Moving the Tipping Point for Creative Places

Human-scaled, creative development isn't getting built because most of the money in real estate comes from institutional investors that prefer predictable, large scale projects like subdivisions and strip malls, says Neil Takemoto of CoolTown Beta Communities.

Why is it that the vast majority of new development is at an institutional scale, and we don't see human-scaled fine-grained urban fabric, the kind that makes historic neighborhoods so desirable? Well, it's mainly because the vast majority of real estate development investment dollars come from institutional investors, and where does that money come from? Your pension and insurance dollars are sourcing this tremendous pool of capital that has to be invested somewhere. To those investment managers with billions to manage, why manage fifty projects if you can manage only ten instead? That simply means they'll prefer investing no less than $5 million at a time, which translates to $15 million projects. That precludes most every single human-scaled building you'd find, explaining why human-scaled neighborhoods weren't built since the 1920s, leaving only large-scale strip malls, subdivisions, office buildings

The thing is, the emerging you-centric market is demanding customized and personal, not mass-produced and commoditized. So how in the world is the supply of investment capital going to accommodate this? By focusing on the long tail - which is essentially anything and everything else that's a 'non-hit' or 'non-blockbuster', but in sum is greater. The good news is that it's inevitable - witness the rise of Netflix instead of Blockbuster; Amazon/eBay/iTunes instead of Wal-Mart; YouTube instead of TV, all of which focus on the thousands of individual niches of smaller interests that are in sum greater than the only the most popular interests. All that was missing was a reliable system of delivery.

Chart: The Long-Tail of Investment

So, the long tail of real estate development - the $1 million to $5 million investments that none of today's major investors want any part of (just like the 42 million video titles Blockbuster won't carry) - will eventually inspire a system to invest in human-scaled buildings in human-scaled neighborhoods once again, just like Netflix devised a system allowing people to rent any one of those 42 million of ‘unwanted' videos. To get a better understanding of why real estate management isn't quite there yet, see 'Why placemaking isn't crowdsourced... yet.'

As you can see in the long tail diagram above, institutional investors aren't interested in development projects costing less than $15 million, which on average require about $5 million of their capital. When you're managing billion dollar funds, anything less than $5 million is too small. However, you can also see that the market demand in the growing knowledge economy is largely left out. Read about the 19 conventional product types of the industrial age vs the 19 urban development/place types of the knowledge age here.

In other words, while many of us would rather live in a multi-unit rowhouse type of building, our only choices may be apartment towers, because only the latter is big enough to finance in today's investment world. The tipping point is too high, and the result is a de facto built environment of monumental projects like you'll find at GlobeSt.com, the de facto real estate investment news site.

Hopefully sooner than later, but inevitably, the investment industry will cater to the long tail (ie the masses, or 'everybody else') and establish contemporary management structures that can handle a greater number of smaller development projects, as low as $6 million requiring $2 million in capital (ie a multi-unit rowhouse) - see diagram below. At the same time, crowdfunding will provide more financing options from the other end, letting the market finance their own preferences. That's when you'll finally see the 19 more creative urban development/place types define the new quality of life that creatives demand.

Chart: The Long-Tail of Investment

In other words, next generation investors will work with certified developers to buy several smaller buildings at once, provide them with progressive tenants upfront via such contemporary methodologies as crowdsourcing, and enjoy a much greater return (financially as well as socially and environmentally) than if they invested the same amount in one 'GlobeSt.com project'.


Neil Takemoto is the founding director of CoolTown Beta Communities, a crowdsource-based placemaking and economic development firm codeveloping natural cultural districts with creatives.See the original source for this article, Moving the tipping point for creative places, at www.cooltownstudios.com. Thanks to Jamal Williams of Red Dove for contributing to this entry.

Comments

Comments

Additional thoughts from an institutional real estate geek

I work in the institutional real estate investment world. This article make some good points, but there are a few other things that are relevant that I would point out:

1. The retail components of large-scale developments will invariably skew to "boring" chain retailers because institutional investors want rated, "credit" tenants occupying their developments. By leasing space to known, credit-worthy chains, the resale (or "reversion") value of the retail component will be higher because investors will view the income stream from a credit tenant as less risky, and they will thereby pay a great multiple (or lower cap rate) for it. I believe there is a market opportunity for a national operator of local street fairs, booth retail, festivals, events, etc. to create a national management, "credit" entity which could lease space at such developments and in turn sublease sub-units to truly local retailers who sell local wares, hold interesting cultural events, and otherwise harness the power of "crowdsourcing". By pooling their power into a larger operating structure, the long-tailers and crowdsourcers that make for compelling places could create the credit and entity-level gravitas required to appeal to the (often institutional) owners and operators that make leasing decisions for large-scale developments.

2. Regardless of whether or not institutional investors are involved with large-scale development projects, the developers are incentivized to maximize the buildable square footage of a land assemblage, as that will maximize their income/proceeds. The land itself gets sold to the highest bidder, and the highest bidder is usually the developer who can justify the highest SF development envelope, as a developer looking to build a smaller project marketed to the "long-tail" would have to be able to justify massive psf rent and price premiums to make up for the smaller density of the project and be competitive in bidding for the land. For land sites that have upzoning potential and are not single or double lots, therefore, the most aggressively-scaled concept allowed under the zoning is likely to win, and get built, REGARDLESS of whether or not the underlying capital is institutional or non-institutional, and REGARDLESS of whether or not demand for smaller-scale projects exists.

3. This is not to say that large institutional investors are not interested in smaller "long-tail" projects which might sell/rent for some type of per sf or per unit premium, and might be ideal on small sites that do not have massing/density potential to accommodate large-scale concepts. I concur that the author is correct that deploying capital in $5 million or smaller increments does not offer appropriately efficient economies of scale to large institutions. HOWEVER, those institutions may, in some instances, elect to make entity-level investments or other structured, platform-level joint venture investments with small-scale, long-tail developers that have demonstrated repeated success in building such projects. By working with such a developer that has internal economies of scale because they are developing multiple small projects at once, the institution can efficiently deploy the capital, but at the entity-level across projects, not on a project-by-project basis. In fact, this already occurs in select real estate markets where such strategies have a proven track record.

4. While I personally prefer unique, non-cookie cutter developments, I have yet to see quantitative, survey-based research involving the general population showing that the masses actually care whether or not something is "human-scaled" or "interesting" or not. Is there objective research showing this to be the case? Has anyone quantified what % of the population would prefer such developments, and how much of a premium they would pay in apartment rents/ condominium prices/townhome prices/retail goods costs to support the necessary levels of residential and retail demand to sustain such developments? I sometimes wonder if the general population does not actually care as much about compelling design and development formats as planners, architects, and designers think they should or do.

Nonetheless, great article!

Human-Scaled

Human-Scaled creative development isn't getting built because it is actually illegal in 99.9% of the places in the United States. Unless you happen to be in a place that was developed prior to the 20s (that beat the rules by being there prior to the rules), the land use requirements (zoning, general/specific plan, building codes, etc.) attached to any particular parcel make it illegal to build the development you are talking about in signficant quantities. Insitutuional investors love these predictable requirements as it lowers their risk (same with the chain stores). There is also the time involved in projects, as in CA (not true with other states) getting a small, human-scaled project entitled and built could take a decade and cost a small fortune... this is a barrier to entry which benefits larger, better heeled developers and their institutional backing (and also forces the development of much larger projects as, on a per unit basis or per SF basis, the costs can be spread out over more units/SF).

There is definitely a market for the buildings and neighborhoods you desire... the problem is simply that are development process has made catering to that demand virtually impossible. Freeing up land use regulations (even a little bit, no need for wholesale jettisoning) would unleash the creativity of the smaller fish in the real estate development/finance world to cater to the demand that we all know is out there. Institutional investors will simply follow once the little guys prove it can be successful.

the creditworthy don't always make the best competitators...

Block E in downtown Minneapolis makes an interesting case study on the pitfalls of trying to have "creditworthy" national tenants try to compete against in a downtown scene with the best restaurants and entertainment venues in the region which are mostly located in smaller, older buildings.

From a Star Tribune article, "Much of the criticism aimed at Block E has focused on the presence of national chains, like Applebee's and Hooters, that can be found throughout the Twin Cities. Graves said he believes ULLICO [life insurance company investor] pressed for some of those merchants early on because they were considered stronger financially. "But these days that thinking has changed with so many national chains suffering," Graves said." www.startribune.com/local/82651527.html

Although many of the retailers were considered to be stronger financially at the time, about half the space is now vacant. The former Snyder's drugstore space will be a police substation. It doesn't help that the building's design is poor with a Los Vegas-style EIS exterior and an interior layout that is confusing at best. It's almost impossible to figure out how to get from the first to the second floor and one cannot go through the building on the first level. Not surprisingly, there have already been calls for redevelopment.

great post

Maybe federal banking regulations should be rejiggered such that, to get a mortgage, not only the fact that one has a job but where that job is located was also somehow calculated in to give property owners an incentive to live in closer proximity (at or within, say, 20 miles)? Just like folks are given an incentive to perform such supposed public goods as, ahem, get married? According to AAA, the composite cost per mile average for driving in 2008 was .71$/mile (up .09$/m from a year ago). Maybe a strategy to reduce the number of VMTs in this manner will free up more disposable income, which would make housing, among other things, more affordable?

David Parvo
Most Senior Fellow
The Placemaking Institute
http://placemakinginstitute.wordpress.com/2010/01/28/a-modest-proposal-2/

Excellent article.

Great points.

"The good news is that it's

"The good news is that it's inevitable - witness the rise of Netflix instead of Blockbuster; Amazon/eBay/iTunes instead of Wal-Mart; YouTube instead of TV, all of which focus on the thousands of individual niches of smaller interests that are in sum greater than the only the most popular interests. All that was missing was a reliable system of delivery."

The rise of those media greatly helps real estate industry. Real estate agents should utilize carefully those media to be successful in the work they're doing.

Florida real estate

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