Mixed-Use Building Syndication: How to Buy and Raise for Apartments With Retail Units
On this page
- Is a mixed-use building residential or commercial?
- How do lenders treat the commercial space?
- How are commercial leases underwritten differently?
- How do you value a mixed-use building?
- What should you check on zoning and insurance?
- What will investors ask?
- How should the offering describe the commercial units?
- How DoorRaise fits in
- FAQ
You can syndicate a mixed-use building (apartments above, shops or offices on the ground floor) much like any apartment deal, but you are really buying two businesses. The apartments behave like apartments: many small leases, steady turnover, predictable vacancy. The commercial units behave like commercial real estate: a few long leases, long empty stretches when a tenant leaves, and real money spent to sign the next one. Lenders treat the commercial share as a limit, appraisers often value it with a higher cap rate, and investors deserve to see it underwritten on its own. If the apartments carry the deal and the commercial space is a modest share of the income, a mixed-use building can be a good apartment syndication. If the shops carry the deal, you are syndicating a retail property with apartments attached.
This post is part of our guide to real estate syndication. It covers financing, underwriting, valuation, zoning and insurance, and how to describe the commercial units to investors. The example figures are illustrative.
Is a mixed-use building residential or commercial?
It depends on who is asking. To a lender, a building with ground-floor retail is still a multifamily property as long as the commercial part stays small. To the city, it sits in a mixed-use or commercial district with rules for each use. To the IRS, it is "residential rental property" (depreciated over 27.5 years) only if at least 80% of gross rental income comes from dwelling units; otherwise the building is nonresidential real property, depreciated over 39 years. That test can bite when the shops pay high rent. See are apartment buildings commercial or residential for the three definitions side by side, and ask the deal's accountant before you promise investors a depreciation schedule.
How do lenders treat the commercial space?
Fannie Mae and Freddie Mac multifamily loans are built for apartments. Both allow some commercial space in an eligible property, but they limit how much of the building's net rentable area can be commercial and how much of the effective gross income can come from it. The exact limits sit in each agency's guide and can change, so ask your loan broker or lender for the current numbers on your building early, before you sign the purchase agreement.
What that means in practice:
- Small commercial share. An agency loan may be available, often with the commercial income haircut or underwritten at a higher vacancy than the apartments.
- Larger commercial share. Expect a bank, credit union, life company or CMBS loan, which usually means shorter terms, recourse or different reserves. See apartment loan types for how those lenders differ.
- Vacant commercial units at purchase. Many lenders give little or no credit for income that does not exist yet. Plan the loan size on the apartments alone and treat signed commercial leases as upside.
Lenders also ask for the commercial leases, tenant estoppel certificates and sometimes a subordination, non-disturbance and attornment agreement (SNDA) from each commercial tenant. Build that into your closing timeline.
How are commercial leases underwritten differently?
Lease type: NNN or gross
Under a triple net (NNN) lease the tenant pays its share of property taxes, insurance and common area maintenance (CAM) on top of base rent. Under a gross lease the owner pays those costs out of the rent. Many small mixed-use buildings have modified gross leases somewhere in between. Read every lease and note which costs are reimbursed, whether there is a cap on CAM increases, and whether the reconciliation each year has actually been billed. A building with NNN leases on paper and no reimbursements in the trailing 12 months has a collection problem.
Vacancy and downtime
When an apartment tenant leaves, a unit typically sits empty for weeks. When a retail tenant leaves, the space can sit empty for many months while you market it, negotiate and build it out. Underwrite commercial vacancy separately from apartment vacancy, and include downtime between leases for each space whose lease ends during your hold. See vacancy and credit loss for how vacancy lines are built.
Tenant improvements and leasing commissions
Signing a new commercial tenant usually costs money: a tenant improvement allowance (TI) to build out the space and a leasing commission to the broker who brings the tenant. Renewals often cost less but rarely nothing. Budget TI and commissions for every lease that expires during the hold, either as a reserve each year or as a lump sum in the year the lease ends.
Tenant credit and lease rollover
A single regional chain is a different credit than a new restaurant run by its first-time owner. Look at the tenant's financial strength, any personal guaranty, how long it has operated there, and whether rent has been paid on time. Then lay out a lease rollover schedule: each commercial lease, its expiration date and any renewal options. If two of three shops expire in the same year, that year carries real risk.
How do you value a mixed-use building?
Value the two income streams separately. Apartment income and commercial income trade at different cap rates in most markets, and commercial income often carries a higher cap rate because it is lumpier and costs more to re-lease. Use market evidence for each cap rate (broker opinions, appraisals, recent sales). See how to calculate cap rate.
Illustrative example. A building has 20 apartments and 3 ground-floor shops. The figures are an example, not market data.
| Income stream | NOI | Cap rate (example) | Value |
|---|---|---|---|
| Apartments | $420,000 | 6.00% | $7,000,000 |
| Commercial units | $90,000 | 7.50% | $1,200,000 |
| Total | $510,000 | 6.22% blended | $8,200,000 |
Applying the apartment cap rate of 6.00% to all $510,000 of NOI would give $8,500,000, or $300,000 more than the sum of the parts. That gap is how sellers of mixed-use buildings get overpaid. Run a second case with one shop vacant for a year plus TI and commissions to re-lease it, and see how the value and the loan coverage hold up.
What should you check on zoning and insurance?
- Zoning. Confirm the commercial use is permitted in that district and on that floor. A change of use (say, an office becoming a restaurant) may need city approval, parking or a new certificate of occupancy. If the current mix is grandfathered, read legal nonconforming zoning for what happens after a casualty.
- Insurance. A restaurant with cooking equipment, a gym or a dry cleaner raises the property's risk profile and premium. Ask your insurance broker to quote with the actual tenant uses, and require each commercial tenant to carry liability insurance naming the owner as additional insured.
- Environmental. Past or current uses such as dry cleaning or auto repair are a reason to order a Phase I environmental site assessment. Most lenders require one anyway.
- Estoppels. Get signed estoppel certificates from every commercial tenant confirming rent, term, deposits and any defaults. See estoppel certificates.
What will investors ask?
Expect accredited investors to ask:
- What share of income comes from the commercial units, and what happens to cash flow if they are empty?
- When does each commercial lease expire, and are there renewal options?
- Who are the tenants, and how strong is their credit?
- Which cap rate did you use for the commercial income at purchase and at sale?
- How much is reserved for TI and leasing commissions?
- Does the loan depend on the commercial income?
Have the answers written down before you open the raise.
How should the offering describe the commercial units?
Describe the property as what it is: "a 20-unit apartment building with 3 ground-floor commercial units." In the business plan and pro forma, show commercial rent, reimbursements, vacancy and TI and commission reserves as their own lines. Include a short lease summary table (tenant, size, rent, lease type, expiration, options). In the risk factors, add the specific risks: re-leasing time and cost, concentration in a few tenants, the effect of commercial vacancy on the loan, and any zoning or depreciation issue. Investors who see the commercial risk spelled out are better placed to judge the deal, and you are better protected than if it is buried.
How DoorRaise fits in
DoorRaise helps sponsors raise equity for apartment buildings with 5 or more units from their friends and followers, including apartment buildings with some ground-floor commercial space, and runs the investor side after closing: quarterly distributions from the deal's bank account, investor updates and K-1 delivery. The deal's accountant prepares the K-1s; DoorRaise delivers them. DoorRaise also forms the deal's LLC, prepares the offering documents, files Form D and verifies every investor's accreditation, in 506(b) and 506(c) deals. Investors fund by wire into escrow at Enterprise Bank & Trust. Sponsors can also add the optional Property Books & Taxes service for the deal's bookkeeping. DoorRaise charges two flat fees: $1,500 to set up (non-refundable) and $5,000 a year for administration, the first year paid at closing from the money raised and only if the deal closes. A building that is mainly retail or office is outside what DoorRaise supports.
Check the blended numbers with the free cap rate and DSCR calculator.
FAQ
Can I get a Fannie Mae or Freddie Mac loan on a mixed-use building?
Often yes, if the commercial space and commercial income stay within each agency's limits. Ask a lender for the current limits on your specific building early.
Should I use one cap rate for the whole building?
No. Value apartment and commercial income separately with market cap rates for each. A single apartment cap rate on all the income usually overstates value.
How much vacancy should I use for the commercial units?
More than for the apartments, and include downtime plus TI and leasing commissions for each lease that ends during the hold. Base it on local leasing evidence, not a rule of thumb.
Does commercial income change the depreciation period?
It can. If less than 80% of gross rental income comes from dwelling units, the building is generally depreciated over 39 years instead of 27.5. Ask the deal's accountant.
What is an NNN lease?
A lease where the tenant pays its share of property taxes, insurance and common area maintenance in addition to base rent.
Sources
- 26 U.S.C. 168, Accelerated cost recovery system (Cornell LII)
- IRS Publication 946, How To Depreciate Property
- Fannie Mae, Multifamily fixed-rate mortgage loans
- Freddie Mac Multifamily Seller/Servicer Guide
This article is general information, not legal, tax or investment advice. The example figures are illustrative. DoorRaise is not a real estate broker, lender, law firm, broker-dealer, investment adviser or funding portal.