Property investors and developers that traditionally operate in the residential real estate market are increasingly diversifying into more specialist types of investment. During my nine years in the property industry, I have seen many developers famed for large single dwellings move to multi-unit stock, before diversifying further and become more opportunistic, snapping up care, storage, and other commercial premises.

What is driving this diversification?

The pandemic can be said to have played a part, presenting investors with opportunities to purchase properties at attractive prices, but more often than not, diversification is part of a considered strategy, based on substantial research and data.

Regulatory changes and tax hikes within the residential sector over the years, have made commercial property more attractive and some investors have chosen to hold commercial stock tactically, with a view to converting into residential dwellings in the future.

However, while commercial property can diversify a residential portfolio, the commercial market has its own risks, particularly if a developer’s experience lies in residential schemes. The pandemic highlighted some of these risks and there remain disputes between commercial tenants and landlords about rent arrears. So, many developers are considering an alternative approach, with mixed use schemes that combine both commercial and residential elements.

Mixed-use schemes

Mixed-use can be defined as real estate assets that combine two or more land-uses in the same or adjoining structures. Historically, lenders have been cautious about this type of scheme, but as this asset class has established a successful track record, it has demonstrated some clear and compelling merits. Mixed-use, when managed effectively, can provide a greater level of security for investors given the diverse range of tenants and thus income. As such, it is now viewed by some lenders as a more robust option. As well as cost savings in the form of tax benefits and shared facilities (fire and security provisions, for example) for the investor, mixed use developments can also boast better environmental and social credentials – something that is set to be on every property professional’s agenda in the coming years. Think reduced transport usage, increased sense of community, higher footfall to support independent retailers and pedestrianised zones for air quality. 

Whilst I hesitate to say that mixed use is ‘future proof’, it is certainly ‘future enabled’ as trends point to both commercial and residential tenants gravitating towards mixed use communities for both work and play. Convenience is important for residential developments where the tenants increasingly expect to only need to head downstairs to visit the managing estate agent, hairdresser, or supermarket. Apartment buildings with a diverse commercial offering on the ground floor have been shown to command 5% + rent premium than neighbouring solely residential buildings. Office space providing food and beverage, wellness, and retail offerings rather than simply a desk and kitchenette will also likely attract more tenants and be able to command a premium. Successful mixed-use investors often create ‘multi-use’ spaces such as rooms that can be used as a wellness area during the day and transform into an event space of an evening or moveable walls to accommodate varying tenant needs and retain an element of flexibility. Mixed-use spaces may provide a harder design, build and operation than more standard developments, but the extra thought and innovation required to produce an optimum space in the early stages will often prove a more stable asset in the future. Convenient and collaborative environments are here to stay.

The lending landscape

The lending landscape for mixed use has become more competitive, presenting plenty of opportunities for investors. Lenders will generally want to see records of existing or anticipated tenant income. And, given the recent pandemic, even if the accounts are not perfect, if the borrower can propose a clear pathway to improving them, there are many specialist lenders that are willing to take a view on these applications.

Acquiring an existing tenanted and stabilised site would be seen as the ‘easier’ entry point however there is relatively little existing stock, hence why construction is providing a popular entry point to the market. The anticipated higher returns that are possible with this route can often outweigh the perceived construction risk, whether it’s a completely new build or adding value via refurbishment, conversion, and extension. As with residential development, the track record of the developer, main contractor, professional teams and particularly in this case an experienced operator, will be key to determining the products available to a potential borrower. The rates tend to be lower for mixed-use schemes that encompass an element of residential rather than purely commercial premises.

From my experience working with a broad range of investor and developer clients, alongside our team of real estate debt advisors at Sirius Property Finance, responsible lenders will, justifiably, want to see multiple back up plans and exit strategies. We are certainly seeing an influx of borrowers seeking out mixed used products and our lender relations are responding with a healthy appetite to meet these needs. I predict this will only grow stronger within the specialist market in the coming months but innovation and creativity is required more than ever in real estate projects, regardless of the asset class.

By Kimberley Gates, Head of Corporate Partnerships at Sirius Property Finance.