Mixed Use Finance 101 in 2019
By Scott Lynn
Twenty-five years ago, the concept of “mixed-use development” was a product type that most capital providers shied away from citing mixed-use projects could only be successful in major core markets or limited pockets of high-density locations in secondary markets.
Today, mixed-use development projects are the “darling” of the commercial real estate world. Everyone wants to either live in one, work in one, shop in one, eat in one, stay overnight in one, get entertained in one… the possibilities are endless, after all that’s why it is called, “mixed-use”. Over the past several years Metropolitan Capital Advisors has financed numerous mixed-use projects from an eclectic retail/hotel/food hall constructed from storage containers in Waco, Texas to a historic building renovated into a hotel and apartments in Downtown Kansas City.
Whether the capital requirement is $5mm, $50 mm or $500 mm, mixed-use projects require intense planning, careful thought and flexible capital. How the product type is determined, the way a project is incorporated into the overall mixed-use master plan and most importantly…the project design will all have a direct correlation to achieving premium rental rates and fast absorption. Economics on mixed-use must make sense from the start. The projects we see are often very expensive to build requiring costly parking decks, high tenant finish out requirements and extensive amenities or attractions.
As our firm has financed projects around the country, we’ve learned these projects often require rental rates that are at a substantial premium to the existing market. It’s hard to find comparable property if no comparable property exists in particular submarket. Or, stated differently, how do prove up what an apartment dweller would be willing to pay to have walkability to live, work and play? More times than not, we are supporting the case by extrapolating mixed-use comparables from other similar real estate markets, but not necessarily comparable in terms of being in the same city. The ability to “prove up” the potential of a mixed-use project to achieve rental rates can be the difference to making the deal. Competent service providers with best in class comparative market data can play an essential role in persuading capital to commit to a mixed-use project.
Project development costs and operating expense allocation are a major factor in determining the economic feasibility of a mixed-use project. Since the project is mixed-use, capital providers will underwrite each individual component of the development in terms of cash flow as well as valuation. Capital providers will often assign Capitalization rate to each individual component of the project. For example, a mixed-use project may value the apartment income stream at a lower Cap Rate versus the retail income stream. How property operating expenses that are logically allocated amongst the components of the project will have an important impact on the bottom line can flow and the valuation of a mixed-use project. Addressing such practical issues such as parking, trash removal, security and deliveries for multiple uses on one site or complex is tantamount to a successful financing process.
Metropolitan Capital Advisors has years of experience financing mixed-use projects. We suggest a real estate developer or sponsor involve us early in their development process so we can advise and avoid many of the pitfalls and challenges when sourcing capital for a mixed-use project.