On Apartments
Happy October! I hope you are well and busy and not paying too much attention to the news. To quote John Lennon, nobody told me there’d be days like these.
Thanks to all for the many responses I got to last month’s note on fungibility. There were a lot of good questions and comments, ranging from management challenges to ways to layer short-term occupancies in with longer leases. Far and away the most frequent criticism: the lenders are going to hate it.
For any property where most of the rent is retail, that’s clearly the #1 issue. Short-term apartment and hotel occupancies are financeable because we have decades of data to back up our cash flow assumptions, but we don’t yet have good data on how the cash from fungible retail actually flows.
What about something mixed-use, where that retail represents only a fraction of the NOI? Perhaps a fraction that the lender has already discounted?? Multifamily developers, we’re looking at you!
As my friend Jeff Ackemann says, in my next life I want to come back as an apartment developer. If any real estate group is going to have a dominant decade, it’s multifamily. While the rest of us are wondering who’s left to pay the rent there’s no shortage of folks who need a place to live. There are plenty of favorable trends in play, and the two negative ones might have their solution in hospitable, fungible retail.
The first negative trend, ironically, has been New Urbanism. While so much good stuff has come from this movement— narrow streets, granny flats, walkable neighborhoods— it hasn’t been an unalloyed good. At some municipal conference somewhere in the early ‘00s, some emboldened urbanist suggested that all new buildings needed ground-level commercial space, open to the public. That requirement is now fairly ubiquitous in major metros.
I mean, I get it. Amazon wasn’t really a thing twenty years ago. No one was saying we had too much retail. Central Perk looked like fun on Friends: what city doesn’t want wannabe Rosses and Rachels lounging about hip coffee shops below urbane apartments?
Guess what happens when the city says what your project mix should be? Often you get a suboptimal project. It’s the ultimate negative feedback loop: you’re not a retail person (it may not be a retail site!) but you have to build it, and being a small portion of the property you don’t invest a lot in the retail and it struggles to lease. When you sell the apartments the buyer tells you the retail portion has no value, so on the next project you invest even less into the ground floor, and so on. The multifamily community is well aware they’re not building great retail. Many say it can’t be done: one developer friend candidly told me their shop calls ground-level retail the “herpes of apartments.”
Raise your hand if you’re an apartment developer and Gunther gave you herpes.
The second recent trend is the oft-reported Amenity Arms Race. Indoor skate parks, outdoor movie theaters and private residents-only restaurants are just a few of the more outrageous (and admittedly rare) cloistered multifamily amenities we’ve seen recently. Amenities are expensive. Apartment cap rates may be headed to 1% but this can’t be an affordable path going forward.
Frankly it’s a boring path, too. Pop quiz: what’s the saddest thing in the world? Answer: a bocce ball court. No one knows how to play, they breed mosquitos, and the only people that use them are five year olds who throw the balls at their sisters’ heads. You know that sinking feeling you get when you go to a new restaurant and you’re the only one there? Unused amenities can have that same effect. We are social creatures. Our caveman brains find empty places suspicious (even during Covid), so beyond a waste of money many apartment amenities can even be detrimental, and unless you’re building 3,700 units you’ll never have enough residents to use it all.
Okay so the podcast studio might actually get used here.
What if we made a radical judo move and combined mandated retail space with under-used apartment amenities? At Revel we think that one way forward during this next cycle will be to do exactly that: build apartment amenities in the ground-floor retail plane that are also open to the public.
These spaces would have privileged access for residents and would be secured so residential areas were off-limits. By putting amenity dollars into public spaces and bringing in non-residents you’d get activated places that might even generate a dollar or two in profit for the landlord. Some recent examples we’ve seen or been involved with:
Shared office space that is run by the landlord and open to resident and non-resident members alike. It may or may not have hot desks but it definitely has meeting areas, private offices and a clubby vibe.
A coffee shop combined with that office space or the leasing center. Props to Walton Communities in Atlanta for being one of the first to do this with Chattahoochee Coffee.
An event space that can be rented and used by anyone. It will be more profitable if it’s connected to the office as well as an outdoor area.
A food truck rally space with a bar run by the ownery.
If there is room, there should be an oversized pool that — you guessed it— is open to paying non-resident pool club members.
Lots of fitness and wellness run in partnership with experts.
Retail storefronts intentionally leased to short term pop-up retailers, artists and temporary events. They’re designed and budgeted to be used on short-term license agreements.
This won’t work everywhere. But if the city is making you build retail and if the buyer won’t credit you for the (non)rent, why not save money and make it cool?
While we’re at it, why stop with street-level retail? I know the world is moving virtual but apartments and hotels have such a huge advantage over office and retail because they’ve got salespeople on site. To date those folks have only been there to rent you an empty box for twelve months. Perhaps the business of apartments can be a lot more.
I’d argue that the apartment building of the future should be there to lease you whatever space you need for as long (or as short) as you need it. Yes that can be an empty flat for a year, but why not a furnished one for a week? Or a private office for a month or a conference room for a day or a yoga class for an hour or a showroom for the holidays? Take advantage of your staff and your software, and of a capital stack inoculated against the treacherous lure of longterm leases.
There are plenty of reasons why much of the above should happen. But alas there are even more reasons why it probably won’t. Strange days indeed.
WEBINAR! Next week I’m hosting our lastest webinar, Mixing Apartments & Retail. We’ll be talking about why it’s so hard to get mixed-use right, hearing what municipalities are saying today, learning how investors value mixed-use, and of course sharing our favorite cocktails. Stay tuned: more details to follow.
If you’ve liked 2020’s work thus far you’re going to love it’s latest album November, due in stores on 11/3. I don’t have a cure for the tumultuous next few weeks but chili never hurt. This is my family’s favorite recipe, and in its own small way it might help you make it through. The secret ingredient: chocolate.
3 lbs ground chuck + 1 lb ground pork (or any similar combination)
2 x 28 oz cans peeled / diced tomatoes
2 onions, diced
4 cloves of garlic, minced
2 tbs flour
6 tbs (yes, tablespoons) chili powder
4 tsp cumin
4 tsp salt
2 tsp coriander
1 tsp oregano
2 oz semi-sweet chocolate
Brown beef and pork in a large skillet and drain. Add to a large pot along with tomatoes, onions, garlic, flour and spices. Simmer, partially covered, for an hour. Stir in chocolate and cook for another ten minutes to blend the flavors.
We like to top ours with onions, shredded cheddar and Fritos. However you have it, it’s great on a cold night. Especially during election season.
As always, thanks for reading! If you’ve enjoyed this, please forward to a friend.
I run an experience-driven retail development and consulting company and write (semi-) regularly on issues facing the commercial real estate industry. If you’re getting this for the first time and want to sign up, just click here.
If you’ve got a multifamily project with more retail than you know what to do with, please drop us a line; we feel your pain!
Cheers,
G