Mixed-Use Development Finance

The valuer will appraise the flats on achieved new-build sales, then capitalise the commercial rent at a market yield. Let a unit at £30,000 a year and capitalise it at 7%, and it is worth roughly £430,000. Leave it empty and the valuer deducts a void period, rent-free incentive and letting costs, often taking a large slice off that figure.

That gap is why the commercial element moves your loan more than its floor area suggests. Our guide to commercial property valuation methods explains the investment method lenders rely on.

Mixed-use properties can make a stronger project than a pure housing scheme, but it asks more of you as a developer. Weigh the benefits and risks before you settle the unit mix, because the commercial share shapes your financing as much as your planning.

Planning policy in many town centres expects active ground-floor uses, so a mixed-use scheme can be the only consent available on a high street site. The two income streams also give you more than one exit.

• Benefit: a let commercial unit can be kept as a long-term investment while the flats are sold to repay the loan.
• Benefit: ground-floor commercial spaces can make a busy street frontage workable where homes at street level would struggle to sell.
• Benefit: a broad Class E consent gives you access to a wide range of potential tenants.
• Risk: empty commercial spaces are valued cautiously by lenders, which can reduce the loan when you need it most.
• Risk: retail and leisure demand varies sharply from one street to the next, so rental evidence must be local.
• Risk: running two asset types in one building adds legal, service charge and management costs.

There is no fixed rule, but lenders broadly sort mixed-use schemes into three groups. The bands below are indicative and shift with location, unit type and whether the space is pre-let.

On commercial-led schemes, our commercial development finance guide is the better starting point.

• Commercial under roughly a fifth of GDV: usually treated as residential, with terms close to a standard housing scheme.
• Roughly a fifth to a third: still widely fundable, but expect leverage nearer 60% and closer questions on the lettings.
• Above a third, or speculative space in a weak retail pitch: fewer lenders, lower leverage and more equity or mezzanine needed.

Most development lenders will consider a mixed-use development project with planning permission, a realistic appraisal and a developer with relevant experience. Their assessment of you carries more weight than on a pure housing scheme, because a mixed-use building means working in two markets at once: home buyers and commercial tenants.

A developer who has completed residential projects but never let commercial space is still fundable. Lenders will want a commercial letting agent appointed early, a managing agent lined up for the finished building, and borrowing pitched a little below the maximum to leave room for a slower letting. The common challenges when applying are below.

• Rental evidence: few recent lettings nearby makes the commercial value hard to support at valuation.
• Traditional banks: some are cautious about speculative commercial space and prefer to lend once the building is finished and let.
• Planning conditions: limits on opening hours, extraction or deliveries can narrow the tenants willing to rent the space.
• Growth assumptions: appraisals that rely on rental growth during the build, rather than current evidence, get marked down.
• Split exit strategies: lenders need to understand how each part of the building repays the loan, and in what order.

A development lender's credit team will assess the ground floor as if it were a separate investment loan. They want to know who will rent the space, on what lease and at what yield, and whether a commercial mortgage lender would refinance it once it is let. A weak answer to any of those questions reduces the value they attach to it.

Expect the valuer to test the rent against recent lettings of similar spaces nearby, not against asking rents. Lenders also look at the type of tenant. A convenience store or pharmacy on a long lease reads very differently from a start-up café on a short one with an early break clause.

Your own financial position matters too. Most loans for mixed-use schemes go to a limited company or SPV, and lenders usually ask for personal guarantees from the directors. On larger schemes, guarantees are often limited to cost overruns and interest rather than the whole loan. Our guide to personal guarantees on development finance explains the main forms.

Most mixed-use developments use more than one of the main types of property finance. Bridging finance often covers the site purchase, development finance funds the build, and mortgage or bridging finance follows on any part of the building that has not sold or let by completion.

Lenders will ask for a clear exit strategy for both elements from the start. A good exit strategy shows which units you plan to sell, which you plan to keep, and what happens if the commercial space takes longer to let than your appraisal assumes. Our bridging loans, mezzanine finance and development exit finance pages cover each stage.

• Before planning permission: a bridging loan secured on the site or existing building at its current value.
• Construction: a development loan sized against GDV and total costs, with staged drawdowns certified by a monitoring surveyor.
• Equity gap: mezzanine finance or a joint venture partner where the commercial share holds senior leverage down.
• At completion: flat sales, a commercial mortgage on let units, or development exit finance to give you time to sell or let.

The loan works like any development facility, with an extra layer of due diligence on the commercial space. The steps below show the usual order from first enquiry to final drawdown, and where the commercial element adds work.

Interest on development loans is normally rolled up, so it shows in your appraisal rather than your monthly cash flow. The next step, once your figures stand up, is to compare indicative terms on leverage, interest rates and fees side by side.

• Indicative terms: lenders review your appraisal, plans and lettings evidence, then quote leverage, interest rates and fees.
• Application and valuation: the valuer reports separately on the residential and commercial values.
• Credit approval: the lender's credit committee signs off the loan, sometimes with conditions on pre-lets or minimum rents.
• Legal work and first drawdown: solicitors complete the security and the land element of the loan is released.
• Build drawdowns: the monitoring surveyor certifies the work each month before funds are released.
• Repayment: flat sales, commercial sales or a refinance repay the loan and rolled-up interest.

Lenders want an exit for each element. The flats are usually sold. The commercial units can be sold as let investments, or kept and refinanced onto a commercial mortgage once they are income-producing.

Keeping the ground floor is a common plan, but a lender cannot rely on a refinance of space that is still empty. Budget for business rates on vacant units, service charge shortfalls and agents' fees, and allow for a commercial void outlasting your flat sales.

Most ground-floor space is now consented under Class E, which covers shops, cafés, offices, gyms, clinics and nurseries, with the homes above in Class C3. A wide Class E consent gives the valuer more potential tenants. A condition limiting the space to one narrow use can lower its value.

Set up the title structure early. Long leases for the flats, a separate lease or freehold arrangement for the commercial units and a fair service charge split all affect saleability. VAT treatment also differs between the two elements, which our VAT on development guide covers.