By Cheryl Nieman Brechlin, Senior Counsel
Mixed-use properties pose unique legal challenges as different types of tenants often have divergent legal interests. In mixed-use properties with retail and residential uses, landlords must ensure their leases provide retail tenants sufficient operational flexibility without sacrificing the residential tenants' need for a quiet, peaceful place to live and, nowadays, work. Understanding the legal nuances of retail leases in mixed-use residential properties is essential for both landlords and retail tenants to maximize the value of their respective businesses and avoid common legal pitfalls. This article summarizes key legal considerations for retail leases in mixed-use residential properties.
- Defining the Common Area. In a mixed-use retail lease, it is critical to for landlords to define what constitutes "common area" as retail tenants often cannot access areas of the project reserved for residential tenants and vice versa. If certain portions of the project will be shared by both retail and residential tenants (such as parking garages), then retail leases must include detailed restrictions, rules and regulations governing shared-use areas. For example, large deliveries of inventory for retail tenants in a project's parking garage should not occur during peak commuting times for the residential tenants to avoid traffic obstruction and lower the risk of accidents.
- Rent and Triple-Net Charges: While base rent in a mixed-use retail lease and a traditional retail lease are largely the same, the reimbursement of triple-net charges is unique in mixed-use retail leases. Typically, retail tenants reimburse landlords for the landlord's common area maintenance expenses, insurance and property taxes. These charges are usually calculated based on the tenant's proportionate share of the total property's expenses and are an essential consideration for retail tenants.
In a mixed-use retail lease, however, landlords and tenants should clarify which project maintenance costs will be reimbursable by the retail tenants and which project expenses are unrelated to the retail areas. Property owners of mixed-use developments may also want to create various cost pools to further segregate common area maintenance charges among certain types of tenants at the project. For example, restaurants tenants may be in a cost pool that pays for grease trap maintenance expenses that the fitness tenants in the project do not pay for.
- Tenant Mix: Like in a traditional shopping center, the tenant composition of mixed-use properties plays a crucial role in attracting retail customers. However, retail tenants in a mixed-use residential project also help create a vibrant atmosphere for residential tenants. A well-curated mix of retail tenants can enhance the overall appeal of the project for retail and residential tenants alike. Coffee shops, restaurants and fitness tenants in a mixed-use residential project serve as an amenity to residential tenants. Similarly, retail tenants that offer commonly used services — such as nail salons, barbershops and pet care — can help make a project more attractive to prospective residential tenants.
- Noise Restrictions: Noise from retail activities such as fitness studios, bars and restaurants can impact the quality of life for residential tenants in mixed-use developments. Landlords should implement appropriate noise mitigation measures, such as soundproofing and designated operating hours, to minimize disturbances and maintain harmony within the development. Retail leases for a mixed-use residential project must contain much more stringent requirements regarding noise generation, soundproofing and hours of operation.
- Parking: Adequate parking facilities are essential for retail tenants to attract customers. However, mixed-use projects often have less parking than the traditional shopping center. Mixed-use project owners must ensure that there is sufficient parking available for both retail patrons and residential tenants, often not knowing the actual parking needs of a retail tenant once in operation. Frequently, landlords will need to designate and monitor specific parking for retail use and subcategories of retail use (e.g., short-term parking, reserved parking, etc.).
- Compatible Uses: In our experience, the retail tenants that create the best amenities for the residential tenants — like fitness studios, grocers, bars and restaurants — often pose the greatest operational challenges for landlords. In addition to noise concerns as noted above, restaurants and grocers can create odors that bother residential tenants, and residents grow tired of rowdy partygoers at bars. Fitness studios, grocers and other high-parking retail users often frustrate residential tenants looking for parking in the project. It is critical for both landlords and tenants to understand the unique characteristics of a project (such as the availability of parking and the quality of existing soundproofing) before entering into a mixed-use retail lease.
- Tenant Improvements: Retail leases for mixed-use projects must consider two important distinctions with traditional shopping center leases. First, mixed-use projects often feature much more sophisticated building structures and systems than traditional shopping centers. That being the case, landlords must have strict control over the approval of proposed tenant improvements and the contractor that will construct such improvements. Oftentimes, landlords will designate specific contractors for specific parts of the tenant improvements to ensure their proper construction and avoid the utilities of the residential components of a project being shut off for long periods of time because of a mistake made by an inexperienced contractor building out a retail tenant’s space.
Second, owners of mixed-use projects must have much more specific construction rules than traditional shopping center owners. Noise, dust and the interruption of utilities, however brief, all disproportionately affect residential tenants. Landlords must clamp down on the hours of construction and construction deliveries to minimize negative impacts on residential tenants. Similarly, construction staging must be carefully planned to preserve the proper functioning of the mixed-use project.
Retail leases in mixed-use properties are complex and require careful negotiation to ensure fairness and clarity for all parties involved and success for the property owner. By understanding the unique aspects of retail leases in mixed-use residential properties and strategically negotiating key terms, landlords and tenants can create agreements that support the success of the development and foster a thriving retail and residential environment.