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IS THE GOLDEN STATE WORTH THE HASSLE?

You bet, say developers tangled in California’s regulations

By Joel Groover

Picture a legal pad with two columns, one titled “Costs of California Retail Project,” and the other “Benefits.”

The lengthy debit side of the ledger might include such scary line items as “impact fees: $10 million”; “11-acre tract in North Hollywood: $38 million”; or “legal bills to fight anti-growth lawsuits that could drag on for years: costs unknown.”

And the “benefits” column? Not to put too fine a point on it, but that side might just read, “Yes! It’s still a gold mine!”

Such is the paradox of doing business in California, where hellish barriers to entry torment developers working on new projects even as they also safeguard heavenly sales at their existing centers.

“Once you have a shopping center, the likelihood is you’re not going to have another one pop up across the street,” said Ben Reiling, president and owner of Los Angeles-based Zelman Development Co. “You can generally get a high enough rent to make it worth your while to go through three years of pain and agony.”

In tightly packed California markets such as the Bay Area, national retailers pounce whenever suitable sites come open — even if that means forecasting uncomfortably aggressive sales growth to justify paying stratospheric rents, says John M. Beaney, senior vice president of retail tenant services at Los Angeles-based Colliers Seeley, a full-service real estate firm.

“What I have seen with the clients I have represented is that, store-for-store, their units in California generally outperform those in the rest of the country,” said Beaney, who has represented the likes of Cost Plus World Market, Linens ’n Things, Loehmann’s and Party City in the state.

“What makes California unique is that roughly 90 percent of the population lives on about 10 percent of the land,” Beaney said. “You’ve got very densely populated markets with not a lot of availability.”

Unlike California’s major coastal cities, however, outlying areas such as the Central Valley and the Inland Empire still offer vast tracts of land. But that does not mean developers working in these fast-growing areas enjoy a free ride. All California municipalities are expected to comply with the strict planning processes mandated under CEQA, the California Environmental Quality Act of 1970 (story, The CEQA challenge).

The process can be time-consuming and costly, says William W. Gerrity, president and CEO of Carlsbad, Calif.-based GMS Realty. “Provisions of CEQA provide a fairly open door for anybody who has any reason to oppose your project to interject themselves and slow it up,” Gerrity said.

“In California it takes you longer to go through the process than it did for the United States to defeat the Axis powers in World War II, said Rex Hime, ICSC’s legislative affairs chairman for California, and president and CEO of the California Business Properties Association. Developers estimate that projects in California are easily 20 percent more costly to build than they are in other states — and if they encounter controversy or lawsuits, they are costlier still, Hime says.

Municipalities, too, often have strong opinions about the way centers should be designed and built. This input may well be intended to make projects better, but planning officials can lose sight of a developer’s budget constraints and other fundamentals of the business, notes Patrick S. Donahue, president and COO of Costa Mesa, Calif.-based Donahue Schriber, which owns 60 centers in California and has an additional 10 in the pipeline. Increasingly, California municipalities enamored of New Urbanism are pushing developers to build urban in-fill projects in rural areas that lack sufficient density, for example. “The New Urbanism is everywhere,” Donahue said. “People say, ‘This is what we want, because we’re planning for the future.’ Well, they’re planning for 50 years from now.”

Meanwhile, the vagaries of the entitlement process can make it difficult for developers to have faith in their own short-term plans. California’s multiplicity of activist groups is ever the X factor, says Gwen MacKenzie, CLS, senior vice president of retail investments at Irvine, Calif.-based Sperry Van Ness. “You never know what’s going to happen once you start the process,” she said.

The threat posed by powerful environmental groups looms large. MacKenzie lost a shopping center deal in San Diego last year after Donna Frye, a local activist known for her staunch support of green causes (and for her marriage to devout environmentalist and world-famous surfer Skip Frye), emerged as a dark-horse mayoral candidate.

“The REIT was terrified,” MacKenzie said. “They immediately canceled the contract and walked away.”

Another project, in affluent Orange County, failed to woo key retailers after the community nixed a proposed sign along Highway 91. “They didn’t want anybody on the freeway coming to their center,” MacKenzie said. And a project in Anaheim ran into trouble when residents waged a campaign against Mexico-based Gigante Supermarket. “They said Gigante would bring drug dealers and prostitutes,” she said.

Naturally, officials must pay attention to the concerns of vocal constituent groups. But the realities of California’s economy force even the greenest of governments to think twice before adopting an anti-development agenda.

Proposition 13, the state’s landmark 1978 property tax overhaul, limits annual tax growth to 2 percent of a property’s most recent sale price — a virtual freeze on property taxes relative to other parts of the country. As a result, California’s tax system encourages retail development by relying heavily on sales taxes. With respect to sales taxes, municipal governments statewide have grown increasingly fond, as it were.

“Sales taxes are becoming much more important to the operating budgets of California municipalities,” said David J. Contis, CLS, executive vice president and COO of The Macerich Co. “We’re finding that communities that typically were anti-growth and anti-development are becoming far more willing to work with developers on retail projects.”

Enthusiastic officials in Antioch, Cerritos, Fresno, Lakewood and Modesto have worked with Macerich to land department stores, lure restaurants and add lifestyle components, among other mall improvements, Contis says.

Demand for retail is so great, in fact, that a little over a year ago, Buxton, a Fort Worth, Texas-based retail research firm, began working with the Washington, D.C.-based National League of Cities to offer a kind of retail matchmaking service for California municipalities. The idea is to use detailed trade-area profiles to match cities to the specific needs of some 4,500 national retailers, says Buxton’s Amy E. Wetzel, a regional vice president who now works with 30 California municipalities.

But the same budget squeeze that has led communities to embrace retail has also sparked attacks on Proposition 13.

In recent months public employees’ unions worked to put the so-called California Tax Fairness Act on the ballot next June. The proposal, which has since been withdrawn, would have allowed nonresidential and nonagricultural commercial properties to be reassessed yearly at their full market value.

Like frost on an orange crop, such a tax hike would have chilled retail growth by forcing landlords to raise already sky-high rents. “It would be a huge problem,” Contis said. “California has a tendency to look at proposals like this without realizing all the impacts. Remember, there are 49 other states — retailers can go elsewhere.”

The tax clash hints that future battles are likely. California, currently home to 34 million people, could see an additional 12.5 million residents by 2030. Yes, that will translate into more retail demand, but housing shortages, overburdened school systems and clogged roadways could prompt calls for massive impact fees, draconian environmental regulations and the like. There is talk, for instance, of a transportation impact fee of $100 per square foot for developments in some places, Hime says. That would be $100 million on a 1 million-square-foot project.

“The sheer size of this market is one of the reasons it works,” Donahue said. “But it is also its No. 1 issue.”

For now, however, the cost-benefit analysis of development in California tips to the benefits side — as long as developers have deep pockets, political connections and Zenlike patience. And lawyers, lobbyists and PR firms are helpful too.

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