The exponential growth in urban development has coincided with an influx of new forms of capital.
Two megatrends are currently shaping what will become the new normal after the prolonged period of recovery for the U.S. economy. The first is the rapid emergence of America’s metropolitan areas as the true centers of population and economic growth. For the first time in history, more people are living in urban areas throughout the world than in rural communities.
The second is a worldwide shift in the sources and flows of global capital, creating a new world of funding sources available to be configured in new ways toward new goals. The fluidity of global streams is becoming more pronounced and vast sums of capital are seeking stable, long-term returns.
Major metropolitan areas now generate 76 percent of U.S. gross domestic product, are home to 74 percent of the nation’s college graduates, and provide 77 percent of good-paying, knowledge-based jobs, according to a recent report from the Brookings Institution.
Many physical sites left behind when manufacturing declined have been recycled over the decades as city leaders acted on policies designed to encourage conversion of obsolete factories and office buildings to residential and other commercial uses. Large floor plates offered by shuttered factories accommodate creative enterprises that prefer open spaces, such as software developers, new media, advertising agencies, nonprofits, design firms, and high-tech and biomedical research and development. They also are suitable for creating moderately priced, loft-style housing and live/ work space popular with creative types and young professionals.
Downtown Los Angeles, for example, experienced a flurry of redevelopment activity after the city put in place policies to encourage redevelopment of historic structures. An adaptive use ordinance—which halved the time needed to take a project from conception to development and enacted special rules regarding earthquake performance for structures built before 1973—resulted in a 30 to 40 percent reduction in hard development costs compared with new development. The ordinance helped make projects viable, such as the Martin Group’s conversion of a long-dormant Los Angeles office building into the 1100 Wilshire condominium, a 37-story glass tower with 228 luxury units.
Conversion of the 1880s-era Barker Brothers furniture factories and warehouses in downtown Los Angeles into 297 loft condominiums was funded with capital from the California Public Employees’ Retirement System (CalPERS) and JPMorgan Chase. This project matched the fund investment priorities of the institutional investment system with the positive outcome of creating housing affordable to public employees and other working families.
Even in an economy in which home prices have declined, there is unmet demand for moderately priced housing, especially for working families in high-cost cities like Los Angeles, Boston, New York City, San Francisco, and Washington, D.C. Kalahari Harlem, a 249-unit condominium project in central Harlem, is an example of the demand for this type of product in New York City.
Kalahari attracted institutional investors, including Goldman Sachs Urban Investment Group, with a workforce focus and a clear green strategy that includes on-site generation of energy to meet 25 percent of the building’s needs.
In west Los Angeles, TLofts, an 84-unit condominium project, sold 22 units within a month of opening last August and today is nearly three-quarters filled. Similarly, at the WestEnd condo project, in the Marina del Rey area, 88 of the 119 available units were sold within just the first four months.
Public employee pension funds were recently invested in the Venue, an older apartment complex on 4.8 acres (1.9 ha) in the heart of Warner Center, a major job center and transportation hub in Los Angeles’s San Fernando Valley. The complex, within walking distance of 6 million square feet (557 million sq m) of office space and the Warner Center Metro Line, will be renovated using green technologies for energy efficiency.
For more than a decade, pension funds have been an important source of capital in the urban marketplace, and they will continue to play a leading role. Although the market turbulence experienced over the past few years has resulted in some portfolio rebalancing and changes in allocations for some funds, including a decrease in their allocations to urban projects, other pension investors see the current climate as offering the perfect time to reengage. A growing number of pension investors are recognizing that the economy is gaining strength, with urban centers playing a lead role in the recovery. They believe that as a result, the risk/reward balance has improved and that the fundamental investment proposition in urban centers has become more attractive, so they have begun showing increased appetite for urban housing and commercial projects.
Many institutional investors, including many major public pension funds and investment companies, have set aside capital allocations for investments in urban development and redevelopment projects. For instance, the New York City Comptroller’s Office, which serves as a member of the board of trustees of four of the five city public pension funds, has an economically targeted investment program through which such investments can be funded. Also, Goldman Sachs has established an urban investment group to provide economically targeted investments in urban spaces. The Columbia Commons project, bringing 48 condominium residences to Brooklyn’s Columbia Street Waterfront District, is one example. The development is expected to be complete this fall and represents a new approach in allocating funds for the transformation of developing neighborhoods in the New York City area.
The exponential growth in urban development has coincided with an influx of new forms of capital. Equity investment capital can now be sourced from a broad range of institutional investors, including insurance companies, private equity firms, high-net-worth investors, and family offices—small entities representing high-net-worth family investors. Each investor type has different requirements with respect to risk tolerance, deal structure, return expectations, needs for income and cash flow, average equity investment size, and leverage. Despite these differences, the stage is set for a new generation of investors to partner with managers and developers with experience in the urban marketplace to generate strong economic and social returns.
Some endowments and foundations also are primed to invest in urban real estate. For example, the Rockefeller and Kellogg foundations each continue to invest in projects to generate returns or to advance their program-related missions. The Rockefeller Foundation and other philanthropies have partnered with the New York City Acquisition Loan Fund to provide predevelopment capital to developers planning projects that preserve or create affordable housing. The fund will provide $200 million for acquisitions and redevelopment of affordable housing. The Kellogg Foundation recently provided seed money for a nationwide program of HOPE VI communities.
Still another source of capital is foreign investors. With real estate values and the dollar down, foreign investors are committing significant capital to U.S. urban markets. The Canadian Pension Plan Investment Board recently announced a major investment in 1221 Avenue of the Americas, a prominent New York City office building. The Chinese government is beginning to shift money from U.S. treasuries into hard assets, and private Chinese investors also are investing in U.S. properties. For example, a Chinese investment group is building a green industrial park in Mount Pleasant, Wisconsin, and a wealthy Chinese investor purchased the vacant Northridge Mall in Milwaukee with plans to reopen it with more than 200 Chinese retailers.
A recent survey by the Association of Foreign Investors in Real Estate (AFIRE) found that more than half of its nearly 200 members believe the U.S. real estate market offers the best opportunity for long-term capital appreciation and plan to invest here. Current foreign investors plan to boost capital allocations for U.S. assets above 2009 levels, with increases of 62 percent for equity investments and 83 percent for debt, the survey found. One example is AE Capital Advisers, an investment manager based in Sydney, Australia, which has invested $3.5 billion in infrastructure projects worldwide. CityView, a Los Angeles–based institutional investment firm focused on urban real estate, workforce housing, and metropolitan infrastructure, recently partnered with AE Capital to provide $45 million in subordinated debt to the Central Texas Regional Mobility Board for an extension of a toll road in the Austin area.
As metropolitan areas reassert themselves as engines of prosperity, astute investors can find strong returns in funding urban projects that help build America’s future.