Five Key Economic Drivers for Mixed-Use HTC or NMTC Properties, and how a Market Study Can Help

Published by H. Blair Kincer on Tuesday, January 9, 2018 - 12:00am

Real estate economics are key drivers in the success or failure of mixed-use developments, even those using equity from historic tax credits (HTCs) and new markets tax credits (NMTCs)–something that’s becoming more and more evident as Novogradac & Company LLP provides market analysis for clients on a broad range of mixed-use properties. More and more investors, lenders, developers and others are recognizing the importance of deeper understanding of the real estate market.

Consider one recent investor who asked, “How many boutique hotels does one small town need?”

In 2017, Novogradac was engaged to perform more market studies on mixed-use real estate developments that used equity from HTCs and NMTCs–suggesting this is a significant trend deserving of some high-level considerations for those who are ordering such analyses.

Here are five things that should be part of the economic consideration of mixed-use HTC and NMTC properties and some questions that should be asked.

1. Property Location and Area Revitalization

Many proposed HTC and NMTC properties are in areas of revitalization, so it’s necessary to evaluate strengths and weaknesses of local neighborhood to determine how those factors will affect the development.

A first consideration is what redevelopment is occurring in the area and what is the path of that redevelopment. Often an HTC- or NMTC-financed property will not be in the area’s best or hottest market. However, it could be in a positive market in the foreseeable future, it’s wise to see whether it’s in the path of the redevelopment, which means it will ultimately benefit from the synergy of the broader market.

To this end, a market study could also address:

  • What are the underlying economic drivers in this economy?
  • What are the strengths and weaknesses of the local economy and region?
  • What are the demographic trends of the local area and overall market?

2. Varying Rental Revenue Analysis Techniques for Each Real Estate Type

Mixed use means various income streams with various lease or tenant payment conventions. Offices are leased differently than apartments, and hotels generate revenue from multiple sources. Each use has differing analysis requirements. Further, geography affects how each use should be evaluated. A good market study will evaluate real estate trends that affect the analysis of rental revenue within the local geography. For example, many commercial leases in Los Angeles are quoted on a monthly basis rather than an annual basis. Additionally, in Los Angeles bachelor units– which offer kitchenettes without ovens or refrigerators–are prevalent; but in other markets in the U.S. these multifamily units do not exists. It is important for investors, lenders, and developers to understand these nuances.

Here are some other questions a market study could address:

  • What are monthly quoted rental rates and utility structures for multifamily properties in the market?
  • What are annually quoted rental rates, lease types and reimbursement structures for office properties in the market?
  • What are annually quoted rental rates, lease types including percentage leases and reimbursement structures for retail properties in the market?
  • What are achieved annual occupancy, revenue per available room and average daily rates for hotel properties in the market?
  • What are the effects of different flag associations for hotel properties in the market?
  • What ancillary sources of income should be expected?

3. Varying Capital and Operating Expenses for Each Real Estate Use

As with revenue sources, operating expenses will be different for each use. A strong market study will address reasonable operating expenses with support from operating-expense comparables in the market. 

Other questions a market study should address include:

  • What do market participants, including tenants and real estate owners, believe are reasonable tenant improvement allowances, leasing commissions and free rent concessions for office and retail properties in this market?
  • What are reasonable hotel departmental expenses including food and beverage, nondepartmental expenses, administrative expensive and franchise fees that are supported by operating expense comparables in the market?
  • How are real estate taxes allocated across uses?

4. Interrelated Revenue Streams from Various Real Estate Use Types

When looking at a development financed with HTCs or NMTCs, it’s important to consider the potential variety of revenue streams and their purpose. For instance, examine whether retail space is truly a revenue stream or an amenity for hotel guests. Will a coffee shop or restaurant have a separate lease or be included in hotel departmental revenue?

Part of the consideration is whether a coffee shop or restaurant be successful as a standalone retail space. Also worth considering is whether in a mixed-use property, the hotel portion will offer any fee services for multifamily residents such as a concierge, maid service or room service.

5. Reasonable Fees

As always in HTC development, the reasonableness of a developer fee is crucial and must be informed by the guidance provided by Rev. Proc. 2014-12.

Some of the questions a market study could inform include:

  • What is a reasonable and supported developer fee?
  • What is a reasonable and supported management fee?
  • What is a reasonable and supported asset management agreement?
  • What are the roles and responsibilities in the master leasing structure?

In HTC development, like anything, information is gold. A solid market study of a HTC-equity-financed property will address the aforementioned issues and help the developer, investor and others make a wise decision.