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Big risks, rewards in mixed-use development
January 9 2013

Obstacles exist amid mixed-use development, but sources say the rewards can be well worth the risks.

  • Finding financing for mixed-use developments is hard, but spreading the risk amongst multiple entities can help mitigate losses.
  • A contract for mixed-use developments should include enforcement mechanisms that put pressure on the owner to comply with standards.
  • Mixed-use developments thrive in city centers where scarcity of land in urban areas attracts vertical multi-use projects.

REPORT FROM THE U.S.—Developing the Radisson Blu Aqua Hotel Chicago mixed-use development—which houses a hotel as well as apartments, offices and condominiums—was no easy task. Finding financing proved to be difficult and legal red tape abounded.

But the benefits outweighed the obstacles, according to the project’s developer.

“Combining uses on top of each other, it makes for a synergistic use,” said Brian Gordon, VP of development for Magellan Development Group LLC, which developed the Chicago project that comprises 334 hotel rooms, 474 apartments and 262 condos. All apartments are 100% leased and condos are 100% sold, he said.

“Complimentary amenities, shared parking, sharing costs split among all the different users so it operates more efficiently” are all beneficial, Gordon said.

Brian Gordon
Magellan Development Group

“We want to do more of it,” he added.

Financial planning
Finding financing for mixed-use developments is hard—“probably harder” than a standalone project, Gordon said.

“Nothing is easy,” he said. “Hotels are a class of real estate that is still hard to get loans on. … It’s a complicated transaction because of the moving parts. It is doable, but the banks require equity and security for that transaction.”

Getting financing is “absolutely more difficult,” said Dan Leverett, executive VP and managing director of development at PM Realty. There’s more risk involved for the bank, and if the property is vertically mixed, then “you’re also taking multiple asset-class risks.”

“You have an office underneath and a multifamily on top and retail at the base. There’s a different asset-class risk that comes into play,” he said. “Bankers worry about everything.”

But John Lancet, director and partner at HVS’ Miami office, said spreading the risk between different usages provides an avenue for lenders familiar with how these uses operate with each other. “How they complement each other, that actually helps improve in some circumstances the business dynamic and financeability of the project.”

The Radisson Blu Aqua Hotel Chicago is only one successful component of the mixed-use development, which includes office space, apartments and condominiums.

“The overall risk could be mitigated by sharing uses,” he said.

For a hotel connected to the mixed-use development, it might help lower operating costs for the hotel because the uses are spread out.

“But on the flip side of that, I have seen some situations where the hotels share some space with the other uses … that depresses the earning potential for hotels,” he said.

Legal woes
Once financing is found, owners need to deal with the legal liabilities.

Catherine DeBono Holmes, attorney at Jeffer Mangels Butler & Mitchell LLP, said it’s important to put in specific standards in contracts because “at the end of the day, you have to count on the owner to pay the cost of the common area, maintenance and to meet the standards. And sometimes they can’t do that.”

The fear is an owner of one part of the development goes bankrupt and can’t pay their share of the project.

“That’s the biggest risk: How do you deal with owners who can’t or won’t pay their fair share or meet your standards?” she said.

“One of the things we do when we create a legal structure, not only setting standards, but what kind of penalties (or) enforcement mechanisms can we apply if people don’t comply with requirements,” she said.

The trick is to work through what kind of enforcement mechanisms are available to put pressure on the owner to comply with the standards, DeBono Holmes said.

Great risk, great rewards
“Retail is a very big risk. Hotel is a big risk,” Leverett said.

But it comes down to one simple choice that can turn those risks into great rewards: “Location, location, location,” he said.

“You need to make sure you have the market for the asset class you’re thinking of developing.”

PM Realty developed the Woodland Town Center, a horizontal and vertical mixed-used development in Houston, a city that is growing with business and transient travelers from around the world. And it’s “one of the most successful mixed-use developments in the world,” Leverett said.

The 11 hotels in the Woodland Town Center, which include a Candlewood Suites, a Best Western, a Drury Inns, a Hilton Garden Inn and more, total a number of about 2,000 rooms, and achieved average daily rate, occupancy and revenue per available room numbers greater than competitors, he said. The Woodlands Waterway Marriott Hotel & Convention Center has seen strong occupancy and RevPAR numbers, he added.

“It’s a story that’s a statement to proximity of office and other things … especially if you have meeting space,” he said. “The key is, if you have a mixed-use center, it has a variety of things going on,” which helps cover hotels during shoulder periods.

The hotel serves as an anchor for other real estate uses, Lancet said.

“It’s really about generating interests in other products, and the hotel is a source of those potential purchasers of those other products,” he said.

Lancet, however, is not seeing a desire to develop hotel/condo mixed-use projects. “That’s a dying use.”

Markets to watch
Mixed-use developments are happening more and more, especially amid ramped up urbanization, said Jim Mouzourakis, senior managing director of hotel real estate services company Paramount Lodging Advisors.

In the 1960s and 1970s in the U.S., urban sprawl meant cities were growing outward to the suburbs, but now people are heading back to city centers and developments are “going vertical rather than horizontal,” Mouzourakis said.

This is because of a scarcity of land in urban markets, Lancet said.

Additionally, luxury hotels benefit from mixed-use developments because it “can drive the (project) values,” he said. For example, Four Seasons or Trump Tower mixed-use developments bring with them a certain affluent image.

“People are buying into that brand image. Combining your tower with Four Seasons, there’s this cache and extra amenities you’re buying into. This has a certain value added to some buyers compared to down the block with just the (condo) tower,” he said. “If done properly, it can be quite magical, where you get different components where some of the parts are greater than the whole.”

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