Though construction headwinds persist, the potential of mixed-use projects motivates many developers to keep going.
Some of today’s most successful projects can be described as a melting pot of sorts. That’s because they internalize the three Fs: flexible, financeable and functional — or, should we say, multi-functional.
“Mixed-use concepts, in particular, seem to be the 401(k) of real estate development,” says Matt Silvers, vice president of Project Management Advisors in Austin, Texas. “They provide a bit of everything for everyone, including investors, and the mix of uses nicely hedges market bets.”
THE MANY BENEFITS OF MIXED-USE
Merouane El Kaoussi, associate and branch manager at Bohler in Boca Raton, Florida, sees the developers’ desire for more mixed-use product on a daily basis.
“Mixed-use developers are diversifying their portfolios by increasing the presence of residential, entertainment, hotel and professional office spaces,” he says. “This shift helps ensure greater income diversity and economic stability within their projects. The emerging trend of the live-work-play concept has breathed new life into retail spaces, presenting a lucrative opportunity for developers.”
There are many reasons why mixed-use developments can be lucrative, not the least of which is an off-kilter supply and demand balance among retail spaces.
Retail construction activity fell 9.7 percent between the fourth quarter of 2023 and the first quarter of 2024. It also plunged a significant 21.8 percent year over year, according to CoStar.
“Most of this new construction is centered around pre-leased freestanding retail, grocery-anchored centers or retail portions of mixed-use developments,” notes Keisha Virtue, senior analyst of retail research at JLL in Pompano Beach, Florida.
Only about 27 percent of the retail space anticipated for delivery in 2024 is available for lease, Virtue adds. The low rates of construction and deliveries have caused the nationwide retail vacancy rate to sink to 4.8 percent.
“Retail tenants looking to expand are finding it increasingly difficult to locate desirable space, which, in turn, is tamping down leasing activity,” she continues.
Another obvious reason why mixed-use remains attractive in this market is its built-in diversification, which allows all parties to naturally mitigate some risk.
“The inherent diversity of uses in mixed-use developments makes them attractive to investors, developers and municipalities,” Silvers says. “This is why one could argue that mixed-use projects are ‘having their moment.’”
Many developers are willing to power through today’s construction headaches and the rising costs of…just about everything…because consumers have shown they’ll do the same for convenient access to the right products and services.
“These projects can often justify the rents needed to keep up with construction costs because consumers are seemingly still willing and able to pay the price for inflated consumer product prices,” Silvers continues.
COHESIVE CONSTRUCTION
Naturally, investing in a mixed-use development isn’t the end-all-be-all key to “winning” in this market. As Silvers notes, prices are still high for everyone, and this market’s fundamentals have brought inherent risks to construction.
“The current sentiment among our clients underscores a heightened awareness of the need to mitigate risks, particularly in aspects such as site selection and design features,” El Kaoussi says. “However, amidst economic shifts and market transformations, lies a unique opportunity to reimagine and reinvent.”
Savvy mall developers are doing exactly that as they transform some of their tired space into a variety of uses. This includes Macerich’s Scottsdale Fashion Square in Scottsdale, Arizona. The 1.9-million-square-foot center is adding two-story storefronts and exterior-facing retail buildings at its south entrance, as well as a new arrival courtyard that will include a valet and up to five destination restaurants.
Life Time opened its luxury athletic club at Fashion Square in March 2023, while the 265-room Caesars Republic Scottsdale debuted across from the center this past March. It includes 20,000 square feet of indoor and outdoor event space, two restaurants from celebrity chef Giada de Laurentiis, two pools with cabanas, and a rooftop bar and lounge.
Macerich is planning even more mixed-use elements on a seven-acre parcel immediately north of Fashion Square. These will include high-end residential units, Class A office space and hospitality uses.
“This multi-phased project is part of Macerich’s long-term strategy, as well as the center’s own history, of continually reinvesting in our irreplaceable retail destinations,” noted Tom O’Hern, Macerich’s CEO, in a release announcing the new construction phases.
Like Hern, Silvers sees diversifying into mixed-use as a sound strategy for existing retail owners. This is particularly true, he notes, if the center isn’t its area’s dominant shopping destination.
“Anything less than a true Class A regional or super regional mall will likely continue to lose tenants due to store underperformance as those formats continue to lose consumer support,” he explains. “The bottom line is that people don’t want to shop in mega indoor complexes any longer. These centers and certain outmoded lifestyle centers will see an increase in vacancies.”
Another mixed-use asset that’s performing well, according to Silvers, is smaller and neighborhood centers that provide an outdoor environment and a variety of services.
“This concept will continue to remain highly sought after,” he says.
Terry Todd, associate principal at RDC in Long Beach, California, was recently a part of such a project. He and his team helped redesign the historic I. Magnin & Company department store building in Pasadena, California. The single-tenant space sat empty for nearly 10 years after Borders Books & Music vacated.
Today, it’s a thriving mixed-use asset with retail, medical and daycare uses.
Upscale grocer Erewhon opened on the building’s ground floor and basement this past September. Brella, an app-enabled childcare center, and Tia, an integrated women’s healthcare clinic, opened on the second floor in late July.
“This adaptive reuse project transformed the historically significant property and local cultural touchstone that originally opened in 1949,” Todd says. “Now open for more than six months, this location is one of the most successful stores in the Erewhon chain.”
Like most projects, construction on the historic space wouldn’t exactly be described as easy. The adaptive reuse included restoring and preserving the building’s original architectural features; replacing the building entry doors with a modern aluminum storefront that paid homage to the space’s original architect; removing entrance awnings; substituting exterior lights with fixtures that resembled the original; and refurbishing the deteriorating original wood-framed fixed windows.
The owners also rehabilitated the structural integrity by upgrading the entire plumbing, electrical and mechanical systems, in addition to replacing the roof to meet modern sustainability goals.
Though there were challenges to overcome, working with an existing space prevented some of the speedbumps inherent in new construction. Namely, building — and financing — a project from the ground up.
MAKING IT WORK
El Kaoussi believes one of the best ways to ensure a project makes it to completion is simply that: do not stop. That doesn’t mean continuing construction full speed ahead no matter what. Instead, it means always thinking about, analyzing and acting on the information you have available.
“The key to asset resilience lies not in freezing progress, but in strategic assessment and prioritization,” he says. “Rather than place a blanket hold on all projects, consider assessing each site uniquely, weighing each one’s approval status, the depth of design progression and/or the potential for rezoning.”
El Kaoussi also understands the profound impact financing can have on a project. This is true whether a loan has already been secured, whether interest rates go up or down or whether projected rents will seemingly compensate for high construction costs.
“The age-old adage ‘time is money’ resonates more profoundly in today’s economy than ever before,” he says. “With interest rates soaring to a 23-year high, developers find themselves navigating increasingly stringent schedules. The slightest delay can tip the project into financial uncertainty.”
El Kaoussi’s best advice in this situation is to engage with a local consulting expert early on. This is more important than ever, he notes, as many development team members wear multiple hats.
“There is a noticeable strain on development teams, so collaborate alongside your full design team,” he says. “Draw from their diverse experiences across markets, garner unique perspectives and foresight and unearth creative solutions. Allow them to help you seek avenues for cost reduction, reevaluate timelines and reimagine possibilities.”
Leveraging municipal laws and incentives can also help a project stay on track and on budget. The I. Magnin & Company building project, for example, gained Mills Act approval.
The act provides property tax relief for owners who actively participate in the restoration and maintenance of their historic properties.
El Kaoussi predicts many municipalities will move toward an easier, more streamlined and development-friendly process as they see — and reap — the benefits of adding mixed-use projects to their areas.
“These innovative mixed-use projects serve municipalities in multiple ways,” he says. “They mitigate traffic congestion and alleviate parking demands, foster sustainability practices and cultivate a stronger sense of community among residents.”
They can also provide convenient, necessary services to the surrounding residents and daytime population. That was the idea behind Thompon Thrift’s newest mixed-use project near Taiwan Semiconductor Manufacturing Company’s (TSMC) nearly $40 billion computer chip making facilities in Phoenix.
“The project consists of more than 35,000 square feet of multi-tenant and free-standing restaurants and shops, as well as 224 Class A multifamily units,” says Chris Hake, senior vice president and director of the Southwest region for Thompson Thrift. “The development is a stone’s throw away from the TSMC facility.”
Hake adds that his company is still able to raise debt and equity for projects due to its nearly 40-year track record, but recognizes that the lending environment isn’t so easy for everyone.
This is especially true in two specific mixed-use scenarios.
“A vertically integrated mixed-use project is difficult to get off the ground in today’s environment, especially if the commercial and residential are being built by unrelated parties,” he says. “This normally calls for two lenders, multiple equity sources, etcetera, which add complexity to the project.”
The other scenario is when size becomes a factor. This can happen more often than one might think, as certain mixed-use components require a substantial amount of space.
“Even if the entire project is being built by one developer, the size of these projects can cause difficulty in securing debt and equity purely due to the project size,” Hake continues.
That’s why he’s a fan of horizontal mixed-use projects as the different asset classes can be segregated, with portions carved up into smaller “bite-sized” pieces for the development team.
A proactive approach can also stave off costly delays, Todd notes. This is something developers, contractors and designers learned the hard way during COVID when the supply chain crumpled. In some instances, it still hasn’t recovered.
“The main challenges we are seeing in construction relate to equipment and materials that still require long lead times,” he says. “Electrical switchgear, in particular, is a year out from order to delivery.”
That’s why Todd advises pre-ordering electrical gear before construction drawings even begin.
“This early approach to ordering key items is one of the ways we have adapted to the challenges we see in the industry right now,” he continues.
Of course, delays are almost synonymous with construction despite anyone’s (read: everyone’s) best efforts. With this in mind, it never hurts to add a little buffer.
“My advice to other developers would be to make sure you have plenty of time built into your overall project schedule,” Hake adds. “Everything at this point seems to be taking longer than anticipated, so building realistic schedules for acquisitions, entitlements and construction is key.”
Proactivity, for Silvers, starts even earlier.
“It all comes down to studying and understanding the market that a developer wants to build in,” he says. “Every project is a cost continuum and that cost is passed, ultimately, onto the end user — in this case, the consumer. If those consumers are able and willing to pay, there is no question that they will. For now, at least, this will focus projects in geographic areas that check this box.”
And just how can one be certain that they’re confidently checking this box?
“Due diligence is key to every project, and that includes formulating a comprehensive understanding of what it will cost to design and build,” Silvers continues. “Developers are often caught off guard when they finally understand just how much the cost to construct has increased over the last several years. Compounding this, is the true cost of debt. If rents can sustain these costs — which ultimately means that there are consumers who are wiling to pay inflated prices to support high rents in specific geographies – then projects will be built. If they can’t sustain these costs, then they should not be built.”
It can’t get more black-and-white than that.
— Nellie Day
This article originally appeared in the April 2024 issue of Shopping Center Business magazine.