Making Mixed Use Work Financially (Part Three)

For the last few weeks we have been exploring the financial differences between two different buildings – a four-story building consisting of all apartments vs. a four-story building with commercial space on the first floor. Of course, the differences are found in many variables, including construction costs, market rental rates, parking availability, financing terms, etc. The biggest factor affecting the ability to do mixed-use in predominately residential neighborhoods is the rental rate on the retail. Most small market, small business owners operating café spaces cannot pay typical $20NNN-plus and run a successful business. Developers that have forced more commercial space onto a site know that it can compromise the feasibility of the overall project. Further, if for some reason it is included and then underperforms, it presents a negative image of the project and undermines the leasing of the residences. It’s our job to bridge this gap through design and construction in order to deliver space that works for both developer and tenant, yet provides a desirable use for the neighborhood.

Download the full proforma here:
Milhaus Mixed-Use Proforma Compare Full.pdf

In last week’s post, we demonstrated what happens to the proforma during the permanent financing in each of these two building types. Let’s look at the overall value of the project and how much is created in the investment. Notice the apartment building actually receives more loan dollars at refinance since it will have a lower cap rate at its sale than the building with commercial in it (7% v. 7.25%). Appraisers simply do not value the space the same. So, looking at stabilized NOI, the projects are yielding very similar amounts at around $500,000. However, in the mixed-use example, it cost $850,000 more to get that same return. After the different exit cap rates are applied, you can see the value created is $543,734 more if you develop the apartment building on the left. So, which building would you develop?

Today’s economy is characterized by high commercial vacancy rates, low residential cap rates, investors flocking to safety, and high demand for urban apartments in walkable environments. However, without free parking, TIF, tax abatement, or some other subsidy; it is nearly impossible to develop apartments on top of all-commercial space in a mid-market city today. This combination of factors is causing us to pursue buildings with very limited commercial space (all wood construction) and in only the most outstanding locations. If designed and built correctly, these buildings can still add a lot of value to both investors and neighborhoods. Let us know if we can help you with your next project.