retail markets–34 out of 50–saw rent decreases in 2012. Rent drops may help lower vacancy rates, but they certainly don’t make for valuable property.

Two Midwestern markets stand out: Omaha and Little Rock. Like a few other cities in the middle of the country, these areas have quietly grown while the rest of the country struggled against the sluggish economy. In fact, during the financial crisis of 2008-09, Little Rock had the second best economic growth after Des Moines. Similarly, Omaha was named a top tech market by Newsweek and a top market for Fortune 500 companies, showing there’s far more than just agriculture to drive certain Midwestern economies. Even if their rents started out significantly lower than those of high-value retail markets like San Francisco, at least their rents are headed in the right direction.

Noun, informal. A decent, upright, mature and responsible person. 

Schlemiel 

Noun, slang. An awkward, clumsy, or unlucky person whose endeavors tend to fail; a loser.

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Mensch of the Week:

Todd Schuster, Ares Commercial Real Estate

Ares Commercial Real Estate (NYSE: ACRE) has been busy. The mortgage REIT, which focuses on mid-market multifamily loans, recently announced the acquisition of AREA Property Partners in a move that quadruples the company’s capital to $8 billion, according to Commercial Property Executive. Last week, ACRE bought EF&A Funding (better known as Alliant Capital LLC) for almost $63 million while also announcing a new co-CEO, Todd Schuster.

Mr. Schuster is a board member with both ACRE and an Alliant Capital affiliate, which makes him ideal to lead the unification of these these two companies. This appointment is also an extremely high-profile one and likely pleasing to investors.

Here’s a bit of Mr. Schuster’s resume:

• He was the founder and principal of CW Financial Services
• He’s familiar with mergers; CW Financial Services merged with Canadian pension fund manager Caisse de depot et placement du Quebec in 2002
• Through his former company’s subsidiaries, he oversaw the provision of multifamily debt, high-yield CRE loans, and special servicing (through CWCapital Asset Management)
• He also worked with Salomon Brothers and Bankers Trust, according to his bio on the ARES website

So, he has pretty good credentials.

After many years of impressive growth, the multifamily sector has become extremely competitive, whether we’re talking about gateway or secondary markets. Under Mr. Schuster’s (co-)leadership, ACRE has a great opportunity to serve this active market, providing debt for the many multifamily deals we can expect in coming years.

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Schlemiel of the Week:

The Pestronk Brothers

Philadelphia developers Matthew and Michael Pestronk, aka Post Brothers, have a knack for getting media attention. During their seemingly unending battle with the city’s organized labor during the conversion of a vacated industrial property, they seemed to capture headlines week in and week out. Making enemies with the city’s unions will certainly do that.

Now, their embattled development, a high-end residential tower named Goldtex (after its former tenant) is nearing completion and has begun leasing. To get the word out, they began an aggressive ad campaign featuring what one writer calls “Ads Targeted to Desperate Postadolescent Males.” To wit: scantily clad women, provocative poses, and innuendos so unsubtle they belong in an Austin Powers movie.

What is more, the Goldtex listings on Craigslist featured provocative–albeit sophomoric–titles that you’d expect to find on a very different section of Craigslist.

I started to report on this in last Friday’s Week in Review, then got a sneaking suspicion that the Post Brother’s weren’t behind this. I checked the Goldtex website and found it to be completely classy–entendre-free, not a near-naked woman in sight. I assumed these ads were someone’s efforts to smear the Post Brother’s reputation. (A preview party for the building was nearly derailed after an “anonymous” report to authorities that the building didn’t yet have the necessary paperwork to hold such an event.)

As it turns out, the ads were indeed okay’d by the Post Brothers. Questioned about this marketing decision, Matthew Pestronk told Philly Magazine’s Liz Spikol,

People remember them, don’t they? …The people who rent from us, which is to say typically 25- to 35-year-old professionals of all types, are generally attracted to the marketing.

No question the ads get attention, though I showed the ads to a female in the Pestronks’ target age demographic and her reaction was, and I quote, Eww… So the question of how successful these ads really are seems unanswered, though this old New York Times article suggests highly sexualized property marketing gets far more attention than actual returns.

Whether this helps lease space in the Goldtex building remains to be seen, though it goes without saying that the Post Brothers have officially established their “bro appeal”–though it remains to be seen how many “bros” can afford one of their lofts.

But before you assume such marketing is only found on the commercial side, take a look at this residential realtor’s ad:

When’s that open house again?

That’s just one type of “self-storage.” Since we talk about commercial real estate, though, I want to talk about self-storage property investment. Specifically, I want to look at the “Big Four” (which is to say, the only four) of the publicly traded self-storage REITs: CubeSmart (NYSE: CUBE), Extra Space Storage (NYSE: EXR), Public Storage (NYSE: PSA), and of course Sovran Self-Storage (a/k/a Uncle Bob’s) (NYSE: SSS).

The REITs recently released their first quarter reports, and it looks like the recent trend of exceptional growth has continued into 2013. Here’s a breakdown from Inside Self Storage (check out their article for a more in-depth discussion of Q1 results):

• CubeSmart reported FFO [funds from operations] per share of $0.20, a 25 percent year-over-year increase. Same-store net operating income (NOI) at its 328 facilities grew 7.6 percent year over year. …The same-store physical occupancy was 85.7 percent as of March 31.
  
• Extra Space Storage: Same-store revenue increased 7.5 percent and NOI rose 10.8 percent compared to the same period in 2012. FFO was 46 cents per diluted share, resulting in 39.4 percent growth compared to the first quarter the previous year. … Same-store occupancy grew by 290 basis points to 88.6 percent…
• Public Storage: Revenue for same-store facilities increased 5.4 percent, or $21.1 million…
• Sovran Self Storage: Total revenue increased 17 percent over the previous year’s first quarter, while property operating costs increased 14.9 percent, resulting in an NOI increase of 18.1 percent. 

A great way to start the year.

If you look at CoStar’s recent article, 25 REITs Most Likely to Sell You a Property in 2013, you’ll see all the major asset classes represented: hospitality, office, retail, industrial, and even multifamily and healthcare. But self-storage is conspicuously absent. It seems the consensus is that this market and asset class have room to grow. The value of storage facilities is yet to peak.

But how much more valuable can this sector become? I’m thinking about three major factors that have contributed to the sector’s stellar growth:

1. As the U.S. population ages, more and more families are winding up with someone’s stuff–furniture, clothes, antique harpsichords, etc.–and nowhere to put it except for one of these facilities.

2. Americans are increasingly mobile (moving to a new city, going to school, etc.).

3. The housing bust and recession made home ownership less accessible to Americans, meaning more people have crowded into apartments and Mom and Dad’s house–leaving less space for belongings.

The first condition certainly isn’t changing: those who inherit relatives’ belongings and don’t have the heart to get rid of them will continue to depend on self-storage. Same goes for the second. The third condition, however, is slowly changing.

As U.S. employment and housing data continue to move in a positive direction (however slowly), the prospect of home ownership is once again proving feasible for many Americans. A home means they can once again leave the things they don’t want to part with (or deal with) in attics, basements, garages, etc. Will this affect the self-storage industry?

In another article on Self Storage Insider, Ben Vestal looks at the macroeconomic conditions affecting the sector. While the market is clearly growing and outperforming pre-recession levels, this asset class is not thriving across the board.  He explains:

More than 80 percent of the country is currently absorbing excesses [of] self-storage space. However, the performance varies greatly by location and market.

He goes on to say,

The unevenness in the self-storage recovery links back to the abnormally slow economic recovery. With a GDP growth rate of 2 percent, there’s simply not enough growth to go around. The best properties in each market will continue to outperform the other properties that are competing for the same customer.

Like office, hospitality, retail, and most other asset classes, self-storage is not a de facto winner. Location, facility and management quality, local demographics, and other fundamentals still make the difference. But the overall growth of the sector suggests under-performing facilities may not be that way for long. While I’m not sure the sector has enough demand to justify lots of new inventory, rebranding and repositioning current, underperforming assets seems like a great opportunity.

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Matthew Boss, an analyst with JP Morgan (NYSE: JPM), discusses struggling department store chain JC Penney (NYSE: JCP). According to the company, their total real estate holdings are worth $4 billion–roughly the same as the retailer’s current market cap.

Risky Business: 3 Pain Points for Commercial Real Estate Developers

Over the last couple years, the development market has returned to fundamentals. The wounds of the downturn are still fresh, and investors, developers, and banks are more cautious, putting their money behind only what looks like a sure thing. As a result, we’re seeing more tenant-driven development and less speculative development. For example, in the Boise area, we have seen two significant projects break ground in the last year: Eighth and Main (a high-rise office building) and Village at Meridian (a retail lifestyle center). Both projects were over 75 percent pre-leased prior to going vertical. We’re also seeing a lot of owner-user product being developed, such as automotive dealerships.

Speculative, capital-driven projects that don’t fit an existing market need are just one risk that developers should avoid. As more developers return to fundamentals, here are three ways projects can go wrong and how to avoid them.

1. Misreading the market. Never assume that there’s more demand for your proposal than there actually is or act as if the trends from the last couple years will last indefinitely. Pursue projects driven by a market need rather than one pushed forward by capital in search of a return. Before starting a project, know exactly what you’re going to build based on your target market. Know who the users (buyers or tenants) will be, what rent or price level they can pay, and what design features they want. Know your competition, not just vacancy rates but also how much new product is coming to market. And, while this might sound self-serving, do a market study to get a critical, objective look at your project’s potential absorption rates and rent levels to get a clear sense of the project’s feasibility.

2. Losing out in approvals and entitlements. Many developers underestimate the potential for neighborhood opposition to a development. Failure to get approvals has derailed many a project; I’ve experienced this when trying to develop apartments and senior housing in single-family residential areas, for example. Even if you buy a site where the zoning allows you to build, if the property backs up to neighbors, they might appeal to the city council at a public hearing, and regardless of whether the law’s on your side, the democratic process can put enough pressure on elected officials to kill a project. Developers should approach projects fully appreciating this potential. Obviously this issue is location-specific, but one of the better ways to hedge your risk is to option a site instead of buying it outright, or set a closing contingent upon approvals. Another option in the face of such risks is to negotiate a discount on the site to provide a cushion if the project can’t move forward.

3. Choosing the wrong architect. Hiring the architect is one of the most important decisions in the development process. When potentially millions of dollars are at stake, it pays to find an experienced architect. I once worked on a project with an architect who had misread the building code and had designed a building twice as big as the code would permit. We almost lost the deal, and we wasted months and tens of thousands of dollars. When seeking an architect, ask a trusted colleague for a recommendation and choose a firm in touch with the market that can design the product so it’ll be well received by the end user.

The development business is certainly risky, and there’s no shortage of horror stories of developers that have lost millions. At the same time, it can be a very lucrative business. It’s a classic illustration of risk versus return. By sticking to the fundamentals and pursuing market-driven projects, developers are better able to limit their risks and boost their returns.

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Courtesy of Integra Realty Resources. Republished with permission.

Week in Review for May 11 – 17:

- CoStar Group releases a list of 25 REITs “Most Likely to Sell You a Property in 2013.” The list includes many well-known public REITs, and just about every major asset class is represented, including multifamily and healthcare properties.

- Post Brothers, an up-and-coming multifamily developer in Philadelphia, begins listing apartments for its latest development, a conversion of a former industrial property on the outskirts of Center City.

- In developing this property, Post Brothers had a tense stand-off with the city’s labor unions in response to their use of non-union workers.

- JW Pepper & Son acquires a 43,000 -SF office building in the Stone Ridge Corporate Center in Exton, PA, a suburb of Philadelphia. They acquired the property for $5.1 million ($118/SF), reports CoStar.

- In Los Angeles, Hines REIT sells the One Wilshire building, an office and retail property, to GI Partners for $437.5 million, as well as one other property for $112.5 million. 

- Plano, Texas-based jhme announces its participation in the redevelopment of Twickenham Square in Huntsville, Alabama. The sprawling mixed-use project will include retail, medical office, multifamily and lodging properties.

- Empire State Realty Trust, a proposed public REIT whose properties will include the Empire State Building, nears approval from investors, reports CNBC. The proposed REIT and its founders have faced an ongoing legal battle with legacy owners of the Empire State Building.

-  In April, CMBS delinguencies fell significantly. According to Fitch Ratings, April saw the fewest new CMBS delinquencies since before the recession, reports the Wall Street Journal.

See our previous polls here.

Thanks in part to Hollywood, developers have a reputation as the “bad guys”–the greedy corporate bulldozers whose plans always run counter to the will of the community and woodland sprites. This certainly isn’t the case in many locales. Here in Philadelphia, long-abandoned row homes, overgrown lots, and industrial facilities are being converted to town homes and multifamily properties–and I’m yet to hear anyone complain (except maybe a few union members not hired for the project). Often, developers–whether it’s just a couple local guys or a major firm like Trammel Crow or Toll Brothers (NYSE: TOL)–receive resounding approval from community members who appreciate the economic growth that comes with new projects.

Sometimes, however, new residential and commercial projects, no matter how feasible from a market perspective, meet vocal resistance from members of the community. And the fear of losing green space and a nice view is only one of the many reasons residents will fight a proposed development or commercial tenant. Here are a few other businesses and commercial projects that have struggled with public opposition:    

• The California Supreme Court recently upheld efforts by local municipalities to ban the operation of medical marijuana dispensaries. Even though California was a forerunner in medical marijuana laws, many of its communities are against the idea of dispensaries and the “public safety” issues that might arise in their vicinity (unclear what these public safety issues are: slow-moving people? overwhelming demand at the local burrito shop?). Even though such businesses have a small foot print, anti-dispensary ordinances could affect the landlords of community shopping centers and other real estate.
• In South Philadelphia, community groups are protesting proposals to build casinos in their area. The Pennsylvania Gaming Control Board, tasked with selecting the recipient of the city’s second casino license, is still deliberating. Meanwhile, residents in the city’s Fishtown neighborhood have voiced support for the Wynn Philadelphia, a casino proposed for the area.
• Also in Philadelphia, the city has worked to evict a branch of the Boy Scouts of America from its local headquarters in response  to the organization’s anti-gay stance.
• In the Atlanta area, residents and businesses are apprehensive about a proposed Dunkin’ Donuts. The establishment will take the place of a currently vacant stand-alone property. Those challenging this location say its drive-through will create traffic and noise problems for the community.
• Also in the Atlanta area, community members came out en masse to fight a zoning variance for a proposed mixed-use development by Four A International. Opponents are, yet again, wary of increased traffic.
• In Kansas City, community members are fighting a Wal-Mart proposed for their neighborhood (an American tradition, these days)
• Here’s my favorite: the Concord Monitor reports that the small town of Pembroke has ruled against an “adult boutique” called Trevor’s Toybox. Apparently, its location wasn’t zoned for whips, leather and latex apparel.

Zoning variances happen all the time. When it comes to community sentiment, however, zoning presents a perfect opportunity to voice opposition to a development. As we see in the examples above, neighbors have plenty of reasons to reject a potential development: noise, crowds, traffic (that’s usually the big one), developments that threaten the “character” of a neighborhood, visual pollution (billboards, etc.), pot heads, and leather-clad mannequins are just a few things communities find objectionable, even if the developments and businesses are otherwise financially sound.

So, how can a developer or operator deal with negative public opinion? For some developers, unsubtle gift-giving is a viable strategy (planting trees, building a park, doing other things to “invest in” the community). For other developers, sitting down with residents at a zoning board or town hall meeting may assuage their concerns (but at that point, it may be too late to change any minds).

One thing’s for sure: neighbors’ attitudes toward a proposed project or new tenant have a profound effect. Even if public sentiment isn’t discussed as often as other fundamentals–like supply/demand, demographics, local economic drivers, etc.–it deserves consideration at every stage of the development process.

Following our ranking of the 10 Most “Absorbent” Retail Markets, here’s a list of the Top 10 U.S. Retail Markets with the Highest Rents, based on data published in the Colliers 2013 Retail Outlook for North America (here’s the PDF). This ranking is based on shopping center stats from the end of 2012 for the country’s biggest retail markets (with the exception of New York City).

10. San Diego, CA (Quoted rent per SF: $20.28)

9. Oakland/East Bay, CA ($21.04)

8. Washington, DC ($22.25)

7. Los Angeles, CA ($22.41)

6. Orange County, CA ($22.70)

5. Long Island, NY ($23.35)

4. Miami-Dade County, FL ($23.55)

3. San Jose/South Bay, CA ($26.15)

2. San Francisco, CA ($26.27)

1. Hawaii ($40.43)

If you read any of our related Top 10s, you may have had an inkling that Hawaii would trounce the competition. With quoted rents nearly double those of other markets on this ranking, it’s clear that Hawaii’s retail market is unique. With a retail vacancy rate of 4%, the market’s retail offerings are more constricted than those of New York City (which is 5%, according to IRR), and not far from San Francisco’s 3.8%. Yet Hawaii is conspicuously absent from any list of the top retail markets for new supply or development, suggesting there is continuing opportunity for retail investment in Hawaii–at least until development picks up, as it’s bound to do.

If you examine the above list, you’ll notice the cities with the highest quoted retail rents have two characteristics in common: density and tourism. Density, of course, drives up rents through simple supply and demand, while tourism can support retailers with a constant flow of new customers (case in point: the Forum Shops at Caesars in Las Vegas is America’s most profitable mall, with annual sales of $1,400/SF!).

For Hawaii, the recession proved extremely costly. With a bleak economic situation and declining employment, the hospitality and tourism industry on which Hawaii thrives saw sharply reduced activity–with a corresponding downturn for its retail market. But as Hawaii’s hospitality/retail rebounds, demand for retail real estate is outpacing the availability of new supply–significantly.

This is one of the reasons Alexander & Baldwin, a locally based investor in real estate and agriculture, is doubling down on opportunities in its home state. In a recent interview with MauiNow.com, the firm’s chairman and CEO, Stanley Kuriyama, points out a strong improvement in fundamentals in just the past year:

Alexander & Baldwin reported net income for the first quarter of 2013 of $5 million, or a 20% improvement over the first quarter 2012…

Alexander & Baldwin has shifted its strategy as a result of Hawaii’s recovery. Now, the company is in the process of selling off its holdings on the mainland in order to build up its portfolio of Hawaiian assets, a portfolio which will certainly include retail properties.