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MIXED USE: Passing The Bucks

Not long ago, developers had trouble securing debt financing for mixed-use projects. But with more such complexes moving from the drawing boards to construction, lenders have undergone an attitude adjustment.

“Most lenders were reluctant to finance mixed-use projects because they require a higher level of complexity,” says Philip Carroll, senior vice president at KeyBank Real Estate Capital. “Now that we have some experience, we've been able to get more comfortable.”

KeyBank isn't alone. “Until five years ago, mixed-use was an unproven concept and we would not have even entertained proposals,” says Edward Riedlinger, senior vice president and managing director of GMAC Commercial Mortgage Corp in Horsham, Pa. “But we're seeing a change where residential and retail can be inherently beneficial to each other in the right location.”

Fact is, the capital markets still favor borrowers, who can demand favorable terms, special provisions and a greater degree of flexibility than ever before for construction and permanent loans — even for mixed use.

There remains some question over whether one lender is best for one project, or different lenders should be responsible for the different pieces, providing an easier exit strategy. In either case, developers are being advised to segment the pieces of the complex — or to use the latest real estate buzzword, condominiumize them — so they can be sold off at different points in the development's growth cycle.

A new attitude

The reality is that lender attitudes have changed so dramatically in recent years that even mixed-use projects in smaller markets can find debt financing if the blend of apartments, condos, retail and office makes sense and if community demand exceeds supply. “The financial markets have matured to be able to finance mixed-use projects outside of the traditional urban cores of New York and Chicago,” says Robert Carmichael, senior vice president and team sales leader for KeyBank's Orlando office.

KeyBank, for example, recently provided a $74 million loan for acquisition and construction to Prospect Capital Corp. for a mixed-use tower in Coral Gables, Fla. Called X Aragon, the downtown project consists of 184 residential units, 42,000 square feet of retail and 24,000 square feet of office space above structured parking.

The Elmsford, N.Y.-based borrower used the KeyBank funds to purchase the tower and convert the residential units from apartments to condos. By structuring the ownership of the project into three different pieces — the parking garage, the residential and the commercial (office and retail) — Prospect Capital was able to sell off the condos and finance the parking garage and commercial component separately from the residential.

“We've found that mixed-use projects create synergies, but now the issue is understanding the ownership structure,” says Carmichael. “And we have just now collectively gotten comfortable with different structures.”

Carmichael says KeyBank was able to underwrite X Aragon separately by “figuring out what the retail will support independent of the condos with the lease-up schedule.” Additionally, the loan included extension options to allow the retail to stabilize.

It's not unusual or impossible for large mixed-use projects to receive construction and debt financing from one lender. Entertainment Development Group Inc. and the Texas Real Estate Fund, for example, are financing their Houston Pavilions project through one construction lender. The $200 million project will span three city blocks and will offer nearly 700,000 square feet of space including a 134,000-square-foot condominium tower, 200,000 square feet of loft-office space and 366,000 square feet of ground floor retail space.

In fact, some lenders prefer to make the only loan on an entire project to maintain greater control. Take GMAC Commercial Mortgage, for example. “As a lender, you're better off controlling as much as you can because the components are dependent on the other,” Riedlinger says. “To me it's foolish for a lender to do one part and not the rest.”

Although Entertainment Development Group and the Texas Real Estate Fund obtained one construction loan, the partnership did use a condo regime to segment the uses so it can get permanent financing on different uses separately.

Breaking up is hard to do

Borrowers are increasingly finding it in their best interests to use different lenders for different pieces of the development. “We recommend strongly that developers subdivide the project as much as they can so they can get different loans if they need to,” says Claudia Steeb, managing director in Holiday Fenoglio Fowler LP's Pittsburgh office. It provides flexibility.

The process of segmenting a project, also known as condominiumizing, means that the legal structure of ownership for the various aspects of the project can be held legally under different entities. That way, a developer can put in place different pieces of financing that are best for the property.

For example, a developer may decide to sell off a piece of a mixed-use project while it's under construction. If the developer didn't segment, or condominiumize, the construction loan, he wouldn't be able to dispose of any land without having to restructure his entire loan. Moreover, a developer needs that flexibility if he has to sell pieces of his project as it's finished to fund the equity portion of future projects. “Even if a developer wants to keep the property for a period of time, we still recommend segmenting and getting separate loans,” Steeb says.

That's what Ross Development & Investment and Danac Corp. did when they obtained construction financing to develop the condominium and retail portion of the new 15-acre Rockville Town Center in Rockville, Md. The complex, which will offer 644 condominium residences and 180,000 square feet of retail, restaurant and entertainment space, was financed by two lenders, according to Jack Jaeger, a Danac principal.

Ross and Danac obtained two construction loans and a mezzanine loan to fund 95 percent of the $220 million total investment. Corus Bank financed two buildings totaling $70 million, while Fremont Investment & Loan provided $41 million. Lehman Bros. funded the mezzanine piece, and Ross and Danac put in the rest of the equity.

“Lenders have grown familiar with condo regime legal structure, so they're comfortable financing their own pieces,” Carroll notes. And, as projects grow in scale, a condo regime may allow lenders to avoid large transactions and then being forced to syndicate them to other banks.

Developers also need to be thinking of exit strategies when they secure their construction financing, experts say, because it's easier to dispose of mixed-use properties when they have multiple financing facilities.

“In the past, a construction lender would analyze the projected cash flow of the entire project and then see if a permanent lender would refinance it once it was finished,” Carroll recalls. “Today, the construction lender will underwrite each part of the project anticipating that the developers will get perm loans for each piece as it becomes stabilized.”

Borrowers are taking note. “The lending market wasn't as fluid as it is now because you don't have to have a discussion about it being one project,” Shores says.

Rentals vs. condos

That's not to say that any and all mixed-use properties can nail down funds. “For example, I think it would be hard to finance a mixed-use project in Atlanta with apartments because the rental market is so soft,” says Steven Shores, a development partner with Urban Realty Partners.

Indeed, mixed-use properties are inherently more risky than single-use properties because the different property types can have different trends behind them, Riedlinger notes. That's why projects with significant pre-leasing or condos are especially attractive to lenders.

“Many high-end hotel or retail projects that would have been difficult to finance in past years are getting done by incorporating a residential condominium element into the project,” says Rick Kopf, founding shareholder of Munsch Hardt Kopf & Harr P.C., a Dallas-based law firm. “The sale of units can significantly reduce the overall basis in the project, reduce the risk for the lender and result in higher initial loan-to-value ratios and a greater pool of available debt financing.”

Perhaps that's why Urban Realty Partners was confident about obtaining construction financing for The Brookwood. The company is partnering with Melaver Inc. to develop a $100 million, mixed-use condominium building in the trendy Buckhead area of Atlanta. The 19-story project will offer 275 condos priced from the high $200,000s to the $800,000s, along with roughly 20,000 square feet of restaurant and retail space on the ground floor.

“We've had very good luck with the financing,” says Sheldon Taylor, Urban Realty Partners CFO, adding that the construction loan documents for The Brookwood are ready to be signed. “I think the market is pretty good for well-conceived, well-located mixed-use projects.”

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