Better Together: The Opportunity in Mixed-Use Retail Condos
A wave of high-density mixed-use development has swept across the country within the past decade. A number of forces have contributed to this activity, including demographic trends, shifts in housing demand, environmental concerns, as well as governmental forces and municipalities seeking to create sustainable, pedestrian-oriented communities that incorporate a mix of uses.
As a result, developers are building ground-up mixed-use projects or converting older hotels or apartment and office buildings into residential developments featuring apartments or condominiums. The street-level retail portion of the development is, in most cases, also converted into a condominium. This process has created a specialized real estate product known as the retail condominium or commercial condominium. The retail condominium has now emerged as a popular, alternative real estate investment platform.
Retail condominiums were traditionally in major metropolitan cities like New York or Chicago, but are now debuting in suburban markets throughout the country. Pasadena, long thought of as a suburban neighbor to downtown Los Angeles, now boasts mixed-use developments like the Pasadena Collection and 482 Arroyo. These projects offer a mix of residential, office and retail condominiums. The Harbor Lofts development in downtown Anaheim, Calif., also includes residential loft condominiums above ground-floor retail condominiums.
The sale of the retail condominium portion of a project can represent a significant dollar amount in proceeds for the developer. Many of these mixed-use projects are also executed by residential developers that don’t typically have a long-term interest in the ownership of the commercial/retail portion. For example, the sale of the ground-floor retail at the Seychelle and the Waverly on Santa Monica’s Ocean Avenue resulted in sale proceeds of $32 million for about 19,000 square feet of commercial retail condominiums. The retail portion was part of a 158-unit luxury residential condominium development.
Retail condominium sales are generally structured in one of two formats. The entire retail space that is leased to a single tenant or multiple tenants can be sold to an investor. The income stream is structured in much of the same way as the income stream of traditional retail buildings or shopping centers. From a pricing and valuation standpoint, the pricing achieved from a ground-floor retail condominium sale can be equal or, in some cases, greater depending on the cache of the building and its location.
The second format used to sell a retail condominium is the sale of the retail condominium unit to a single user, whether it is the entire ground floor or one of the retail condominium units. The sale of the individual portions of the retail condominium space, which was separately parceled in advance and structured as a unitized condominium, is also a popular growing trend.
The 482 Arroyo development enabled a private entrepreneur to purchase the entire ground-floor retail unit for $1.3 million, or about $600 per square foot, to operate an extremely high-end retail store. Had the retail condominium not been available for sale, the purchaser would not have been able to open a store at this location.
Retail condominiums have a tremendous advantage for both individual and institutional investors. The structure offers the investor the opportunity to purchase a stabilized investment at proven locations that may have traditionally been unavailable previously to investors. Due to the location and component of other types of real estate uses in the development, this would have required an investment of tens or hundreds of millions of dollars.
While many individual attributes make the retail condominium a potentially attractive investment and the possibility to acquire commercial real estate in prime urban markets, investors need to be aware of certain considerations. First, while the purchaser will own its individual piece of real estate, the overall real estate is most likely subject to being governed by a condominium association and Covenants, Conditions, and Restrictions (CC&Rs). While more traditional types of retail ownership are subject to a reciprocal easement agreement as well, each condominium development has its own nuances.
Investors should have strong clarity as to the process of allocating expenses, restricted types of uses for retailers, and clarity in common-area responsibilities like parking garages and sidewalks. The condominium association may not be attractive to certain investors as the association has control of operational expenses that affects the commercial condominium owner.
Retail condos can present a tremendous opportunity to own and operate real estate in some of the most dynamic markets in the country. With the scarcity of land and the demand for mixed-use, pedestrian-oriented developments, retail condominium development will continue well into the future. As a result, the retail condominium will continue to be a product in the marketplace, becoming as common as multi-tenant apartment buildings, multi-tenant shopping centers and single-tenant investments.
— By Carlos Lopez, Executive Vice President, Hanley Investment Group in Corona del Mar, Calif. This article was originally published in the July 2017 issue of Western Real Estate Business.