Property development includes residential dwellings, i.e., flats, houses, and with this development, sizes are scalable from one at a time to mass developments with yield from this set against a constant backdrop of demand for housing. But what about investing in mixed-use property? What does this entail, including the benefits and disadvantages of this type of property development, and how to invest?
Many developers are keen to review their ability to rationalise investments such that they are not reliant on only one stream of income, e.g., residential. Income from multiple sources will build resilience in the business model. For example, the market for office space has declined, as witnessed through the pandemic, and an increase in retail footfall could offset this. If you have a property portfolio that includes mixed-use developments, the benefits are clear. Also, for the consumer, the benefit of convenience shops being available as part of the building is advantageous now that flexible working is on the increase, which has seen more people working from home.
Suppose the longer-term working landscape is for flexible working to stay for people. In that case, mixed-use property that could include cinemas, bars, restaurants etc., plus shared living outdoor spaces, surely looks increasingly appealing from a developer perspective.
Types of commercial property
As per the Town and Country Planning Order 1987, every property in the UK is assigned a specific Use Class Category, which then defines a property type and what activities a residential or commercial property can be used for. Recently updated in September 2020, it can support property owners to change their building use more readily to adapt to ever-evolving social needs.
In terms of what constitutes mixed-use property, properties that consist of two or more types of real estate, for example, industrial combined with office space or retail with residential space, can be considered mixed-use property.
The archetypal image of mixed-use property is a simple row of shops below residential accommodation. But, whilst mixed-use developments can be on a smaller scale, they can equally be much larger multi-million-pound developments consisting of restaurants, gyms, licensed premises, and other non-social outlets such as shops, banks, estate agents, etc. For example, suppose you think of the Shard in London at the other end of the scale. In that case, its website describes the building as “a vertical city where people live, work and relax, comprising world-class offices, award-winning restaurants, being well connected and serviced by transport infrastructure, facilities and amenities.”
Consider the Shard’s advertisement of a ‘vertical city’ against the broad categorisation of mixed-use developments as follows:
- Vertical – public service or retail space on the ground floor with offices on the middle floors and residential or private commercial residence such as hotels on the upper floors.
- Horizontal – generally single-use buildings which offer retail, business and residential, but all within walking distance of each other.
- Walkable – typically larger footprint scale developments as they are surrounded by central space. These can contain a mixed-use of vertical and horizontal development.
Any of these types of development can be a seamless integration of residential and commercial tenants, creating a community where residential tenants or owners have the amenities on their doorstep, and the commercial tenants have the very customers their business seeks within walking distance.
Owning mixed-use property allows the investors to diversify their income streams. Such diversification can prove invaluable in future economic downturns, but it is not all a success story if the developer doesn’t carefully plan the portfolio.
For successful implementation, consider the following factors:
- Are there potential conflicts between the commercial and residential tenants? Identify the needs of all parties and factoring them into the planning stage. Failure to consider these points could create a development that’s unappealing to all parties involved.
- Transport links are essential. If you are planning a development that will make up a small community, public transport is crucial for residents to get to work and for those working in the mixed-use development. Suppose the development is in a city centre. In that case, parking for residents and customers is likely to be at a premium. Therefore, amenable and regular public transport is crucial. Limited revenues will be realised if you are unable to draw on customers from outside of the community.
- To create an appealing mixed-use development of residential and office or retail space, you’ll need to consider creating outdoor space for recreational activities needs as the tenants will want somewhere appealing to live and visit.
Advantages of Mixed-Use Development
- Creating such communities creates more social interaction in this space, which in turn conserves land and subsequently minimises the need for environmental resources. If the development is city centre, then from a planning perspective, the type of development being mixed-use is more appealing to town planners.
- Not only are there are benefits to regenerated urban areas through the introduction of new business, but also from a sense of community delivered through larger-scale mixed-used developments. There are also benefits to the local economy due to the increase in footfall and sales revenue.
- In terms of the costs involved in building from new, if you diversify construction costs between residential and commercial components of a mixed-use development, this can significantly impact tax depreciation and capital gains when you sell the development.
- If constructing from new, the utility assets, security and fire protection are only required once as opposed to separate buildings for commercial and residential, which lowers the capital costs for construction. However, ongoing maintenance can be problematic to distribute between the commercial and residential tenants once up and running.
- As depreciation can be variable between residential, retail, and leasehold improvements, such depreciation can be better managed as a developer with a mixed-use development from a tax perspective. You will be able to leverage growth in one area to offset the depreciation in another.
- Equally, in terms of growth, mixed-use space allows real estate investors to diversify risk and increase long-term returns, even in recessions and difficult market conditions.
- As the amenities that come with mixed-use development are right on the doorstep of the residential tenants, the building owner can charge above-market rates for rental income. For the tenant, this is not an unattractive proposition. Due to the location and good transport links, it is more appealing than other properties located further away, thereby creating a win-win between tenant and owner.
- The building owner can turn commercial units into residential ones or vice versa as the economic landscape changes and demand fluctuates between the two. The ability of the building owner to do this insulates them from affecting yields. However, note that whilst this has been simplified with recent changes in planning, if not followed adequately with the right permission and approval, there can be costs involved in terms of fines and the costs to revert the buildings use back to the original classification.
Disadvantages of Mixed-Use Development
- For the building owner, there are different challenges in terms of tenants, as residential shorthold tenancies will typically be for 12 months at a time. In contrast, the commercial side will typically be five years or possibly longer. Managing revenue streams between the two and their different legal rights will need more resources, and the larger the development, the more management required.
- As the property or development will be of mixed-use and the scale of this can vary, specialist insurance is required, and as this will be bespoke, it will usually be more expensive than the on-average residential or commercial only type.
- As a developer, you need to consider the types of tenants that you have from a commercial perspective and how the residential tenant will receive this, e.g., if you have a shop below and residential above, a resident may not be happy if you let the space for a bar or pub with the late opening hours, noise etc. A similar scenario could occur if you were to lease to a restaurant with odours etc. A failure to consider all stakeholders with a mixed-use development could make the building unattractive to future tenants, possibly through reputation alone.
- In terms of the commercial element in a mixed-use development, there will be increased maintenance costs due to the nature of this part of the building.
Ways to Invest
Once the build is complete, the benefits for a buyer of a mixed-use development will be the reduction in stamp duty liability as they will only pay stamp duty on the basis the entire property is a commercial unit which is advantageous compared to the stamp duty rate if the property was fully residential.
However, depending on the size of the development and the finances available to invest in the first place, it may not be possible to purchase it outright. Therefore, other options are available, such as investment funds to effectively pay a broker to invest sums in mixed-use property development. In return, you are paid a return on the growth value. Equally, you can buy shares in some companies that invest in such types of property, which in turn, you can sell if the company grows or equally receive dividend payments.
If you decide to invest in this way, i.e., not outright ownership instead of constructing and then managing the asset yourself, then you avoid the hassle of property management. However, if you avoid this and decide to invest through third parties, the rewards will be less, and you will, of course, not have a say in terms of how the development will look, but it could be a less risky investment. It all depends on how ‘hands-on’ you wish to be and the confidence level and experience you must have to make it work.