DEVELOP—Novel Development Strategy Targets Housing Downtown

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Finding that money-making retail operations have driven up the cost of otherwise vacant downtown property, developers are trying a different tack to meet growing residential demand.

By converting buildings to condominiums and allowing sellers to retain ownership of lucrative ground-floor retail, investors are bringing costs down enough to make residential projects viable.

One of the first to make use of the idea was DECOMA Industries, developer of the Toy Warehouse Lofts, a 20 residential condominium project at 215 Santa Fe St. in the Toy District that sits above ground floor retail.

Steve Notaro, president of DECOMA, said the ground-level space was sold for $1.25 million and will become a law office.

Because DECOMA’s project did not involved the building’s seller retaining ownership of the first floor, the deal for the former toy warehouse represented a variation on the emerging trend.

Irving Bonios, a senior vice president at NAI Capital Commercial, said separating retail portions of a building that is otherwise vacant or underperforming makes sense for all parties.

“People who own these buildings are (otherwise) not being energized to sell them because they have something that is stable income,” he said.

Still, not everyone is convinced.

“I think it’ll be hard to accomplish because, typically, the buyer wants to buy the whole project and control it,” said Ed Rosenthal, investment specialist at Grubb & Ellis Co.


Deal in the works

If a developer can separate the components, said Frank Gamwell, a principal in Oxford Street Properties, one of the developers considering ways to improve the economics of conversion projects along Broadway, “what it means is you can look at the upstairs pure.”

Oxford Street and Bonios, its agent, are working on a couple of deals with building owners that would eliminate the cost of the ground floor.

While he wouldn’t identify the parties in negotiation, Bonios said the concept works one of two ways: either the buyer and seller joint venture in the building or the building is “condominiumized” and the ground floor stays with the seller while the buyer acquires the upper floors.

Oxford Street Properties is doing the joint venture program at the Irvine Byrne Building, also known as the Giant Penny building, after its ground floor retail tenant.

Gamwell said ground-floor retail space along Broadway sells for an average of $100 per square foot when fully leased. The vacant upper floors of a building go for an average of $20 per square foot.

“Most of the owners like that regular income and they’re not ready to give that up too easily,” he said.

Bonios said ground-floor retail space rents monthly for between $3 per foot and $10 per foot depending on the location and size of space.

An obstacle to making these sorts of deals work is that sellers often have to give up some active retail space to allow for lobby and elevator access to upper-level residences.

But Rosenthal said he’s finding buyers reluctant to give up control of the ground floor of their project.

Dave Zoraster, a vice president at CB Richard Ellis Inc., said the scope of a residential conversion is such an undertaking that continuity and coordination among all floors, particularly during construction, is key to success.

“These are pretty massive remodeling projects,” he said. “To do it without full ownership of the building is difficult and darn near impossible.”

A bigger problem is synergy between the relatively pricey residential development upstairs and the low-end retail on the street, most of which is geared to working class Latino consumers.

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