Retailers See Gold in Poor Areas

After decades of neglect, poor urban communities across the country are attracting unprecedented interest from retailers, developers and investors, and many say the current economic downturn is unlikely to reverse that trend.

National chain stores are rising on blighted corners from Harlem to South-Central Los Angeles. Investment funds across the country are targeting entrepreneurs and real estate deals in poor areas.

And most notably, conservative institutional investors and pension funds--both public and private--are starting to pitch in, lured by the promise of solid returns.

Once discounted as problem-ridden charity cases, low-income neighborhoods are increasingly viewed as vibrant untapped markets. Driving the trend are shrinking suburban opportunities, a growing urban population with low individual incomes but high combined spending power, and the beginning of a track record from pioneers in the field.

Home Depot, for example, has seen some stores in poor areas vastly outperform the chain average in sales per square foot. And New York-based UrbanAmerica, a real estate investment company formed in 1998 to focus on distressed areas, is on track to deliver 20% returns to investors. Among them: J.P. Morgan Chase & Co. and pension funds for General Mills and Baltimore Gas and Electric Co.

“People began to see a new reality that is pretty robust,” said Harvard Business School professor Michael E. Porter, founder of the Boston-based Initiative for a Competitive Inner City. “I’ve never seen anything like this.”

The market-driven approach is succeeding where years of social policy failed. Efforts to lure national retailers and other developers to South-Central in the wake of the 1992 riots, for example, were largely a bust.

Ironically, the movement to invest in these long-neglected pockets is gaining steam just as the economy is losing it. Capital that flowed freely in search of novel opportunities in boom times is drying up, and some big retailers may put expansion plans on hold. But, while investments may slow, observers are convinced that the changing attitudes have made a lasting mark and will survive even a prolonged downturn.

The projects that have already taken root will probably buffer some of the country’s poorest communities. Nationwide, new developments promise to create tens of thousands of jobs--although a number offer relatively low pay and poor or no benefits. In Los Angeles alone, thousands of new jobs will come online just in the next year.

Investors such as the California Public Employees Retirement System have vowed to wait out a slowdown. The nation’s largest public pension fund has dedicated more than $1 billion to so-called underserved markets, about two-thirds of that in the past year.

“I think it’s important that these programs get set up now,” said state Treasurer Phil Angelides, who has crafted much of the CalPERS policy.

Communities that have seen little capital or competition could be even more eye-catching in a downturn, he said, as other options sour. “As the economy slows, capital tightens up,” he said. “Then it searches for solid opportunities where there’s a reliable market.”

Angelides’ words would have stunned community development proponents just a few years ago. Then, urban investment funds that promised market returns were unheard of.

Developments in distressed neighborhoods are still difficult to broker: Land parcels are often small, costly and hard to assemble. Environmental contamination is common. Security is often a concern. And local politics can be a minefield.

Furthermore, many retailers remain unconvinced that residents in low- or mixed-income neighborhoods have money to spend. And accurate data have been nearly nonexistent, in part because a booming informal economy goes largely unmeasured.

But much of that is changing. And the evidence dots the region.

Stores Flocking to South-Central L.A.

At Wilshire Boulevard and Union Avenue, the Pico-Union neighborhood’s largest development in decades is rising from an 8 1/2-acre lot. Tenants include Home Depot, Food4Less and Rite Aid.

The development will serve some of the city’s poorest Central American and Mexican immigrants. But though incomes are low, the neighborhood is among the densest west of the Mississippi River, with multiple wage-earners living together. It is also on a main artery that middle- and upper-income professionals use to commute downtown.

“The retailers ask you, ‘What are the demographics? What’s the traffic count? What’s the household income?’ ” said Fred Leeds, a developer of the project. “If you can give them the numbers they want to hear, they’re willing to open a store.”

A growing number of Latino immigrants--with multiple-income households, large families and small children--has also helped dramatically alter retailers’ perceptions of South-Central Los Angeles, said Grubb & Ellis broker Armando Aguirre. The message has traveled from retailers to developers and “up the food chain to the lenders, who are now seriously looking at projects that a few years ago would have been considered too low-end.”

Another Home Depot and Food4Less are under construction at South-Central’s Chesterfield Square, the largest development there in decades. A third Home Depot is slated to replace a vacant building at Pico and San Vicente boulevards in the Mid-City area. And in January, the home improvement chain opened new stores in Inglewood and Huntington Park.

A gleaming Target stands at the site of a shuttered South Los Angeles Fedco--and another is rising in Inglewood. Kmart is planning several Super-K stores in low-income neighborhoods here, and McDonald’s is targeting the areas for some of its outlets. The fast-food giant built two restaurants in underserved urban neighborhoods in each of the past two years, but plans “five or six per year in the next three years,” said Jim Carras, director of development for the L.A. region.

The list goes on. Abandoned lots and buildings from Vermont and Manchester avenues to the old Sears tower in East Los Angeles are in various stages of development. And the story repeats across the country, in once-hollowed cores of Atlanta and Chicago, in blighted pockets of Las Vegas and Tampa, and on the streets of Harlem, where a striking renaissance is taking root.

Many of the properties stood stagnant for decades, but a brisk economy sent capital flooding into more upscale markets. With those areas all but saturated, retailers began searching elsewhere, discovering the country’s growing minority spending power. Low-income urban neighborhoods--often referred to as inner cities--tend to be densely populated and mostly minority, giving retailers easy access to a large and overlooked market.

Many of the sites under development in Los Angeles have been promoted by Deputy Mayor Rocky Delgadillo’s Genesis L.A. initiative, which facilitates deal-making and helps bring in subsidies, grants and private investment capital when necessary.

Genesis officials secured sponsorships and site commitments from key tenants. They are helping to shepherd more than 20 projects through the city’s red tape. And they recently joined forces with the nonprofit San Francisco-based Business for Social Responsibility, which has formed a group of major national retailers interested in underserved urban markets.

At a meeting of the group hosted by Ralphs at the company’s corporate headquarters in Compton two months ago, Genesis officials pitched sites to the retailers. Among them: Blockbuster Video, Starbucks, the Gap, Lowe’s and New York-based Phillips-Van Heusen Corp., which sells its Van Heusen, DKNY, Izod, G.H. Bass and Geoffrey Beene clothing brands through its own outlet mall stores.

With suburban locations all but exhausted, the lower-income urban neighborhoods satisfy a key condition for the outlet stores: that no general mall be nearby.

Low-Income Shoppers Buy Trendy Items

The Los Angeles meeting was the largest ever of the group, formed about two years ago, said Alexis Morris of Business for Social Responsibility’s community economic development program.

Developers have even found themselves with backup tenants for projects that went begging just a few years ago. Among them: a shopping center at Slauson and Central avenues under development by the nonprofit Concerned Citizens of South-Central and Regency Realty.

A recent study by the Initiative for a Competitive Inner City found that low-income urban households spend more than average on everything from home furnishings to athletic shoes, apparel and groceries.

Latino households in core urban neighborhoods, for example, spent as much as 20% more on clothing and food, largely because of bigger family size, the study found. And more than 50% of Latinos and African Americans surveyed ranked trend-setting fashion as somewhat or very important when making purchasing decisions, compared to only 30% of all U.S. shoppers.

But other studies have shown that those shoppers are forced to make many of their purchases outside their neighborhoods.

National retailers are starting to get the message, with strong results: “This is much needed,” retired Los Angeles resident Frances Washington said of the new Target at Rodeo Road and La Cienega Boulevard. “In some areas there’s absolutely nothing and people have to spend their money elsewhere.”

But projects in distressed urban neighborhoods have always been hard to finance. Now, an increasing number of investment vehicles are emerging and they are luring capital with the promise of strong returns.

The privately managed Genesis L.A. Real Estate Investment Fund, which was conceived by the mayor’s office, raised $85 million and has funded three projects in low- and moderate-income areas.

And Beverly Hills-based Canyon Capital Realty recently formed the Canyon-Johnson Urban Fund in partnership with Magic Johnson Development Corp. The fund will channel $300 million in equity investment into urban real estate deals, with a targeted return of 20% a year. It has already raised more than $100 million from major institutional investors, including public pension funds, said managing partner K. Robert Turner.

Other new funds are cropping up to provide private equity to entrepreneurs in low-income minority neighborhoods, build housing or clean up soil contamination. Genesis L.A.’s second fund, for example, will channel expansion and start-up capital to manufacturing and technology companies in predominantly poor parts of the city.

Porter’s group helped launch a fund that has raised more than $130 million to invest in minority-owned and inner-city companies. And among other funds, the San Francisco-based Bay Area Council is raising money for cleanup of contaminated sites, or “brown fields.”

Urban development initiatives long drew contributions only from those banks compelled by the federal Community Reinvestment Act to channel money back into communities where they operate. Now, however, powerful institutional investors are turning to the funds as good business risks.

Financial services giant J.P. Morgan Chase is stepping up its involvement in urban-focused funds. Global investment banking behemoth Goldman Sachs Group Inc. hired New York City’s former economic development guru last summer to create its own urban investment initiative.

And in what could be the most critical source of funding to date, CalPERS staff on Monday will recommend a dozen investment partners from nearly 70 who applied to help manage the California Initiative, a $500-million venture approved by the board last summer to invest in “traditionally underserved” markets.

The initiative, conceived by state Treasurer Angelides, will channel capital into a group of funds targeting overlooked urban and rural companies. It could eventually include urban real estate development.

Even those entities that receive Community Reinvestment Act credit for their projects are increasingly viewing them as opportunities rather than obligations. Washington Mutual, for example, has placed funds in Urban-America, the Genesis L.A. real estate fund and two Bay Area funds, among others.

Investments Appear to Be Paying Off

While it is too early to tell in most cases whether the funds will deliver their promised returns, several East Coast-based initiatives are showing signs of success.

UrbanAmerica, in its third year with $155 million in assets, is on track to deliver 20% returns, said founder Richmond McCoy. The real estate investment company has purchased 15 supermarket-anchored shopping centers, combining the developments with office space for government agencies--stable tenants even in recessionary times.

The Retail Initiative, also based in New York, expects to deliver a 12% to 13% rate of return to investors, said President Oliver Wesson. It has been backing supermarket-anchored projects since it raised its first fund nearly seven years ago.

To be sure, the current economic slowdown will probably take a toll on the nascent efforts. Chesterfield Square, for example, lost a potential tenant late last year when Hollywood Video suffered losses on its online service--Reel.com--and slowed expansion, said project developer Kyle Arndt, president of Capital Vision Equities.

And those who work in the trenches doubt that the keen interest can outlast a recession. “We’re always prepared for the fact that those who were willing to come into these areas in the good times potentially could be the first to pull out,” said Michael Lizarraga, president and chief executive officer of TELACU Industries, an East Los Angeles economic development company.

Others, however, say many projects in dense low-income urban neighborhoods will prove relatively recession-proof as they offer basic goods with little competition.

“These guys aren’t selling refrigerators or cars. They’re selling bread, milk and diapers,” said Aguirre of Grubb & Ellis.

Even retailers stung by recent disappointing earnings, such as Home Depot, remain enthusiastic about new urban locations. The chain has announced it will slow overall expansion plans, but remains committed to its aggressive urban strategy, said spokesman Chuck Sifuentes.

“There’s no turning back from these communities,” he said. “We see enormous opportunity there.”

As cities like Los Angeles burst at the seams, there may be no choice but to embrace these new markets, added Porter.

“Long-term economic forces are pushing back toward urban areas,” he said, “and I think that’s going to be with us for the next 10 to 20 years.”