Why Building Smart is So Hard

For more than 100 years, Denver residents walked, rode and drove to Elitch Gardens, an amusement park roughly 3 miles northwest of downtown. Founded in 1890, “Elitch’s” — as it was known — boasted a formal botanical garden, Denver’s first zoo (monkey and circus lions courtesy of P.T. Barnum), a ballroom and a nationally acclaimed theater. Later, Elitch’s added a Tilt-a-Whirl and an enormous wooden roller coaster named “Mr. Twister.”

By the 1980s, however, the park was showing its age. The 27-acre site felt cramped, and the surrounding neighborhood had changed from a solidly middle-class community to a still vibrant but considerably less well-off area.

Elitch’s management decided to move the park. The city offered Elitch’s a 90-acre site near new downtown football and hockey stadiums. In 1994, Elitch’s sold its original land to the city, leaving its infrastructure, including an aging Mr. Twister, to slowly decay.

The original Elitch Gardens could have been reborn as almost anything in the late 1990s, when Denver’s economy seemed unstoppable. A strip mall was as likely as a swath of new suburban-style homes. But the surrounding community wouldn’t settle for simply anything. Residents thwarted an attempt to redevelop the area as a Homebase (a home-improvement warehouse with an attendant sea of parking spaces). Eventually, the city sold the site to Perry Rose LLC, an entity controlled by two developers, Charles J. Perry and Jonathan F. P. Rose, who had a very different vision for the old amusement park’s future.

Perry, a developer of affordable housing in Denver, and Rose, a New York-based developer with impeccable smart growth credentials, would together try to meet community demands for something other than a big-box retailer. While Rose and Perry’s redevelopment of Elitch Gardens would become a model for smart growth projects across the country, their efforts would go against the grain of this nation’s entire property development system.

Building “smart” in America is hard. There are a host of reasons: a less-proven market for pedestrian-oriented neighborhoods, higher costs of building, inflexible mortgage lending requirements, rigid building and zoning codes, and unpredictable “not-in-my-backyard” opposition. Together, these obstacles render building smart growth projects both more difficult and less profitable than building conventional sprawl.

In most cases, the lesser return on investment and greater difficulty of building “smart” means only one thing: that sprawl flourishes, regardless of the hundreds of articles and books penned in support of smart growth. Understanding the story of Highlands’ Garden Village, the model smart growth development that Rose and Perry built on the Elitch’s site, helps answer the pressing question that developers, politicians and community activists ask: why building “smart” is currently so hard — and how it can be made easier.

The Vision Behind a Community

Rose’s vision for the old Elitch’s site was simple to elucidate but difficult to achieve. “The most important thing was the creation of a community, and community implies diversity,” explains Rose. “We wanted to demonstrate the economic model of including all types of housing on a site.” In this case, “all types of housing” would come to mean 52 single-family homes, 20 carriage homes, 54 townhomes, 63 units of senior housing, 124 apartments and 33 co-housing (or cooperative housing) units — a total of 326 housing units on a relatively small site.

Demonstrating the cost effectiveness of environmental responsibility was another central pillar of the vision for the site. The actual construction of Highlands’ Garden Village — as Rose and Perry eventually named the new community — pioneered a number of “green building” techniques, including the extensive use of recycled construction materials and energy-efficient mechanical systems, appliances and windows. The existing water and sewer infrastructure surrounding the site could be reused, as could many of the existing trees and gardens. Originally, the developers even hoped to recycle the wooden joists and beams of the decommissioned roller coaster, but the discovery of lead-based paint made that impossible.

The role of public space in a community also lay at the heart of the developers’ vision. “We wanted a public realm that is gracious, filled with gardens, and supportive of arts, culture and spirituality,” Rose explains. To that end, the original carousel pavilion and Elitch Theater were to be renovated and transformed into spaces for community events, arts and culture. Finally, a network of paths, parks and gardens would bring the various uses together into a functional whole.

Rose describes “integrating living and working” as the final facet of the vision for Highlands’ Garden Village. The many types of housing would add an element of economic diversity to the site. But incorporating 100,000 square feet of office and retail space into the site would allow a more authentic community — with a diversity of both residents and uses — to develop. After two years of discussions with neighborhood residents, Perry and Rose hired Calthorpe Associates, a nationally recognized urban planning and architecture firm with smart growth expertise, to develop a plan for the site. Perry and Rose intended that the plan, and the resulting development, would function as a model for other mixed-use infill development projects, such as dead malls, abandoned military bases, and other large sites within built-up cities.

While it’s not yet clear if that model is working, the early indications are positive. Although an apartment building is under construction, the historic theater has not yet been renovated, and the retail corner of the site remains to be built, the completed apartments and homes have sold or rented rapidly. Many people who have bought homes were residents of the existing neighborhood who were looking for larger, newer places to live, but who didn’t want to leave the neighborhood. And although conventional thinking says that mixing expensive and more affordable housing in the same neighborhood doesn’t work, Perry and Rose have successfully sold the market-rate houses at prices above their own projections — as high as $275,000. Since most homes in the surrounding area sell for closer to $125,000, it’s clear that Highlands’ Garden Village is meeting with some success in broadening the market for smart growth communities in Denver.

But even this degree of success has not come easy. Examining the challenges that Perry and Rose have faced make it clear that much work needs to be done before many more developers will embark on new smart growth projects in Denver or elsewhere.

Financing Difficulties

The developers of Highlands’ Garden Village assert that they conceived of the project as a model for successful mixed-use infill development in Colorado and around the country. But while Highlands’ Garden Village can be a valuable model for developers interested in building within existing neighborhoods, its greater efficacy may be as a model for banks trying to ascertain the risk of financing mixed-use infill projects.

The search for market comparables (or “comps”) is central to banks’ underwriting process. In essence, when banks are asked to underwrite short-term construction loans and long-term permanent loans for a particular building or development, they look to similar buildings or developments — ideally situated close by, and of similar quality and income level — to ascertain the degree of risk associated with the project, the potential income of the project, and the likely success of the project. But when there are no comps, or when the nearest comp is in another state, banks are unlikely to underwrite loans. This makes financing unconventional development projects (such as Highlands’ Garden Village) more difficult and expensive, if not impossible.

Rose had been down this path before. The Denver Dry Goods Building was staple of downtown life for a century. Originally home to a large department store, the building was shuttered in 1987 when the store closed. Rose converted the historic building into a mix of affordable and market-rate housing, office and retail space. Since nothing similar had ever been attempted in downtown Denver, banks — lacking the hard proof of comps — were skeptical that a market existed.

Establishing market comparables, however, is actually one of the less intractable problems facing proponents of smart growth. “Once you build one project,” says Rose, “you create a market comparable, and it becomes much easier going forward.” This is the pattern Rose saw after renovating the historic Denver Dry Goods Building. When it turned out that there was a market for apartments and retail downtown, other developers followed suit, eventually rehabilitating more than 20 buildings downtown. It’s likely that the same pattern will obtain in mixed-use infill projects.

A more significant stumbling block for developers trying to obtain loans is that lenders are simply unwilling or unable to underwrite mixed-use projects. Chuck Perry grouses, “Lenders just don’t get it. They don’t know how to underwrite a shopping center and an apartment building together.” While few banks are willing to lend to mixed-use projects, developers can — with difficulty and creativity — obtain the necessary loans. The solution is to reduce the complexity of mixed-use projects by breaking up one large mixed-use loan into multiple single-use loans. In Highlands’ Garden Village, Rose and Perry obtained separate loans for single-family homes, senior housing and commercial space.

Although developers can obtain loans for each of their uses individually, dealing with each extra loan adds time and complexity to the development process, thus making mixed-use projects more difficult (and expensive) to attempt. When confronted with a choice between building all single-family homes and obtaining one loan, or mixing uses and obtaining multiple loans, most developers choose the simplest option.

Why aren’t lenders willing to underwrite mixed-use loans in the first place? Only some of the answer comes from a lack of knowledge on the lenders’ part. Even if lenders want to finance such projects, structural problems in the United States mortgage banking system make underwriting mixed-use loans all but impossible.

Until the 1940s, if an individual needed a loan to buy a home, he or she would visit a local bank, which would loan funds drawn from the savings accounts of depositors at that bank. But once that bank had loaned out the funds it had on hand, it would no longer be able to originate any new mortgages. To solve this problem, the federal government created three institutions: Fannie Mae, Freddie Mac and Ginnie Mae.

Today, after a local bank lends you funds to buy a home, that bank sells your mortgage (eventually to be packaged in a “pool” along with hundreds or thousands of others) to one of the above institutions. With its coffers now replenished, your bank is free to originate yet another loan to yet another potential homebuyer. (Eventually, even Fannie Mae, Freddie Mac and Ginnie Mae sell off their loans, but this time to Wall Street, and in the form of bonds backed by mortgage interest payments — so called “mortgage-backed securities.” Then the cycle begins again.)

Fannie Mae, Freddie Mac and Ginnie Mae offer similar programs for “multifamily” buildings (i.e., apartment houses, garden apartments, condominiums, etc.). After a bank makes a loan to a developer to finance a new apartment building, that bank follows the same route it takes in creating mortgages for single-family homes. In many cases, the bank sells the apartment building mortgage to Fannie Mae or one of the other national mortgage institutions, thereby freeing up capital for the next lending opportunity.

Basically, lenders can’t easily underwrite mortgages for mixed-use developments because the mortgage banking system is highly standardized. Before being sold off to Wall Street, loans are pooled together with other loans of very similar size and degree of risk. Smart growth projects — due to their uniqueness — are hard to group with other loans. As Rutgers professors Robert Burchell and David Listokin put it in Linking Vision With Capital, a recent report by the Research Institute for Housing America, “smart growth projects, with their custom crafting of mixed uses, mixed incomes, layered subsidies, and the like, run counter to a standardized financing regime.”

Essentially, the mortgage banking system is designed around the expectation that developers and homebuilders will build very many of precisely the same thing — similar homes or apartment buildings in similar neighborhoods at similar prices. While this formula allows for mortgages to be sold in a secondary market, thereby freeing capital for new loans to potential developers or homeowners, the rigidity of this system means that banks are often unwilling to lend to mixed-use projects.

According to Burchell, this situation isn’t likely to change anytime soon. Banks and the secondary mortgage market are locked in a “you first” battle over financing mixed-use development projects. Banks are unwilling to loan to mixed-use projects without an assurance from the secondary mortgage market that they’ll be able to sell their loans. Institutions that participate in the secondary mortgage market, on the other hand, when asked what they will do to enable mortgages with a mixture of incomes and uses, reports Burchell, “shut their mouths and say, ‘We’ll get involved when the banks do.’”

Return on Investment

Ask Chuck Perry about the profitability of smart growth projects and he’ll volunteer a devastatingly clear answer: “You’re not going to make as much money in the same timeframe as you would by building all single-family homes or a power center. The premise that socially good building can compete with mass production is false. It can’t, it won’t, it never will.” The smaller size of most smart growth projects and greater diversity of housing unit types in those developments means that mass production techniques are less efficient. Costs, therefore, are higher, and profits often correspondingly lower.

Burchell, who is well versed in the financing of smart growth, concurs. “If you really want to make money, you’re on the edges of the big interstates, working within standard building codes. I don’t think smart growth is as profitable, and I don’t think it can be.”

Rose, however, is more sanguine. “While you could make more money with a power center, it wasn’t an option. The community turned it down.” What the community didn’t turn down, however, was what Rose called the option available to a “less principle-based developer”: building solely single-family homes. The problem with building only single-family homes, of course, is that it negates the possibility of mixing uses and incomes — what building a real neighborhood is all about. This leads to a real conundrum for the smart growth movement.

If the market rewards those developers who are willing to forgo diversity and build only single-family homes, or those who build power centers, the future of the smart growth movement becomes extremely murky. And when you add Perry’s contention that “the larger the site, the greater the incentive to do a conventional project,” you begin to wonder if smart growth will ever be anything but a drop in an ever-growing bucket.

The only potential savior for smart growth is this: it appears that people may be more loyal to smart growth projects than conventional projects. And over the long term, that loyalty is worth a lot of money. Take Highlands’ Garden Village as an example. In a weakening rental environment where more than 10% of the Denver metropolitan area’s apartments are vacant, Highlands’ Garden Village boasts a rental occupancy rate of 98%. Furthermore, turnover is low. And as noted before, homes at Highlands’ Garden Village sold for prices above — sometimes far above — initial estimates. The reason for the low vacancy rates and the high sales prices is the same: some people want to live in authentic communities and neighborhoods, and they are willing to pay for that opportunity. If in the long term, developers and investors see a substantial premium attached to smart growth projects (either in the form of lower vacancy rates or more rapid increases in value), then more smart growth development will inevitably follow.

Not In My Back Yard

Not-in-My-Back-Yard (or NIMBY) activism is often the bane of a developer’s efforts, regardless of whether the developer has proposed a big box retailer, affordable housing or a bucolic mixed-use community. In developing the former Elitch’s site, Perry and Rose took pains to acknowledge the community’s concerns from the outset. And while they eventually gained the overwhelming support and participation of the surrounding community in the planning process, their efforts weren’t free of controversy.

In a 1998 Internet discussion list posting, a community resident described the opposition of a small but vocal contingent of the community: “Most were afraid the area [would] be too densely populated…Some were afraid their shabby businesses would suffer. Some took the opportunity to vent, still pissed from when the park was there and they had to pick up garbage off their lawns. One minute they criticized the scary experimentalness [sic] of the plan and the next, they went after its ‘obsolete, old-fashioned’ mix of income and living styles. None could…explain why a derelict, graffiti ridden eyesore (or in fact, a likely strip mall) was preferable to an integrated neighborhood.”

The site plan was eventually approved by the neighborhood and adopted by the city, but the intensity of the debate — in an environment in which the development team worked hard to allay the fears of local residents — shows that NIMBY opposition can be a serious impediment to pioneering development efforts. While all developers working on infill sites must contend with the surrounding community, most development in America takes place on ‘greenfield’ sites (sites without any prior development). Most major suburban homebuilders and office park developers can therefore proceed without much community opposition, since communities don’t yet exist where they’re building.

Smart growth developers, on the other hand, often become entangled in community politics. Although community opposition has the potential to derail development plans, smart growth developers who work closely with local stakeholders can sometimes succeed where more conventional developers fail. Jonathan Rose points out that the community surrounding Elitch’s turned down a power center but eventually approved his project. Since time is money, the quicker ‘approvability’ of smart growth projects can be very valuable. But while residents of most communities should, in theory, prefer a smart growth development to a strip mall, obtaining community support can be difficult nonetheless. Rose acknowledges that “while people are opposed to what they don’t understand, getting one project done in a community can help overcome a lot of future opposition.”

Zoning and Building Codes

As many proponents of smart growth have pointed out, rigid zoning and building codes are serious impediments to the creation of pedestrian-oriented mixed-use communities. In creating Highlands’ Garden Village, for example, the developers faced a city requirement that roads be 32 feet wide — far wider than neighborhood streets in many of Denver’s existing neighborhoods. Although these proposed “neighborhood” streets would be as wide as country highways, the city was only willing to bend so far: intense negotiations led to 30-foot wide streets in Highlands’ Garden Village. The stated reason for the extra-wide streets? Access for fire engines. Fire engines, however, are able to maneuver through the narrower streets of Denver’s older neighborhoods without much difficulty. This constant need for negotiation over minute detail is a severe impediment to building smart growth projects quickly and profitably, in an industry where time really is money.

The absence of such negotiation over minute details of city code is a key reason why suburban sprawl can occur so rapidly. In much of the country, homebuilders working within the standard building and zoning codes can build “by right.” In essence, once they have title to the land, developers can proceed without gaining approval from the zoning and planning councils of the county or city in which they’re building.

Encouragingly, in much of the country, the codes and zoning requirements that hinder smart growth projects are slowly being changed, or at least made more flexible. The danger, of course, is that decades will pass as local governments move tentatively towards new zoning guidelines and building codes. In the meantime, conventional development will continue unabated, and smart growth development will be slowed — and made more expensive — by the constant need for negotiation over planning and zoning guidelines. Ideally, reforms would level the playing field by allowing more freedom for non-conventional development projects and requiring greater oversight for sprawl-inducing projects.

Highlands’ Garden Village still faces challenges. The building of the retail component of the project — so essential to the mix of uses that is the hallmark of classic, walkable neighborhoods — has not yet begun. While the project appears profitable, long-term success is dependent upon Highlands’ Garden Village residents continuing to build a strong community that engenders the loyalty and popularity that keeps prices up. Such development of community is a factor even the best developers and planners can’t control.

Over the long term, however, the real measure of Highlands’ Garden Village’s success is not in its return on investment or its growth as a community, but in its achievement in broadening the market for smart growth projects in Colorado and throughout the country. On that basis, its success is less clear, if only because the impediments in the path of the smart growth developer are still so great.

Jonathan Rose and Chuck Perry should be commended for an extraordinary effort. But while their work will help lead the way for other innovative developers, much remains to be done. While a handful of developers pursue niche projects like Highlands’ Garden Village, others build thousands of conventional suburban single-family homes each year in the Denver area with relative ease. Without major changes in loan underwriting, building codes, and a government approval process biased towards conventional sprawling development, a handful of innovative subdivisions built by unusually motivated developers will likely be the smart growth movement’s only response to an ever-widening gyre of sprawl.