Editor’s note: The following is based in part

Editor’s note: The following is based in part on the article “Financing New Urbanism “ by Christopher B. Leinberger and Robert Davis, published in 1999 in MIT’s architectural journal Thresholds. Alvarado stands out from other redevelopment projects in several ways. It has progressed very rapidly: the request for proposals went out in November 1998, the master developer was chosen by April 1999, and the master plan by Moule & Polyzoides Architects and Urbanists was approved in September. The first phase, which includes a block of retail and offices anchored by a multiplex movie theater, is now in design, and construction will begin later this spring. The Historic District Improvement Company (HDIC), the master developer, is an unusual partnership between a development company and two nonprofit groups. Chris Leinberger, Robert Davis, and Joe Duckworth’s Arcadia Land Company is joined by the Downtown Action Team, a group of business and civic leaders seeking to breathe life into a downtown that goes quiet after five in the afternoon. The third partner is the McCune Charitable Foundation, the largest New Mexico-based foundation, which has made a $5 million investment in the project. “For all three groups, the bottom line is not driving everything. We are much more concerned about building something that will stand the test of time,” says Pat Bryan, president of the Downtown Action Team. But HDIC also works with “normal development folks who are just trying to make money,” Bryan says. These include Trammel Crow, which will build apartments in downtown, and Century Theaters, which anchors the first phase. Time tranches Alvarado is the realization of Leinberger and Davis’ theory that a project can be divided into several pieces, or “time tranches,”and sold to investors with varying expectations for the speed of return. The tranch concept is borrowed from the commercial mortgage backed securities industry, where pieces of debt from a project are divided according to the risk associated with each of them. For example, the authors suggest that the building development (65 percent of the total cost) should go to banks or other investors whose priorities are fast cash flow, short-term returns, and a quick exit from the project. Financing of infrastructure development and parking (25 percent of the total cost), and the land (10 percent of the cost) should go to institutional investors with a mid- to long-term investment horizon. Leinberger and Davis maintain that charitable foundations like McCune are the investors most likely to reevaluate their approach to real estate investment, because they can combine an interest in promoting smart growth and sustainable development with an interest in superior mid- to long-term returns. Instead of donating returns on investments in conventional development to smart growth advocacy, the foundations can invest directly in new urbanist projects and reap long-term financial benefits. From an urban design standpoint, the time tranch concept may also be beneficial. Since only 65 percent of the project is required to return the investment within five years, the developer has more time and resources to build a project of higher quality. Conventional development bias Leinberger and Davis argue that new urbanist projects have difficulties attracting financing because investors use methodologies that favor conventional development and short-term returns. They warn that applying these financing techniques to innovative projects will “hurt the ability of the projects to meet the social, environmental, market, and ultimately the financial goals of their sponsors.” Real estate investors evaluate a project on the basis of, among other things, the expected internal rate of return (IRR). This measure combines the interest rate on borrowed money with the expected percentage of profit. As the perceived risk of an investment increases, so does the expectation for IRR. Conventional developments operate with an IRR of 15 to 20 percent annually, but for innovative projects perceived as riskier, this can rise to 35 percent. This higher expectation can make a project far more difficult to finance. Wall Street traders and investment banks, which treat real estate as a standardized commodity to be bought and sold like pork bellies, intensify the bias in favor of conventional development. Conventional projects are divided into single-use specific categories such as “neighborhood center” or “power center,” and only projects that conform to the formula obtain fast and inexpensive financing. “It’s not that Wall Street is fundamentally ‘opposed’ to innovative products; it is just that it has little experience with them,” Leinber- ger and Davis write. The examples are there Pedestrian-oriented developments are not only more complex than these standard formulas, they require critical mass to function as planned. This takes time, and a new urbanist project may therefore require additional investment and generate less cash flow in the early phases. Despite this, several recent projects have created and sustained value that exceeds that of their conventional competitors. Mizner Park in Boca Raton, Florida, and Seaside are prime examples. In 1982, Seaside lots began selling for $15,000. Only 20 sold in the first two years. After critical mass was reached and retail took hold, prices increased rapidly. The last of the 300 lots was sold in 1999 for $500,000, while the downtown was appraised for $60 million in 1998. Leinberger and Davis conclude that new urbanist and other alternative developments have to provide superior mid- and long-term returns in order to encourage investors to take the risk of trying something different. Another key is to find an institutional investor — ideally a nonprofit foundation — to make a relatively long-term investment in a portion of a new urbanist project, allowing banks to get in and out within five years.