Mixed-use projects: develop, sell or mothball in today’s environment?
Just three years ago, it was almost unheard of to see a new, five-star hotel erected in Canada without complementary components like residential, office or retail space thrown in the mix. At the time, the barriers to entry were punitively high to build a downtown luxury hotel, but by pre-selling residences and leasing office and retail space, a developer could drive more revenue back into the property and create synergies that made it function better as a whole. When each part of a mixed-use property complements the others, RevPAR goes up, as does the value of the residences, office and retail space. What developer doesn’t want that?
But in today’s risk-laden market, the recession has changed the way developers and lenders are approaching newly built, mammoth mixed-use hotel projects. Many are leaning toward building smaller stand-alone hotel projects in secondary markets, at least until the economy recalibrates itself. “We like the diversity of doing smaller deals, having the regional diversity, the brand diversity, and the borrow diversity,” says an executive from a prominent lender into hotel real estate.
That’s all well and good, unless you’ve already got a huge hole in the ground for your project, have been selling residences for two years, and now have to come up with the money to see it through at a time when the availability of capital is as low as it’s been in decades. But while the economy is certainly ailing, it’s not time to run for the hills just yet, even if you are building a large mixed-use hotel. While combining residential, office or retail space into your hotel can cause legal hiccups and lead to higher costs associated with longer construction time, it doesn’t necessarily mean it’s time to sit back and wait until the economic slump passes.
Ron Taylor, senior vice-president and director of Arcturus Realty Corporation, admits the current economic climate will lead to many financial roadblocks, but he’s adamant it’s more important than ever to be cautiously optimistic and push ahead on projects if possible. “I wouldn’t ever be just sitting around,” says Taylor from his office in Victoria. “I’m busy right now trying to influence government and the financial sector,” he adds, while explaining the importance of stimulating the economy. “[We must] find innovative ways of doing [business]; look at best practices from Europe and the U.S.”
Speaking of the U.S., Canada isn’t experiencing a sub-prime mortgage crisis like our southern neighbours, but we are battling rising unemployment rates, and while gaining financing for a large hotel project may seem more difficult than ever, it’s not a lost cause. In fact, one of Taylor’s clients was recently successful in securing financial backing. It’s the entity processing and managing the loan, which is backlogged.
Getting in the door may be hard, but Carol Pennycook — a Toronto-based partner at Davies Ward Phillips & Vineberg, who specializes in the financial sector — suspects there could also be some challenges negotiating loans. Financial institutions could be asking for a host of new requirements before doling out large sums to developers. A lender, for example, may require that a higher percentage of condominium units in a mixed-use condo/hotel property be sold before financing is made available.
Even with the best of intentions, it’s no secret that some mixed-use developments may be in the hole — literally and figuratively. “Depending on the state of construction, in some cases projects have stopped and the gates have been locked,” explains Taylor. “[Sometimes] the happiest developer is the one who hasn’t actually started to do hard construction.”
Of course, some provinces are faring better than others. “Downtown Toronto is a work/live/play community, so it’s a desirable area for people to go when, financially, things get tight,” explains Taylor. That’s one reason why Toronto is home to numerous mixed-use hotel developments that are currently under construction, including a new Four Seasons flagship property. The hotel/residence, which is expected to be finished in 2012, will be comprised of two towers — one with 259 hotel rooms and 101 private residences, the second with 103 private residences. The hotel will also include a restaurant, bar, ballroom, meeting space, spa and health club.
Luckily for the project’s developers, 75 per cent of the private residences have already been sold, with the down payments made on those units used to offset some of the construction cost. “We were fortunate to have started sales and sold the majority of the private residences before the economic downturn began,” says Erika Hansen, development manager of Four Seasons Hotels and Resorts in Toronto. But that doesn’t mean things are easy for the Four Season’s sales reps. “Our biggest challenges now are [vigilance] and lack of general market confidence among potential buyers. Our sales team continues to work hard to assure buyers that the combination of brand, service, location and physical product make the Four Seasons private residences in Toronto a good investment.”
While new hotel projects are in various stages of development in cities across Canada, it may also be the best time to retrofit or reposition an existing property. Lenders are willing to free up capital on deals that help improve existing assets. “Construction costs are low, and demand is low,” explains Taylor. “Spend the time [and money] to do it now, so you’re ready when the economy turns around.” But just when that might be is anyone’s guess, as it’s hard to make any short-term predictions considering the economy is in a constant state of flux.
“If anyone absolutely knew the answers going forward, that would be terrific. But I don’t think anyone really does,” reiterates Pennycook. Still, it’s clear the short-term forecast isn’t looking sunny. That said, industry insiders are sure at some point in the next few years we will recover from this slump, and when things get better, it’s only natural that newly built or renovated mixed-use buildings that boost infrastructure will be considered prime real estate for decades to come.
“There’s a co-relation between mixed-use projects and the sustainability movement. We’ve seen some great examples of that, not the least of which are resorts that have focused in on maximizing those efficiencies,” Taylor says. When more and more people live and work in the same building or surrounding community, people spend less time commuting, which eases congestion on roads and public transportation. It also gives people more time to work or spend time with their families while stimulating the local economy by visiting restaurants and going shopping.
“I’m bullish about mixed-use, and I think that we’re going to see more and more official plans and zoning,” says Taylor. “I think you’re going to see more of a government push toward mixed-use projects in the future. It’s going to be very much top of mind.”