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Curt Gunsbury wants to replace a vacant parking lot and auto repair shop in northeast Minneapolis with a seven-story apartment building.

City zoning rules say that because the site is in a commercial zone he’s required to devote a portion of the building to storefronts. Gunsbury says prospects to fill that space are dim.

“Nobody wants it, and nobody is willing to pay for it,” he said.

While such requirements are well-intentioned, he said, there are rows of empty storefronts near his proposed project that have had For Lease signs in the windows for years. He worries there will be more.

So Gunsbury plans to ask the city for permission to replace some of that required commercial space with walk-up apartments, which are easier to fill than retail, he said. If denied, Gunsbury said the apartment tenants will end up subsidizing the cost of any vacant retail through higher rents.

“If we’re talking about affordable housing, this [retail rule] is absolutely the wrong thing to do,” Gunsbury said, saying it can jack up rents on the tiniest units by $20 per month.

With rising commercial vacancy rates in the Twin Cities, developers are imploring city planners to let them build more apartment units on the street level where commercial space is now required. While planning departments try to make cities more livable with such mixed-use projects, developers argue vacant commercial space increases rents at a time when renters can least afford it. Plus lenders are less willing to finance such projects.

The situation is putting community planners and developers at odds over a popular, long-standing planning concept that’s been credited with creating more vibrant, walkable communities in urban and suburban areas alike.

Minneapolis City Council Member Andrew Johnson said developers have a responsibility to make neighborhoods more active and said he regularly gets calls from small businesses seeking affordable spaces. So he said he often “pushes back” when apartment developers complain they can’t find retail tenants.

“Developers can make a profit,” he said, suggesting that they need to re-examine their commercial rent levels and work harder to find small local businesses that would benefit the community. He also suggested they forgo luxury lobbies that go largely unused and invest instead “in a little coffee shop.”

Jeffrey Herman, president of Urban Anthology Commercial Real Estate in Minneapolis, said COVID-19 has essentially “destroyed” the inner-city commercial market and the prospects for a recovery are uncertain. And while developers would love to land a neighborhood coffee shop or locally owned service business, many of those merchants can’t afford the kind of new space that’s getting built. “If you put in a neighborhood florist you almost have to pay them to be there because they don’t make any money,” he said.

Mixed-use zoning is a long-standing concept that’s aimed at incorporating a variety of uses into a single development. It’s supposed to enable people to live, work and shop in high-density areas. It’s seen by cities as a more efficient use of land and resources.

But Gunsbury and other developers say such requirements often have unintended consequences. With demand for commercial space waning and demand for rental apartments raging, they want more flexibility.

Ted Abramson, senior vice president of multifamily investment properties for CBRE Inc., said he recently sold a 118-unit apartment building in St. Paul where 70% of its apartments rented within seven months of opening in November. But the first-floor retail space is empty.

He said it’s increasingly difficult to get such projects financed because lenders understand the growing demand for housing but remain leery of retail — especially because it’s hard to land those sure-bet anchor stores such as Target, Cub Foods or Aldi.

“The underwriting and the credit that a lender is willing to give toward the retail component on those mixed-use developments is heavily scrutinized,” Abramson said. “Even pre-COVID-19.”

David Daly, a CBRE senior vice president of retail properties, said city rules can create a big risk for builders even if the deal gets financing. A housing developer could build out its first floor for a restaurant only to wind up with a fitness center tenant instead and a significant renovation bill.

Drew Johnson, senior vice president of development at Oppidan Investment Co., said mixing restaurants with housing is particularly costly because developers have to install industrial kitchen “odor scrubbers” or grease exhaust vents that can add $250,000 in costs.

Oppidan thought it had a home run of a plan for the city to approve when it presented its 2018 plan for 150 market-rate apartments upstairs, anchored by a Cub Foods on the first floor of its Hiawatha Avenue and 46th Street project in Minneapolis. The city, however, wanted more. It asked for small storefronts along the 46th Street side instead of just a solid wall or a window into Cub’s meat section.

Oppidan complied and built a series of storefronts. But 20 months later, the 4,000-square-foot commercial space, which cost $1.2 million to build, has never had a renter. If occupied, the space could have generated $100,000 a year in rent.

“The irony of it is that the city’s whole policy was to help ‘activate’ the street with storefronts,” said Johnson. “Now it’s a mini black eye on an otherwise successful project.”

Developers often ask planning commissions for exceptions to such requirements, a process that can be time-consuming and expensive with no promise of success.

When the Minneapolis Planning Commission approved Lupe Development Partners’ plans to build two apartment buildings on Lake Street near Lyndale in May, the approval came with strings.

Lupe was required to include 10,000 square feet of retail on the first floor. That didn’t sit right with Lupe’s vice president, Steve Minn, who complained to the city that its retail mandate was too great, especially when a whopping 25,000 square feet worth of storefronts sat vacant nearby.

Minn wanted to use his first floor for more affordable apartments, a community room and a fitness room. He won an appeal in June. Now construction crews are set to begin work this month on the $32 million, seven-story Lago building. It will have 132 apartments and 2,000 square feet of retail.

“The purpose and the good intentions for which the retail [mandate] was originally to be a part of [apartment builds] are no longer true in the marketplace,” Minn said. “What you ultimately get is empty storefronts.”

Minn and other developers say they’ll plead with cities to let them swap retail for community rooms, fitness centers and party rooms that can be used by renters and sometimes the community. Alex Gese is taking that approach to help secure approvals to build an apartment building in south Minneapolis that would replace a longtime neighborhood restaurant. During a recent presentation to a committee of the city’s planning commission, some members suggested adding commercial space to the building.

Gese, who owns other commercial properties in the area, is reluctant to revise his plans. Retailers and restaurants in the area are already struggling and he’s had to lower rents, he said. If the city persists, “You’re going to see empty storefronts all over the city, and I don’t want to add to the glut.”

Jim Buchta • 612-673-7376

Dee DePass • 612-673-7725

Correction: A previous version misidentified Urban Anthology Commercial Real Estate.