Ground-floor retail in a mixed-use apartment development

Two buildings sharing one structure

A mixed-use apartment building is usually described as apartments with shops underneath. From inside the work it is two buildings sharing a foundation, a roof, a lender and a schedule. Above, a residential product leased by the unit to households on annual terms. Below, a commercial product leased by the square foot to businesses on multi-year terms. They are designed, built and financed differently, and they do not fill at the same speed.

Our communities page shows the type twice. Ogden in Columbus is a photograph of a finished building with shopfronts along its ground floor; Arcadia in Shaker Heights is a rendering of a community the page still marks Coming Soon, drawn with balconies above a glazed ground floor of shopfronts. What a given ground floor is used for, and by whom, is a question about the individual community. This is about the category: what a commercial ground floor does to the structure, the loan, the schedule and the pro forma.

The ground floor is the expensive floor

An apartment building is a repeating structure: the same walls, the same plumbing chase, the same bearing lines, floor after floor. That repetition is where the cost discipline lives, and a commercial ground floor breaks it.

Retail wants an open span and clear glass at the sidewalk; apartments want bearing walls close together. The two grids never line up, so the loads above have to be carried around the open space below. That is a podium: a concrete or steel structure at grade holding up the frame above, with transfer members where the lines do not meet.

The commercial floor is taller as well, because a business needs ceiling height and room above the ceiling for ductwork, sprinkler mains and exhaust. Mixing occupancies adds fire separation, separate egress and usually a separate entrance. Then the space is built as a shell and stops, its interior a second project paid for later. Between the podium, the added height and the shell, the ground floor costs more per square foot than the floors above it, and it finishes last.

A lender underwrites two income streams, not one

To a lender, the apartments and the bays are different collateral.

Residential income is granular: many small leases renewing at different times, so one resident leaving is a rounding item. Commercial income is concentrated — few leases, each large, each carrying the credit of one business, so a lender looks at who the tenant is, how much of the term remains, and what happens to the space if that business closes.

Two things follow. Income not yet in place counts for nothing: a bay under negotiation, or leased but not open and paying, is normally excluded or discounted when a loan is sized. And the mix changes the lender, because the programmes that finance apartment buildings generally cap how much of a property’s income and floor area may come from commercial space; past that point it is usually a different loan, on different terms. The construction loan in a development deal’s stage-by-stage sequence has to be replaced, and a commercial ground floor changes who is willing to replace it.

Parking, loading and the service side

Residents park overnight; customers park in the middle of the day. A zoning code counts the two demands separately, and the count is settled during entitlement. A garage secured for residents is one a customer will not use, so commercial parking usually sits outside the gate or on the street.

Service is the harder half. A commercial tenant needs deliveries and waste handling on its own schedule, none of it through the residential lobby. A food use needs grease exhaust, and that exhaust rises through the apartments to the roof in a shaft drawn at design time. Rooftop equipment, odour and a fan above somebody’s bedroom are settled years before there is a tenant to consult, and none of it is reversible once the concrete is poured.

Residential leases sign in weeks; retail signs over quarters

A residential lease is a consumer transaction: a prospect tours, applies, is screened, signs and moves in, and the rent starts almost immediately. Even then, leased, occupied and paying are three different counts, and they run weeks apart.

A retail lease is a negotiated contract between two businesses. A broker markets the space, a prospect signs a letter of intent, and then comes the lease: permitted use, exclusivity, co-tenancy, term, options, and where the landlord’s work stops and the tenant’s begins. That takes months. Then the tenant designs its space, permits it and builds it on a schedule the landlord does not control.

Two ordinary terms inside that sequence move cash the wrong way first. A tenant improvement allowance is landlord capital contributed to the tenant’s build-out, usually payable on completion: money out before any money in. Free rent is a period of occupancy that produces none, often measured from the day the shell is handed over rather than the day the doors open.

The same three counts apply to a bay, with quarters between them instead of weeks: it can be leased, built out and occupied while still paying nothing, so a signed lease is not yet income. The commercial income arrives after the apartments have stabilised, sometimes long after. The residential half of a building can be full and performing while the ground floor is still a contractor’s site.

What a vacant bay does to the pro forma

An empty bay costs the way a slow lease-up costs — carrying costs run regardless, and the income that has not arrived is the income a permanent lender sizes against and a buyer pays for — which is the chain a development runs down when it disappoints reaching the deal through a different door.

One cost behaves differently from a vacant apartment. Common area expenses — the cleaning, lighting, insurance and taxes a commercial tenant would ordinarily reimburse under its lease — stay with the landlord for as long as the bay is empty. A vacant apartment stops producing rent; a vacant bay stops producing rent and hands back an expense line somebody else was contracted to pay.

The timing is the part an investor feels. If the commercial income has not arrived when the construction loan comes due, the refinancing is sized off the apartments alone: smaller proceeds, less capital coming back, or an extension bought with a fee or a paydown. It arrives as timing rather than as news, with a preferred return accruing while the distribution waits.

Which leaves the question worth putting to any mixed-use pro forma: what does the deal look like with the commercial line set to zero? If it still works and simply works later, the retail is upside. If it does not, the retail is a condition of the investment and should be described that way.

Why a developer takes the trade anyway

Nobody adds a commercial floor to make an apartment building simpler. It gets built for two reasons. The first is that some corners cannot be built any other way: a municipality that has planned a walkable district requires an active ground floor along its main street, in the zoning district or as a condition of approval. The choice is then not between apartments with retail and apartments without, but between this building and a different site.

The second is that the alternative on such a corner is a blank wall at the sidewalk, poor for the street and for the homes above it. A ground floor with somewhere to eat or buy something is an amenity the residents use, that somebody else operates and pays rent for.

Leasing and running that space is a different discipline from leasing and running apartments: different lease form, different broker, different tenant, different failure mode. It is a fair question to put to any sponsor proposing a mixed-use building — who leases the bay, who manages it once it is leased, and have those people done it before. Vertical integration is an operating structure rather than a mitigant, and the useful question is what the structure actually covers.

Underwriting the commercial line

Our pro formas use untrended rents, and the reason an untrended assumption can be checked while a trended one cannot is set out in how an apartment lease-up works. A commercial line needs that discipline for a reason the apartments do not have: a bay is tested against what comparable commercial space leases for nearby, not against the apartment comparables the rest of the building is set by, and there are usually far fewer of them.

Timing is the other half of the same discipline. A pro forma with the bay opening the month the apartments stabilise has assumed away the sequence above. The honest version puts it where the leasing and build-out calendar does, which is later.

The risks worth naming

A commercial ground floor does not add a little risk. It adds a second set of risks on its own timetable.

• Construction. The podium, the taller floor and the shell carry cost and schedule the apartments alone would not.
• Leasing. The space may lease slowly, lease below the rent underwritten, or not lease.
• Credit. A signed lease is one business’s promise; a tenant that closes mid-term leaves a bay to re-let and often rebuild.
• Capital timing. Allowances and free rent send money out before income comes in, while the construction loan is outstanding.
• Financing. The mix can narrow the field of lenders willing to refinance.

Development involves substantial risk. No return is guaranteed; a target quoted from an offering document is a target and not a guarantee, and nothing here predicts how a project will turn out. Private real estate is illiquid, the hold is long, and an investor may lose some or all of their capital.

What can be examined beforehand is how a sponsor treats the ground floor in its own numbers, and when it assumes the commercial income begins. Our communities page marks those not yet open as Coming Soon; our team will take a question about a specific one.