Retail Niche properties Multifamily

Mixing It Up: Considerations for a Retail-Residential Development

Looking at one hypothetical project can highlight the opportunities and challenges associated with mixed-use developments.

Mixed-use developments, by definition, include competing and often mutually exclusive interests. A developer wants to attract customers to the corner bistro, but those in the rental properties may not be thrilled with commotion later in the evening. Parking and traffic flow must accommodate differing demands from visitors, employees, and residents. In short, complexity is inherent in designing, developing, and operating mixed-use properties.

As these developments grow in popularity - both in cities and suburbs - what are the key considerations for commercial real estate professionals? While every situation is unique, the following hypothetical case study highlights the do's, don'ts, and a few maybes associated with mixed-use.

Let's say you are a well-known developer with a firm in a secondary market. You are asked to respond to a request for quote for a planned mixed-use development at the corner of Lake Street and Willow Drive. The 99,800-square-foot space is an assemblage of three smaller parcels with physically and functionally obsolete smaller buildings. Three years ago, the city acquired the parcels through eminent domain and is now seeking a local developer to work with on the project.

You made the short-list after the initial RFQ. After two meetings with city officials, the city informs you that it would like to proceed with your firm to make this vision a reality.

The site is ready for development - it has been cleaned and cleared; buildings and parking lots were demolished; and a “no further action” letter from the Environmental Protection Agency is in hand. In the past decade, the neighborhood has started to gentrify; the North Lake Street District is becoming hip, with new local restaurants, shops, and even an art gallery or two replacing older strip-retail along the street. Adaptive reuse projects have revamped older buildings and assemblages.  

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Your site sits two blocks south of Oak Avenue, the unofficial southern border of the North Lake Street District, so it's a bit removed from the current center of commerce. The site is surrounded by older apartments, along with some retail and industrial structures. City officials envision the district eventually extending 10 blocks south of its current extent of Oak Avenue, which would put the site squarely in the district's future. For now, though, the city council sees your development as a catalyst to pull the district's development south, and it wants to see this property developed as soon as possible.

Initial analysis:

Strengths:  Shovel-ready. Clean site. Optimistic outlook. Buy-in from the city.

Weaknesses:  Distance to core. Proximity to industrial. Parking and maintenance. Municipality demands and restrictions. 

Developing Multifamily Units

The city council and stakeholders want the development at an urban scale, with a mix of uses in a pedestrian- friendly environment.

After the land was condemned, the 99,800-square-foot parcel was rezoned to allow for residential and commercial uses to a height of 72 feet and no more than five stories. The city code calls for 1,000 sf for each living unit in multifamily buildings that are three stories or less. That requirement is reduced to 620 sf in buildings with four or more stories. Also, based on gross building area, proposed developments with 5 percent or more non-residential use and structured parking may apply for up to a 20 percent residential bonus.

How can you calculate the maximum units you can plan for this site? Look at the solutions in Table 1.

Achieving an Optimal Residential/Retail Mix

Of the three concepts available, the one with 192 total apartments and 10,000 sf of ground-floor retail space looks like the most appealing, thanks to the additional units related to the 20 percent bonus. 

As shown in Table 2, the apartments can have an efficiency factor of 85 percent with the development including a fitness center (3,800 sf), leasing office (3,200 sf), rooftop amenity area including pool (6,000 sf), and corridors, stairways, and other utility space. Also, as shown in Table 3, the 10,000 sf of retail space will be 90 percent efficient.

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Potential Rental and Retail Income?

Overall vacancy in the city is less than 4.1 percent. The North Lake Street District has a vacancy of 2.5 percent, and new product is being absorbed quickly. Another company recently completed 225 units in the North Lake Street District, which are at full occupancy with an average monthly rent of slightly more than $2.50 per square foot according to recent reports. Newer high-end apartments are dominating the local marketplace, partly because of the demand for high amenity units and partly because construction costs make developing lower-end units cost prohibitive. With the strong growth in rents, the newer projects have also seen a compression in cap rates. A 6 percent cap rate used to be considered strong, but now you are wondering if 5 percent is going to be the new normal.

Still, you worry a bit about the potential risk of this project. You are two city blocks south of the southernmost boundary of the North Lake Street District. In other words, if “beachfront” or “ground zero” locations are commanding $2.50 per square foot in rents and selling at a 5 percent cap rate, what does that really mean for your pioneering location south of the perceived district?

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Until you gain more confidence in what the actual rents might be, you project the following range of rents detailed in Table 4. Also, in Table 5, you can see the estimated income generated from retail tenants.

Retail Income?

Next, it's important to analyze the retail portion of this property. A financial institution has agreed to lease 2,000 sf, mostly in accordance with its Community Reinvestment Act initiatives, at $26 psf per year net. You, however, are doubtful the remaining 8,000 sf will also achieve $26 psf per year net rents. Currently, you have a relationship with a popular local coffee shop franchise, and it has verbally committed to 1,250 sf at $24 net. Additionally, your broker says she can secure a national chain at $20 net. If that happens, you will then be able to attract at least one other complementary quick-service restaurant for the property.

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You may rather avoid dealing with retail at all on this project, but you know it's necessary in achieving the density bonus. Community leaders also will favor retail, even if it can complicate the leasing process. 

For now, you view the potential retail income as detailed in Table 6.

Parking

The city municipal code requires at least one parking space per residential unit and one space per 200 rentable sf of retail space. In addition, the code specifically calls for one parking space per 400 sf for your leasing office. Finally, the code calls for a bicycle parking space for every 20 car parking spaces. At least half of the bicycle spaces need to be in the parking structure. 

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Experience with these types of developments teaches two things: 1) parking is expensive and 2) not enough of it can be a disaster. In the old days, developers had to fight with cities to reduce parking requirements. Now, the struggle is to get enough to make a site appealing to possible renters.

The minimum amount of parking is based on one space per apartment. But considering parking's appeal to potential renters, shoppers, and employees, a generous estimation may provide a better picture of what will meet the actual needs of the development (see Table 7). 

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The considerations for this residential-retail development hardly end with parking spaces and rent calculations. Mixed-use projects are popping up in all types of markets - from urban centers to suburban areas. The industry as a whole is gaining experience in mixed-use developments, which has improved our ability to evaluate potential deals. Still, no matter how much we'd like to predict the future, careful analysis can only minimize risk in a project. But knowing the variables, understanding opportunities, and identifying threats will lead to optimal decision-making.


For more on this topic, check out CCIM Institute's "Evaluating Mixed-Use Development Projects" course. 

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Nicholas Leider

Nicholas Leider is senior content editor for Commercial Investment Real Estate. Contact him at nleider@ccim.com.

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