Last August, we wrote about why COVID-19 wouldn’t derail mixed-use sports and entertainment projects. And fittingly, ever since, new developments have seemingly been introduced on a monthly basis, with the Jacksonville Jaguars proposing a $441 million project last week.
While the pandemic did not drive teams away from real estate development (or even prompt them to hit the pause button), its impact on the margins has caused some sports organizations to “rethink how they imagine their [mixed-use stadium] projects,” said Pavan Surapaneni (partner, Sullivan and Cromwell). Remember, the environment in which they are building has changed dramatically over the last 15 months. We’ve seen a mass exodus from the big city occur; remote employment has become prominent, thus reducing the need for office space; a labor shortage has emerged; and the cost of certain supplies (see: lumber) have skyrocketed.
Our Take: Real estate development—from conception to stabilization—takes years. So it’s not particularly unusual that an unforeseen event (often a recession or a natural disaster) would force those behind a given project to change how they think about it in both the short- and long-term. “It is always an iterative process,” Surapaneni said.
New York, Chicago and San Francisco were among the big cities that saw residents move away en masse during the pandemic. So, teams with projects in the planning stages—particularly those intending to develop downtown—should be considering the possibility that a fundamental shift in where people want to reside has occurred (think: if people don’t want to live downtown, does a team want to build downtown). But Surapaneni thinks it is safe for those organizations to proceed as planned, that people will return to the cities cited. “Those urban centers have historically been incredibly popular—not just because that’s where the professional opportunities [have been], but because there are so many other things at your fingertips that you aren’t going to get in suburban or rural areas.”
It’s also worth pointing out, many people who left New York, Chicago and San Francisco during the pandemic didn’t make a move to the suburbs (of course, many did). They split for “secondary markets like Nashville, Austin, San Diego and Denver,” Surapaneni said. Of course, all four of those high-growth cities host professional sports teams.
With companies like Facebook allowing employees to permanently work from home, and plenty of others adopting flexible work models, teams planning mixed-use projects may want to reconsider including office space (or at least the amount of office space). It is too early to tell if the majority of Americans will ever return to the office full-time. But there’s no reason for a team to hold up a project while we wait to find out. Surapaneni is confident “companies are still going to need office space” (they may downsize or replace in part) and in the event they don’t, “People will still need places to live, to eat and to shop.” The team will simply repurpose the space.
It’s worth noting, the Sullivan and Cromwell attorney said, “real estate developers generally—not just sports teams—are not leaving the office market entirely. They are adapting to their current perception of risk” (think: socially distanced interior space as opposed to open floor layouts, more outdoor space and better airflow).
Having to reconfigure the space post-groundbreaking will likely result in a hit to the team’s pro forma. But it wouldn’t be sufficient enough of a loss that anyone would consider scrapping the project out of concern. As Hank Ratner (former president and CEO, The Madison Square Garden Company) explained, “It’s such an important business aspect for a team to use these ancillary opportunities, and the people that they draw in for the team, to create these other revenue streams and business expansions that [the clubs] are all going to find ways to make [the projects] work.”
To make the projects work financially, teams may need to tinker with the product mix within the development (think: converting excess office space into more desirable senior housing or laboratory space). The earlier it is within the process, the easier it is to do. Once a project has been capitalized and the zoning approvals have been issued there may be limitations on what the club can do with the space.
The restaurant business was hit particularly hard by the pandemic (think: lots of available real estate now available, relatively little demand as many restaurants shuttered). So, it’s reasonable to wonder if teams are rethinking how much restaurant space they need. Ratner doesn’t think they should be. He foresees restaurants coming back (so demand should increase) and says while there may be pressure on pricing in the short-term, as we move forward it should return to pre-pandemic levels.
Surapaneni agreed that there is little reason for a club to pivot away from planned restaurants. “Maybe they make decisions a little bit differently in terms of how they size or price them. But you have to have some sort of ground-level product,” he said. That’s because retail and restaurants—establishments typically found on the ground floor—tend to serve a purpose other than generating revenue. In fact, they are oftentimes “loss leaders for real estate development. It’s more about trying to create an amenity package that makes [the property] more desirable to tenants as opposed to the pure lease revenues they would generate from the retail tenant,” Surapaneni explained. The space on top of the ground floor tends to be more accretive.
“When the pandemic started, there was a belief that there would be significant buying power within the construction industry, but that has not been the case with shortages in labor and materials,” Legends Global Planning president Bill Rhoda said. Instead, there is now some short-term expense pressure that may have teams reimagining projects (using alternative materials). But Surapaneni hasn’t “heard of any [teams] having to hit pause” because of rising labor or material costs. “Any development budget has contingencies baked into it for that eventuality,” he said. Ratner added that with “revenues not coming in until [the organization] gets to the completion date on the project, nobody really wants to push that [date] out.”