Magazine article Real Estate Issues

Mixed-Use Development and Financial Feasibility: Part I - Economic and Financial Factors

Magazine article Real Estate Issues

Mixed-Use Development and Financial Feasibility: Part I - Economic and Financial Factors

Article excerpt

INTRODUCTION

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 mixeduse 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 highincome 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. …

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