Scottish Government

5 DEAL STRUCTURE & FUNDING BARRIERS

5.1 This chapter presents the evidence on real and perceived barriers to delivering mixed use development focussing on deal structure and funding barriers. The evidence comes from the first set of stakeholder workshops in Edinburgh and Aberdeen, interviews and the local planning authorities' questionnaire. Specifically, the focus of this chapter includes:

• Deal structuring principles; and
• Funding mixed use development and up-front infrastructure

Deal Structuring: Principles

5.2 Workshop attendees agreed that structuring a deal to deliver mixed use development and organising funding were significant barriers. Local planning authorities, particularly the smaller authorities, may not have the in-house expertise and confidence to identify the key structuring principles of a more complex development agreement covering several different uses or a joint venture deal. Consequently, even if a local authority owned site is allocated for mixed use in a Local Plan, the local planning authority might struggle to progress the proposals and deliver the mixed use development. There was also a view that, in some cases, the private sector developers and their advisors over complicate mixed use development agreements.

5.3 Workshop attendees also agreed that mixed use developments, because of their potential scale, complexity and the involvement of more than one land use, were more challenging to fund. It seems that there is still some reluctance to fund among some institutions and investors but this has been improving, until the recent changes in the economic climate.

5.4 Another issue raised by participants at both workshops is that, traditionally, residential developers want to dispose of housing units immediately while commercial investors want to retain ownership and gain a long term return over several years. These different requirements need to be reflected in more sophisticated deal structures for mixed use development than for single use development. This appears to be a significant barrier. It was also pointed out at the workshops that funders/investors are still looking primarily to identify and promote single use investments:

'vanilla (mono) investment is seen to generate prime property values with only a few focal points that are busy areas of mixed use'.

5.5 Some occupiers also want single use developments or there is a demand from particular occupiers, driven by attitudes and legislation, to be stand alone: examples include supermarkets (with significant quantities of surface parking), schools and hospitals. Two responses to this might be to challenge these attitudes through more research to identify completed examples of where more innovate schemes have been occupied and are successfully operating and also through more advocacy.

Funding & Up Front Infrastructure

5.6 At both workshops, attendees highlighted that, historically, land values for residential were higher than other uses and this is now changing. In January 2009, residential land prices in Scotland had fallen by 43% year on year, the largest year on year fall of all countries and regions covered by Valuation Office Agency data. In contrast, residential land prices in Scotland had nearly tripled between early 2002 and early 2008 (2.8 times) ¹⁷. In their Residential Development Land Briefing Note, Savills ¹⁸ comment:

"although lower land value does, in theory, allow land to be developed at lower residual site values, there are a number of constraints that explain why the land market has stalled completely. On urban land especially, once build costs, cost of remediation and infrastructure provision are factored in, many sites are likely to have negative land value in current market conditions. In many circumstances, existing or alternative use values will be higher than the option to redevelop."

5.7 Therefore, the closing of the gap between the different land use values could create opportunities for more and higher quality mixed use development. Although if a site has a negative land value then from the land owner's point of view there is very little incentive to dispose of land for redevelopment. This position was highlighted in the Clydebank Re-built case study in Chapter 7.

5.8 Workshop attendees pointed out that mixed use developments, because of their scale and complexity are often likely to require more up front infrastructure. Workshop attendees highlighted that in the current economic climate, with very limited demand and dramatically falling land values, Section 75 contributions ¹⁹ and planning agreements cannot be seen as the source of capital funding for major infrastructure. This emerged as a significant barrier and therefore there is a pressing need to consider new models for funding up front major infrastructure for larger more complex mixed use developments: e.g. Tax Increment Financing or some kind of levy to fund community infrastructure. Tax Increment Financing ²⁰ been used widely in the USA in cities like Chicago and the model uses future increases in tax revenues to finance current improvements such as new infrastructure that are expected to generate those increased revenues. In very simple terms it would, for example, enable a local authority to trade anticipated future tax income for a present benefit. TIF has been identified by the Housing Supply Task Force ²¹ and is now being actively promoted as a proposed as new model for funding infrastructure in Scotland.

5.9 The issue of funding commercial uses in residential areas was identified by attendees at both the workshops. This may be a particular issue in a social housing regeneration area where land values for a residential unit will be for example around £30,000 whereas the land value of a commercial unit will be zero or negative. In this context, shops in such areas are unlikely to afford to pay market rents that ensure an economic return for the developer and this will be reflected in the lower or negative land value for retail land use. Housing Association Grant ( HAG) ²² funding for commercial uses is not available so a number of housing associations/ RSLs have set up subsidiaries to develop non-residential uses. However, there is limited scope here for seeking private funding as, under BASEL rules on capital ratios and under Financial Services Authority Regulations building societies have to reserve three times the level of capital against commercial lending as they reserve against residential lending ²³. As a response the possibility of some form of direct funding for business/enterprise space could also be explored by project developers.

5.10 At both workshops there was a clear view that there are opportunities for local planning authorities to take a more proactive role in promoting and delivering mixed development in the current economic climate. Local planning authority involvement might not necessarily be in the form of a cash/funding contribution and other assets like land could form part of the joint venture. There is an opportunity to further explore the use of 'local asset backed vehicles' ( LABV) to deliver mixed use development. LABVs are a mechanism that allow for a public sector organisation to use their land and buildings in an efficient and strategic way to meet an identified local need. Typical applications could include city centre regeneration, enabling new areas for development, improving or rationalising operational property, rejuvenating property or investing in housing.

Evidence from Local Authorities Survey

5.11 As highlighted in Chapter 4, local planning authorities, especially the smaller ones, may not have the kind of expertise to actively promote and deliver mixed use development . The online survey indicated that all local planning authorities (who responded to the survey) rated themselves least skilled at partnership structuring and only slightly more skilled at establishing development funding principles. This point was well illustrated by one local planning authority respondent to the survey:

"most local authority planners don't have private-sector development experience so don't always appreciate the realities of the development process ( e.g. what is reasonable to ask for and what isn't; which uses are viable and which aren't, e.g. small retail units; the effects of delays on development costs and viability. (There is) therefore a need for training planners in understanding of both sides of the development process, including the pros and cons of mixed developments. Temporary secondments to the private sector, seminars etc.; sufficient financial knowledge to know what is viable and what is not (including when developers are bluffing); environmental / amenity issues such as noise traffic generation etc".

5.12 As illustrated in Table 5.1, four of the top ten barriers for both planning authorities and for developers related to deal structuring, financing and the setting up of appropriate development vehicles.

Table 5.1: Deal Structure Barriers Identified by Local Planning Authorities

5.13 Planning authorities responding to the online survey provided some 19 examples of mixed use development, 11 of which had residential as the primary use. This is perhaps key to understanding some of the comments made about deal structuring and suggests that it is often housing developers who have some difficulty in moving out of their comfort zone of providing purely housing developments where they are certain of their product and being able to make a reasonable profit.

Conclusions & Summary of Issues

5.14 Structuring a deal to deliver mixed use development and organising funding were identified as significant barriers to delivering mixed use development. Local planning authorities, particularly the smaller authorities, may not have the in-house expertise and confidence to identify key structuring principles to initiate and promote an appropriate development vehicle. Mixed use developments, because of their scale and complexity, are often likely to require more up front infrastructure. In the current economic climate, with very limited demand and dramatically falling land values, Section 75 contributions/planning agreements cannot be seen as the source of capital funding for major infrastructure and there is a pressing need to consider new models for funding 'up front'.

Issue 5.1: Skills to Identify and Confirm Market for Mixed Use Development

5.15 Responses from the online survey indicate that a lack of 'market knowledge' was also an important barrier leading to delays in business space being occupied or high value uses predominating over others. As a response, local authority planners need to develop more skills and confidence to make robust decisions on the market for mixed use development. At the same time local authority planners should have the support of property professional colleagues to provide wider market knowledge on mixed use development and there is a case for local authorities to use all the professionals at their disposal.

Issue 5.2: Mixed Use: Development Vehicle

5.16 Determining the most appropriate development vehicle to deliver mixed use development is complex but public sector partners need to understand the basics and this has implications for the initial mixed use development scheme concept and principles. As a response it would seem to be appropriate for the key principles in the process and proven 'models' to be highlighted, as part of disseminating good practice.

Issue 5.3: New Models for Funding Major Infrastructure Provision

5.17 New models for funding major infrastructure need to be identified. Tax Increment Financing for example was identified in the workshops and by the Housing Supply Task Force and uses future increases in tax revenues to finance current improvements such as new infrastructure. The issue of funding commercial uses in residential areas was identified in both the workshops and this may be a particular issue in a social housing regeneration area. As a response the possibility of some form of direct funding for business/enterprise space could also be explored by project developers.