As 2005 draws to a close, the impacts of Hurricane Katrina are still affecting the building industry, in ways that are both obvious and hidden. Newspaper headlines continue to track impacts on the larger U.S. economy, the pressure on building material costs, and the flow of workers in and out of the region. But one story of the Gulf States could prove a harbinger of future development trends. The story features Republican Governor Hayley Barbour of Mississippi, and his efforts to redevelop his state in ways that are more sustainable. Rather than taking a business-as-usual approach to rebuilding, this governor has opted to take another approach at reconstruction without limiting the pace of development.

“In 30 years, when I’m dead and gone, people will look at what the Coast and South Mississippi have become… if it is simply a newer version of today, we will have failed those people – our children and grandchildren,” said Governor Barbour.

In the hope of leaving a lasting legacy in his community, Governor Barbour invited more than a hundred planners and designers to suggest a model for growth. This effort has been gaining attention and attracting capital on a nationwide basis.

This article examines the steady and continuing increase of smart growth projects as a real estate investment opportunity, the current state of the market and future demand for this product. By focusing on smart growth as an investment niche, developers, builders and capital sources can better assess the investment nature of smart growth products and anticipate how they can begin to compete for future opportunities.

What Smart Growth Projects Look Like
Smart growth projects are typically portrayed as places where people can live, work, and play. Additionally, they are viewed as walkable places with a strong sense of community. They have vibrant town centers and provide multiple transportation options. Some, like the venerable Seaside in Florida, may recall the appealing towns of yesteryear. Others, like the trendy Pearl District in Portland, may be built on recycled industrial properties and reflect modern styles of architecture. Because smart growth principles are not constrained by a one-market-fits-all implementation program, these projects are able to satisfy consumer demands in a variety of market formats: big cities, small towns, transit centers, and yes, even at the urban edge.

While the brief description above captures the general breadth of what a smart growth project strives to achieve, it omits a fundamental element that is easily overlooked; projects developed with smart growth principles are also real estate investments.

By their nature, smart growth projects include a variety of housing types – single family, multi-family, loft, and granny flats. They are likely to include retail, office, industrial, and hotel uses, as well as schools, libraries, religious, and municipal facilities. Because smart growth projects also incorporate neo-traditional design, the result is truly a new consumer product. The private sector is now producing smart growth projects, and a growing segment of the consumer market is responding positively.

Smart Growth is Happening
Lee Sobel, a policy analyst with the United States’ Environmental Protection Agency (USEPA), looked at 73 smart growth projects under construction throughout the country during 2000 and through the first quarter of 2004. The aggregate amount of capital invested in these projects during this time was estimated at over $9.1 billion dollars.

As reported in the EPA’s forthcoming Smart Growth Capital Report, the construction activity during the study period represented over 22,000 for-sale houses, 11,000 rental units, 6 million square feet of retail and 7.2 million square feet of office, industrial and other facilities on slightly over 30,000 acres. Upon full build-out, these 73 projects will provide over 95,000 housing units, 23 million square feet of retail, and 49 million square feet of office, industrial and other facilities.

“By the end of our study period,” says Sobel, “we identified an additional 125 smart growth projects that had completed their initial planning or began construction after March 2004. In light of these findings, the investment attention in smart growth does not appear to be diminishing.”

The 73 smart growth projects researched by Sobel represent commitments by a diverse and familiar group of developers and builders. Centex Homes, Post Properties, Federal Realty Investment Trust, and other national and local-market players can be found actively participating in this growing property niche. Sources of debt were generally from large banks and local banks, with a few instances of institutional capital and government loans.

Smart Growth in Downtowns and Historic Midtown Neighborhoods
The EPA assessment of smart growth projects and the $9.1 billion capital investment is not a complete representation of the total number of opportunities found within the purview of smart growth investments. The investment pool is actually much, much larger.

The EPA report did not include information from 22 completed projects, nor did it consider resort or second-home projects that incorporate smart growth characteristics.

Additionally, the EPA did not focus on the multitude of new large- and small-scale projects (under 15 acres) or those redevelopment projects that are essentially characterized as urban infill – many of which tend to achieve smart growth goals.

For example, a Local Government Commission (LGC) case study illustrates that a 46-unit development of detached homes built on 2.2 acres in 1998 in midtown Sacramento sold out on a Saturday morning, inspiring other developers to move in and take advantage of this newfound demand. Since then, 300 additional housing units have been constructed in the downtown area and 711 units are currently under construction. Another 1,300 downtown units have recently been approved and 1,356 are going through the planning approval process. About half of these projects have a ground floor retail component.

Approximately 2,000 of the residential units are in high-rise residential buildings, a new product for Sacramento, which not very long ago was referred to as a “cow town.” Notably, high-rise residential housing is emerging in many other downtowns including Los Angeles, Kansas City, Boston, San Francisco, Denver, Miami, Dallas, Portland and San Diego, to name just a few.

According to a 2003 Wharton Real Estate Review article written by Charles Bohl, “Demand for town housing has been very strong in a wide variety of markets throughout the U.S. and rental rates, sales, and resales of properties have exceeded expectations.”

It isn’t just housing that is moving downtown, the same is happening in the retail segment.

According to retail architect Richard Heapes, “Today’s consumers want Main Street and towns, and the retailers are trying to figure out how to do that.”

And retailers are responding to consumers with innovations such as two-story formats, with offices and housing located directly above stores, parking in the rear, and large window displays fronting sidewalks.

Walkable, Smart Growth Residential Neighborhoods
A 2002 poll conducted by the Public Policy Institute of California found that 47% of residents want to live in a mixed-use, walkable neighborhood. Experience shows that home buyers are willing to pay more for the same house in smart growth communities than conventional communities, in some instances by as much as 25%.

A survey commissioned by the National Association of Realtors (NAR) in 2004 revealed that most Americans prefer to live in walkable communities with shorter commutes, and sidewalks and amenities close by — a trend realtors reportedly have seen first-hand. NAR President Walt McDonald has observed, “Realtors don’t just sell homes. We sell communities and neighborhoods. Smart growth communities are the wave of the future.”

A recent report released by the Federal Transit Administration and the Transportation Research Board revealed that more than 100 transit-oriented developments (TODs) have been built in the United States and at least as many are in the planning stages.

According to the study, over the next 20 years, at least a quarter of all new households — 14.6 million — are expected to be looking for housing within a half-mile of transit, more than double the number of households living there today. Meeting this demand will require building an average of 2,100 residential units near each of the 3,391 transit stations that were studied.

For builders and lenders, this represents a tremendous investment opportunity. This market is spurred by a need for low-cost housing and lifestyle options and a population that has grown tired of increasingly long commutes and clogged lanes of traffic.

Financing Smart Growth
Is smart growth getting easier to finance? Maybe.

Real estate trade groups such as the National Association of Home Builders (NAHB), International Council of Shopping Centers (ICSC), National Association of Office and Industrial Properties (NAIOP), Urban Land Institute (ULI), and NAR either have dedicated smart growth divisions or are focusing more on mixed-use development. Their members are certainly investing in smart growth opportunities, thus more lenders are underwriting these projects. There are so many new infill projects today that finding market comparables is no longer the issue that it was even five years ago. And due to interest rates and available capital, the debt and equity sources are actively looking for deals that make sense.  

Future Outlook
The number of projects and actual dollar investments in active smart growth projects today reveal that smart growth is an investment opportunity that is moving away from the “cutting edge” to “business-as-usual.”

Changing demographics is a big driver for new real estate products. Americans are getting older and would like to know that they can get around without being completely dependent on a car. Fewer households have children. In addition, the tastes of the younger generation and of upper-middle class trendsetters are moving away from the suburbs to more interesting environments that have parks, waterfronts, theatres, restaurants, cafes, museums, shopping, transit and people, all close at hand.

Today, it is becoming clear that there is capital to invest in smart growth products, developers are building them, and local governments are making it easier to do. And most importantly, the smart growth product has caught the eye of the consumer and the employer – and they are moving in!  SLDT