Ground Floor Commercial Spaces in Mixed-Use LIHTC Developments: Worth the Risk? 

Mixed-use Low Income Housing Tax Credit (LIHTC) developments featuring a ground-floor commercial space offer developers a potentially powerful financial tool. They can create opportunities for economic diversification and growth within the surrounding community.

However, strict guidelines for maintaining LIHTC compliance, combined with a variety of logistical and financial challenges inherent to a combined commercial-residential building, can make ground-floor commercial projects utilizing LIHTC a challenging endeavor.

The inclusion of ground-floor commercial space within multifamily projects is appealing for a few reasons. Mixed-use construction can diversify the renter base and add a dependable source of income from commercial renters. It can provide lasting community benefits by enhancing neighborhood walkability and enlivening street fronts. Particularly for low-income communities, mixed-use development can reduce neighborhood isolation and increase access to jobs, groceries, and childcare centers.

With these benefits in mind, local policy priorities may result in zoning codes or other regulations that require the inclusion of ground-floor commercial space in some multifamily projects, particularly in business districts within urban cores. However, according to a recent report published by the American Planning Association, many cities are beginning to relax or altogether abandon those requirements as in-person business has continued to struggle post-COVID.

The Challenges of Ground Floor Commercial
Despite the potential benefits of ground-floor commercial space for developers, there are often added costs associated with this kind of construction, such as extra parking spaces, adequate firewalls between ground-floor commercial and upper-floor residential units, and adding elevators. Additionally, local zoning laws governing mixed-use residential can add a layer of complexity during the planning and permitting phases, further driving up costs.

Finally, once a mixed-use LIHTC project is built, developers must then budget time and resources for marketing the ground-floor commercial space, all while dealing with periods of prolonged vacancy in their commercial spaces, once again driving up overall projected costs.

Maintaining a tenant in the commercial space of a mixed-use development can also be unpredictable, says Andy Post, an affordable housing developer for Beacon Development Group.

Pre-building estimations of the viability of a project’s ground-floor commercial space can be complex, with actual revenue often falling short of what businesses and developers project. “Sometimes these businesses don’t garner the foot traffic or business from residents and the broader community as expected,” Post says. “There has to be buy-in from the public’s perspective. Yes In My Backyard (YIMBY) isn’t just advocating for zoning changes or supporting housing in your area, it’s knowing and supporting the coffee shops, restaurants, cafes, community centers, and more that operate in the commercial space of affordable housing buildings.”

On top of these challenges with vacancy, U.S. Department of Housing and Urban Development (HUD) rules stipulate that for projects with ground-floor commercial developments, no more than ten percent of a building’s eligible costs go towards building the commercial space. No more than 20 percent of the project’s income is derived from a commercial source. If the latter rule is broken, developers risk being recategorized by the IRS as a commercial building, thereby losing eligibility for its LIHTC funding. This can be a concern for investors, who may not want to risk recategorization and thus lose the subsidy.

Navigating Mixed-use: Condos vs. the “Master Lease” Strategy
One common strategy developers and investors are now using to protect themselves from financial loss on a LIHTC ground-floor commercial project is through the creation of a “master lease.” This approach involves the developer or an affiliate of the developer signing a lease to take over the commercial space. 

The developer then signs on as a tenant of the commercial space and pays back rent to the owning partnership or entity, while also renting the space to a business, like a shop or restaurant. If the commercial space fails to generate significant long-term income, the developer can avoid defaulting on the master lease by making a new arrangement with their project partners.

“Condominium-izing” the commercial space is another common strategy developers use to curtail some of the financial risk associated with mixed-use projects. Legally subdividing and allowing condo members to own their commercial space allows developers to collect income with relatively less risk compared to leasing the space to retail businesses.

According to Post, the “condominium-izing” approach often results in better overall community cohesion for mixed-use projects. “Commercial condos are another structure we frequently use to allow the commercial space to operate on a timeline that works better for the condo members,” he explains. “Frequently, the commercial condo spaces complete their tenant improvements after the certificate of occupancy is issued for the LIHTC units, allowing lease-up to begin as soon as possible.”

Even with these strategies at their disposal, the risks and complexities inherent to mixed-use ground-floor commercial projects discourage most developers and investors from taking the leap.

While nationwide numbers are unavailable and recent literature and data on the topic is sparse, city-level analyses indicate that mixed-use commercial/LIHTC properties are rare: in Chicago, for example, only 5.4 percent of LIHTC buildings incorporated mixed uses, according to a 2018 study published in Housing Policy Debate.