Shopping the City: Real Estate Finance and Urban Retail Development

Executive Summary

Despite the increase in real estate financing instruments over the past decade, inner city retail development has lagged in all but a select few cities. Indeed, even though new methods of financing have led to more liquid markets with potentially a broader appetite for risk, developers and their financial backers have continued to pursue projects primarily in top-tier cities and suburbs.

To look more closely at retail investment in distressed urban areas, this paper examines the major changes in the real estate finance marketplace, the implications of those changes on development decisions, and public policy actions that could facilitate projects in these markets.

Overall the paper finds that:

  • Out of the ashes of the real estate recession of the early 1990s three major real estate financing vehicles—Real Estate Investment Trusts, Commercial Mortgage Backed Securities, and Real Estate Opportunity Funds—emerged. REITs are now the largest holders of institutional real estate, surpassing life insurance and pension funds.
  • However, despite the robust economy of the 1990s, greater securitization has not led to major shifts in retail development patterns. Instead, REITs are primarily focusing their efforts on the largest investment-grade markets with proven track records. For investors searching for greater returns, along with the attendant risk, small suburban markets have been attractive, not inner city locations. The urban development that has taken place occurred in a select few cities with thriving downtowns.
  • Public policy can bolster the prospects for underserved urban markets. However, rather than focusing solely on subsidies, which can lead to unsuccessful (e.g. vacant) projects, the public sector should examine strategies that mitigate risk and improve returns. This includes improving the availability of information about these markets with tools like property databases, improved demographics, and crime statistics. Also, government guarantees on permit speed and environmental conditions can also greatly reduce risk.

Though the seismic changes in real estate finance has not led to a torrent of investment in inner urban areas, they do increase opportunities for those types of projects, albeit with proper government support. Moreover, often these areas are under-retailed and have significant pent up demand for services other areas take for granted. Also, frequently the complexities and densities of urban neighborhoods preclude other competitive projects, offering additional reward for real estate investors and retailers.