Mixed use developments are schemes which comprise one or more buildings used for commercial, retail and/or industrial use where there is also an element of residential accommodation. Mixed use properties are not a new phenomenon; shops with living accommodation above have been a feature of high streets for centuries. However, modern times have seen an increase in more complex mixed use developments, many of which incorporate shops, restaurants and leisure facilities as well as residential flats.
Mixed use developments have obvious attractions for developers and investors; they combine the opportunity to extract capital value, by selling units on long leases, while at the same time retaining an income stream from the remainder.
There are several ways to structure the legal interests in a new mixed use development. The choice of structure depends largely on the developer’s future plans and whether it intends to retain either a reversionary interest in or management control of the development, or part of it, once it has been constructed and let. The developer must consider the potential impact of the statutory rights available to residential tenants, both on implementation of the scheme and in the future. Once a legal structure has been chosen and established it can be difficult to alter, so it is important to plan for the long term.
In terms of structure, a developer may choose to:
1. Retain the reversionary interest and manage the whole of the scheme/building. This structure is the most straightforward. Under this arrangement:
- The developer (as landlord) retains the exterior, structure and common parts of the building and covenants to repair them;
- The developer grants leases of each of the flats and commercial units directly out of the freehold;
- Any rents payable by the tenants are paid to the landlord. The level of rent payable will depend on the nature of the lease being granted. The Leasehold Reform (Ground Rent) Act 2022 restricts the ground rent chargeable on most new long residential leases to a peppercorn;
- The developer insures the building;
- Each of the tenants covenants to pay an appropriate proportion of the cost of the services (including insurance) provided by the landlord.
2. Dispose of both the reversionary interest and management of the scheme/building by granting a headlease of whole. This structure is suitable where the developer wishes to dispose of both the reversion and its management responsibilities to a third party, but still retain the freehold interest in the building. Under this arrangement:
- The developer grants a headlease of the whole of the building to a third party. Depending on the timing of this headlease, or the agreement to grant it, the developer may have to comply with the Landlord and Tenant Act 1987;
- The headlessee will either grant the leases of the units and flats to the tenants, or take the headlease subject to those leases that have already been put in place by the developer. This will depend on the timing of the headlease and whether the developer wishes to extract the capital value before handing over control of the building.
- Once the headlease has been put in place, the headlessee will become the landlord of the commercial and residential tenants, who will pay their rents to the headlessee. The Leasehold Reform (Ground Rent) Act 2022 restricts the ground rent chargeable on most new long residential leases to a peppercorn;
- The headlessee will take on responsibility for the exterior, structure and common parts and the management of the building, typically also insuring the building. The headlessee will provide the services to the tenants and the tenants will pay the appropriate proportion of the cost of the services to the headlessee.
3. Dispose of the reversionary interest in part of the scheme/building by granting a headlease of part. This structure is suitable where a developer wishes to hand over the management of part of the building, usually the residential areas, but retain the reversion to the remainder. Under this arrangement:
- The developer grants a headlease of part of the scheme/building to a third party. Depending on the timing of this headlease, or the agreement to grant it, the developer may have to comply with the Landlord and Tenant Act 1987;
- The developer will need to decide which part(s) of the scheme/building will be included in the headlease demise. In particular, it must decide which party will be responsible for the exterior and structure of the building and any common parts. Often it is preferable for the landlord of the residential tenants to have control of the structure and exterior, to ensure any long residential leases comply with the UK Finance Mortgage Lenders’ Handbook. The headlease will need to grant and reserve sufficient rights over any common parts to enable access by the commercial and residential tenants to the appropriate areas.
- The headlessee will either grant the leases of the units or flats within its demise to the tenants, or will take the headlease subject to those leases that have already been put in place by the developer. This will depend on the timing of the headlease and whether the developer wishes to extract the capital value before handing over control of the building.
- The service charge arrangements will depend on which party is providing the services. If a headlessee of the residential parts is responsible for maintaining the structure and exterior, for example, the landlord will be liable to pay to the headlessee the proportion of the cost attributable to the commercial units and seek reimbursement from the commercial tenant(s).