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Weekly UpdatesINTRODUCTION
MIXED-USE DEVELOPMENTS ARE GROWING IN POPULARITY AS they reportedly can create additional value and outperform standard single-use real estate developments. The synergy and appeal of a quality mixed-use development can increase office and retail prices, rents and occupancy rates as well as accelerate absorption rates. Retail tenants may be willing to pay higher rents because of the increased customer traffic generated by the compatible and complementary uses. Residents and hotel guests are attracted by the convenient location of dining, retail and entertainment venues on the site. However, some locations are not well suited for mixed-used developments, and careful consideration must be given to the financial feasibility of each specific project. (1)
Financial feasibility of mixed-use development occurs when the return on the investment meets or exceeds the required return of the developer and/or the investor. Evaluating financial return on a mixed-use project is more complex than with a single-use development. While some economies of scale may be achieved, the complexity of multiple uses may raise development and operating costs. On the other hand, the synergy of complementary uses may increase cash flows. Financing development is complex and can be more costly than for single-use developments. Measurement tools for such financial success are expressed in different ways. Discounted cash flow analysis generating an internal rate of return is one important tool. Debt service cover and cash-on-cash are also considered useful tools. (2)
Some developers believe that a mixed-use project diversifies risk across the multiple uses. (3) Other developers believe that the added financial and physical complexity of a mixed-use development, in addition to longer development timelines, heightens the uncertainty associated with the project and thereby increases the level of risk.
Factors influencing the financial success of a mixed-use development can be grouped in the categories of economic and market, financial, physical and public issues. (4) This article will focus on economic and financial factors in the professional literature.
ECONOMIC AND MARKET FACTORS
The Local Economy
A general economic precondition for the financial success of a mixed-use project is a strong local economy. Employment, population and consumer disposable income should be growing. This growth benefits both tenants and customers for the uses on the site. A mixed-use project developed in a stagnant or declining local economy can have problems attracting quality tenants, an adequate number of customers and rent levels high enough to ensure financial success. A stagnant or declining local economy can be perplexing for a community that wants a mixed use development to serve as a catalyst for urban regeneration. However, it may be possible for a certain geographic market area to grow within a larger stagnant local economy. A possible scenario is a high-income geographic market area within a stagnant local economy. The population base of high-income consumers could be underserved (excess demand) for high quality retail goods and convenient personal services such as medical and dental services, accountants, insurance agents and attorneys. In addition, the "empty-nester" portion of the population base desires to remain in the area but also wants to downsize to luxury apartments or condo units. This situation could support a mixed-use development of retail, office and residential units. Another possibility is that a strong tourist component could offset some lack of local economic vitality, especially if hotels and entertainment venues were incorporated into the development.
If the geographic market area is depressed or distressed, whether in a stagnant or declining local economy, public sector assistance, incentives and/or participation need to be considered. Because of the positive externalities that such projects are expected to generate and the risk that developers are taking by investing in a depressed area, these projects will rely heavily on public/private partnerships and financial support. Examples include tax abatement for reimbursement of infrastructure costs, (5) tax increment financing for parking structure construction, (6) and acquisition of land that is then leased to the developer. (7)
Market Analysis
Market analysis for a mixed-use development is important in determining the demand and supply of each use on the site. It should be used in the same manner as in analyzing a single-use project. The analysis should demonstrate sufficient net demand from both on-site and off-site consumers for each use that comprises the development. This is because"... many tenants' businesses will depend on demand from the surrounding area." (8) In addition there are other matters that the mixed-use market analysis should consider.
Market factors are not static; they change with time and other influences." (9) A market analysis should examine trends and forecasts to capture the influence of changing economic, demographic and psychographic factors of demand. "Two keys to success are to do your homework upfront, and to revisit it regularly at every phase and after build-out. These market analyses need to be fine-grained and tailored enough to your locale for you to identify both shifts in preferences and niches that aren't served. This requires a dual-pronged approach to evaluate the market at that point in time and the other to assess how well you're meeting it. As the market changes, so should your project." (10) Market research should be performed early in the developmental process and in some cases, depending on the timing and absorption, updated throughout. (11) These statements apply to single-use as well as mixed-use developments, but the complexity of the analysis increases when the number of uses increases.
A word of caution appears in the following statement: "Just because you have high-end retail doesn't mean you have a high-end condo market." (12) Each use needs to be analyzed with regard to its own demand and supply situation and its relationship to the other on-site uses. Each use on the site must attract sufficient market demand to make it financially feasible. The financial success of one use should not be expected to carry a weak market performance by another use. The contributory value of one use should not subsidize the other uses on the property. The denotation in these statements is clear but connotations are also present. First, while the development is planned and evaluated as a whole, the analyst must also consider the risks of all phases of a multi-phased project not being completed as planned, and some anticipated uses not opening. For example, the project could have retail with residential on top planned for phase one, and offices in a separate building planned as phase two. Over time, the office market could weaken and phase two is either scrapped or changed to more retail and residential.
Second, the completed phases and the active uses should be financially viable. In some situations these phases and the active uses may be financially feasible but not attain the return that was anticipated from the mixed-use project that was planned. The problem/solution partially depends on which use is curtailed or lost. The key retail tenants are those that draw strongly from the traditional retail trade areas but also draw customers from outside traditional trade area boundaries; these tenants cannot be lost. The key residential units must match the demand from the market. If the development plan calls for equal numbers of one-, two- and three-bedroom units in each phase of the project while the market demands only one-and two-bedroom units, vacancy in phase one will be high, making that mix of residential units financially unsuccessful. The planned units must change if phase two is to be built.
The geographic extent of the retail trade areas of each of the anchor tenants and the majority of the non-anchor tenants needs to be considered. (13) Several points to recognize are:
* The retail trade area for each retail tenant is not the same. Some of the shops will attract customers from a greater distance than other shops. Therefore, a three-or five-mile ring could be too much geography for some stores and not enough for other stores.
* The retail trade area for the most prestigious retail store or the major anchor store is not the retail trade area for the project. (14) The anchor store might draw customers from five miles away but the non-anchor tenants may only draw from a two-mile radius because of competition in other retail facilities.
* A properly developed mixed-use property has the potential of attracting customers from outside conventional trade area boundaries. Adding components such as parks, walking trails, playgrounds, ball fields, community centers, and even municipal buildings can create habitual or repetitive traffic flow from outside the traditional boundaries. These elements will give customers more than one reason to come to the development and can ensure that they visit the development on a regular basis. Boutique shops and soft goods retailers, which make mixed-use developments more enjoyable and not just functional, rely on regular visitors from greater distances who are likely to patronize these shops.
* Entertainment venues may draw customers from a geographic market area beyond the market area for the retail uses.
The residential market area for the mixed-use project will more than likely not be the same geographic area as the retail market or trade area, and the office market area may differ from both the retail and the residential areas. The market analysis for a mixed-use development may need to consider a different geography for each specific on-site use.
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