Key Provisions Keep Mixed-Use Property Profitable

Mixed-use properties have become ubiquitous in most areas of the country. Often, they make the most of a property’s layout, especially in tight urban neighborhoods—providing easy-to-access commercial space on a first floor and residential units on the floors above so no space is wasted. And if leases are drafted that protect landlords from both typical lease issues as well as some limited mixed-use-specific angles, they can be financially advantageous. But there are special issues to consider, such as warranty of habitability.

A typical mixed-use property has a retail ground floor and apartments on the upper floors, with the retail space acting as an economic anchor for the building in many instances. There isn’t much of a difference between mixed-use properties and straight commercial retail properties when it comes to leases, in the sense that issues that impact residential tenants in a mixed-use building would also affect typical commercial tenants in an all-commercial building. (Namely, nuisances would interfere with commercial tenants’ and residents’ use of the property.)

Especially in the case of rent-regulated apartments, where the rental income is not as great as free-market rent rates, the owner relies on the commercial tenant to boost its profits. This happens not just by collecting rent, but also by passing through real estate taxes to the commercial tenant and requiring the tenant to pay for its own utilities and in some cases a percentage of utilities for the building. Owners can offset lower profits from residential units by leasing to a business.

However, if a commercial tenant interferes with residents, it can spell trouble for landlords. That’s because residents are entitled to the “warranty of habitability.” Put simply, residential tenants are entitled to use their apartments without their health and safety being compromised or being plagued by other unpleasant conditions, like noise, odors, or safety risks, that would reduce or eliminate their enjoyment of their homes.

Many concerns with respect to residential tenants are after-hours business activities, whereas if a landlord has a straight commercial building, its commercial tenants usually aren’t there after hours. So addressing hours of operation in the lease is key. If there is a restaurant on the ground floor of a mixed-use building, and the bar is open until 2 a.m., that significantly impacts residential tenants. So be aware of the impact that will have on residents. Noise, odors, crowds, improper disposal of waste, and a failure to implement security measures can be annoying or dangerous for residents who live above such a business. That’s why it’s especially important to address those potential problems in the lease.

Also, depending on where your property is located, disturbed tenants could mean a tangle with housing authorities. For example, a complaint being filed with the New York Division of Housing and Community Renewal (DHCR) could result in a rent reduction for a decrease of services, and until it’s corrected a landlord can’t collect future rent increases. This can have major financial consequences.

For four more special issues to consider, and a Model Lease Clause that you can use to address them, see “Protect Interests When Leasing Mixed-Use Space,” available to subscribers here.