Does Mixed Use Really Work? Part One.

We are often requested to explore projects with entire first floors of retail with two or three levels of apartments on top. There are actually some cities that require some degree of commercial space at the ground level of every new building. While we appreciate the amenity that such a use can provide for residents, there are very few markets that support that amount of commercial space. In fact, there is often no financial reason to do it. It usually requires a dense urban market where barriers to entry are very high (eg. New York, Chicago, San Francisco) or some form of subsidy (eg. free land, free parking, TIF, tax abatement, etc.).

To do it in a mid-market city, it requires shrinking the retail space down to a very limited component of the project (see our project that we filed in Indianapolis yesterday as an example). The solution in most places is to keep it in all wood construction and provide flexibility in the design so that it can also be residential space or office space or whatever the market brings. To illustrate, we’ve created an example that is compiled from two different projects that highlights the financial differences between these two building types. Today, we’ll look at the construction costs. Next week, we’ll examine the operational revenue and expenses and finally the results of permanent financing and financial returns to investors.

Our example today (download below) includes the following assumptions to begin looking at the construction side of the deal: identical sites in a mid-market urban area, 4-story buildings with surface parking. On the left is “apartments-only” and all wood construction. For purposes of our illustration, the “apartments-only” building could have a small amount of retail in place of one or two apartments and it would not materially change the numbers. The right column assumes “apartments over retail” with an entire steel first floor and wood construction sitting on top of it. Our “apartments-only” building has 67 units. Our “apartments over retail” building includes 50 units and 12,260sf of commercial space. You can see the differences in pricing according to type. Customary build-out numbers are assumed for the commercial space. The total project costs are $858,715 greater or 15% more in the mixed-use building. Assuming a loan-to-cost ratio of 75%, this translates into $214,679 more funds required to get the construction loan. While significant, this by itself isn’t a deal breaker; but we’ll see when we look at the operational expenses and revenue of the two different parts of the project how these smaller differences result in big financial hits to the returns and feasibility of the project. Let us know if you have any comments or questions. Check back next week for Part Two as we continue diving into it.

Download proforma sheet here: Milhaus Mixed-Use Proforma Compare Construction.pdf