East San Marco Apartment Project on Hold — Some Thoughts

The inability to finance the development of the East San Marco mixed use development has received a lot of press lately. As I said in my last post, I answer YES to the question “Is Downtown Revitalization Important to Jacksonville’s Future?” San Marco and Riverside tie into downtown revitalization because of our geography and lifestyle patterns. So, while the amount of press coverage for the project reflecting apparent interest in greater central Jacksonville is good news, it saddens me that financing could not be arranged.

I am a veteran of trying to do downtown redevelopment back in the late 1980’s and early 1990’s. The issues I faced were in many ways similar to those faced by Whitehall in trying to do East San Marco. In a speech to a local planning group back then, probably in one of my more downhearted moments, I described trying to do a downtown deal as similar to attacking a bastion with gun turrets on all corners and in the middles of all but one of the walls. Not something for the faint of heart to try!

Why is this project so hard to finance?

One reason advanced is that Jacksonville is a tertiary market, not a secondary market. Classification as a secondary or tertiary market is important because it affects investors’ perception of the liquidity risk in the market, and less risk is always better than more risk and perception is more important than reality. The smaller the market, the less diversified is the economic base and the shallower is the tenant pool. But the biggest concern for investors is the risk they are assuming on the exit strategy: Will there be sufficient buyer demand when it comes time to sell? Once you get out of the primary markets, the classification process is subjective. I think Jacksonville is a secondary market, and Real Capital Analytics in its Commercial Real Estate Glossary agrees.

A major necessary condition for market liquidity is transparency. The Jacksonville apartment market is followed by multiple national analytical services providing the necessary transparency to be a secondary market. But that can be a double-edged sword. In their forecasts for 2013, the national analysts underestimated the strength of the Jacksonville apartment market (see my previous blog posts for 2013).

Irrespective of the market classification, however, in either a secondary or tertiary market the size of the tenant pool is critical to understanding the reluctance of investors. Net absorption of apartments in Jacksonville during 2013 totaled 1,844 units according to REIS, and they project absorption for 2014 to be 1,495 units. That’s for all of Jacksonville!

In many urban settings today, urban infill is a very popular product. However, in Jacksonville the population flows are still migrating away from the central core into the suburbs and exurbs, not towards the core. And as Ben Carter (50% owner of St Johns Town Center, a major out migration destination) said in the Jacksonville Business Journal, there’s no leadership or broad support for revitalizing the central core. 220 Riverside is bringing 294 units into the market, and Pope and Land are proposing an additional 310 units in Riverside. Both of these projects are directly competitive with the East San Marco project’s 280 units based on lifestyle and geography. Is it realistic to think these projects combined can capture 59% of the net apartment unit absorption in Jacksonville with the current demographic patterns?

Back to the bastion analogy, 220 Riverside was first to the wall with no gun turret in the middle. Combining the fact that investors realize these projects are swimming against the current with the perception that Jacksonville is a weak apartment market, there are not investors out there with the risk tolerance to tackle a project such as East San Marco whatever locals may think of its prospects. I expect that until the market sees how 220 Riverside is absorbed (create a reality versus a perception, the pioneering project problem), there aren’t going to be a lot of investors rushing to charge the other walls. No investor wants to be confronted with finding an exit strategy for a half-filled building.

That is why East San Marco could not be financed at this time.

If you would like to discuss these thoughts in more detail, please contact me:

            Paul B. Hazlett
            Real Estate Investment Advisor
            Coldwell Banker Commercial - Benchmark
            904.421.8523
            PHazlett@CBCWorldwide.com