Protect Interests When Leasing Mixed-Use Space

August 8, 2017
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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. We’ll explain the special issues to consider, and give you Model Lease Clauses: Put Five Key Provisions in Leases at Mixed-Use Buildings, that you can use to address them.

Consider 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, explains New York real estate attorney Craig A. Kraus. “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,” he notes. (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,” Kraus points out.

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,” Kraus notes. 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,” Kraus says. 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,” he adds. 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, Kraus warns.

Head Off Nuisance Complaints

To try to avoid nuisance complaints that can lead to complaints by residents altogether, work with your attorney to draft permitted use and prohibited use provisions. By clearly controlling what the tenant can and can’t use its space for, you can limit it to activities that aren’t problematic but still can achieve its business goals.

Permitted use. The permitted use clause in a lease spells out how the tenant will use the premises during the lease’s term. The tenant must then comply with this use throughout the term of the lease. Failure to do so may amount to a breach that gives the landlord the right to terminate the lease. Permitted use here is particularly important because limiting a tenant to uses that aren’t likely to spark residential tenants’ complaints can avoid trouble.

You can try to negotiate issues like times when certain activities must begin or end, which can stop noise complaints. Ask your attorney about adapting the language in our Model Lease Clause, which is specific to an art gallery, a business that has the potential to create crowds and noise at a mixed-use property or to display materials that would make residents uncomfortable [Clause 1]. 

Prohibited use. In the same way that you can designate how the tenant is permitted to use its space, a prohibited use provision creates an enforceable agreement that certain things will not be allowed. In the case of an art gallery, noxious paint products can be banned with the exception of art restoration chemicals. And the tenant can be prohibited from selling certain items that don’t comport with residential units, such as pornography [Clause 2].

Keep Signage in Mind

Mixed-use buildings must strike a balance between a commercial and residential nature; the size and nature of signage has a significant impact. Just as with permitted and prohibited uses of the space, landlords can limit signage in a way that will keep residents happy but still allow the commercial tenant to thrive. In addition to parameters for the appearance of signage, it’s not unusual for signage provisions in a lease to name an example of signage at another property that the tenant’s signage must conform to. This move can crack down on arguments that signage that you deem inappropriate is actually acceptable. To build landlord protections into the lease, make sure that the landlord has recourse in the case of tenant violations, such as requiring indemnification from a retail tenant or forcing it to legally abate the issue, Kraus suggests [Clause 3].

Set Operating Obligations to Keep Property Desirable

Operating obligations are another way to keep a mixed-use property running well and minimize complaints from residents. This language can—depending on negotiations and drafting—address all the factors that typically turn into complaints from residential tenants. The clause can ensure that the exterior of the property like sidewalks is kept neat and clean, address the all-important issue of odors, eliminate lines and crowds, and keep sound to a minimum, among other requirements that keep the property looking and feeling first-class. As with signage provisions, and many other aspects of the lease, indemnification can save the day if it’s built into the terms [Clause 4].

Use Quiet Enjoyment to Emphasize Nature of Property

Including a quiet enjoyment provision in a mixed-use commercial tenant’s lease is important. It requires the tenant to “acknowledge and understand” the nature of the building—that it’s home to residential tenants—and, as such, there are special issues to consider such as noise and loitering. It also specifies that avoiding nuisances is “of the essence” and sets out the consequences for a tenant that breaches the lease in this way. To put teeth in the indemnification requirement in this section of your lease, make violations pricey for the tenant while covering your costs. You can do this by making the tenant responsible for paying residential rent that’s withheld as a result of violations—plus any related expenses, like attorney’s fees [Clause 5].  

Don’t Forget the Takeaway

“A lease, whether it’s in a mixed-use building or straight commercial real estate building, is still a document between two parties, so landlords should make sure that their rights and obligations are properly spelled out and they are protected,” says Kraus. But also keep in mind during the negotiation and drafting of a mixed-use lease that there can be an impact from renting to tenants upstairs, which can result in severe economic affects for landlords if violations end up subjecting those tenants to conditions that spark warranty of habitability claims, he stresses.  

Insider Source

Craig A. Kraus, Esq.: Partner, Borah, Goldstein, Altschuler, Nahins & Goidel, P.C., 377 Broadway, New York, NY 10013; www.borahgoldstein.com.