COMMERCIAL LEASING IN MIXED-USE CONDO PROJECTS

Mixed-use residential condominium projects create a number of issues for commercial landlords and tenants that should be addressed early in the leasing process.  

Mixed-use projects are becoming more common as urban infill increases. While all mixed-use projects create a number of issues for commercial landlords and tenants that are absent from comparable single-use projects, these issues are particularly pronounced in mixed-use residential condominium projects.  

The structure of a condominium project tends to decentralize the typical landlord-tenant relationship because the project will ultimately be controlled by an association acting through a board of unit owners. A tenant is unable to look directly to the landlord, who may simply be one owner of many, to perform customary "landlord" functions such as operating, maintaining, and insuring the building and common areas.

As a condominium unit owner, the landlord's interest will be subject to various governing documents. Any lease will need to be consistent with these documents and require the tenant's compliance with applicable restrictions. Lease provisions that parties are accustomed to negotiating at length, such as rights related to use and access, insurance requirements, operating expenses, maintenance obligations, and procedures following casualty events, to name a few, will largely be dictated by the project's governing documents.

To add to this already difficult framework, the nature of the users' interests are fundamentally different and often at odds. On one end of the spectrum are residential homeowners, directly involved in the association and highly invested in the operation of the project. On the other end are commercial tenants who must look to an absentee landlord to ensure their rights are enforced and protected. Commercial units also typically form only a small part of an overall project, putting commercial owners and their tenants at risk of being marginalized by the majority residential owners.

Review The Governing Documents Early

Given the potential for conflict, commercial landlords and tenants should review the project's governing documents as early as possible. These documents include the declaration of covenants, conditions and restrictions, condominium plan, association articles of incorporation, bylaws and budget, and applicable rules and regulations, such as architectural standards. The governing documents in larger projects may also include documents related to a master association, and separate reciprocal easements and cost sharing agreements.

The landlord may be unable to obtain amendments to the governing documents in an existing project, and a tenant or potential purchaser should see the review as part of its early feasibility analysis. A tenant may request revisions to the proposed governing documents if the project is still being developed, and a landlord/developer should generally accommodate reasonable requests and proactively include protections for the commercial uses because a commercial unit may have little value if its use is overly restricted or its share of expenses too burdensome.

Ensure These Critical Issues Are Addressed

Commercial landlords and tenants should ensure the following issues are adequately addressed (at a minimum) when reviewing the governing documents: 

Protection of Minority Interest –

Protections should be included to ensure the commercial owner's interests are not easily overridden or interfered with by the residential majority. This can be done, for example, by requiring a commercial owner's approval for matters material to the commercial unit, and by excluding the commercial unit from, or providing alternative standards for, certain rules and regulations, such as architectural review requirements.

Restrictions on Use –

Restrictions on use, whether blanket restrictions on nuisance activities or specific restrictions on access, hours of operation, noise levels, and the like, are commonly included in governing documents and should be reasonable. Ideally, they would include broad exceptions for contemplated commercial uses, particularly with respect to operating hours, outdoor music and noise, and common odors.

Operational Obligations –

The governing documents should clearly indicate the extent of the association's obligations to insure and maintain the project and comply with applicable laws, such as accessibility requirements, so that the parties can clearly allocate any remaining obligations in the lease.

Appurtenant Rights –

In addition to clearly describing the commercial unit, the governing documents should grant the commercial owner and its tenant the right to use others areas necessary for the tenant's operation, such as parking, outdoor patios, trash enclosures, roof access, and shared signage.

Operating Expenses –

The operating expenses that landlords and tenants customarily negotiate in a lease will instead largely be incurred by the association and passed through to unit owners in the form of assessments. These assessments should be reasonably allocated. Commercial owners should not be required to contribute to facilities used exclusively by residential owners, and vice versa. To the extent facilities are shared, the allocation of costs should generally be based on rates of consumption or use, rather than a unit's pro rata share of the overall project.

This article originally appeared in the Western Real Estate Business magazine

Jonathon Giebeler

Jonathon Giebeler is a graduate of the University of Southern California Law School, where he also earned a Master of Real Estate Development. His practice emphasizes commercial leasing representing landlords and tenants (including retail, office and industrial leases), real estate-secured finance, and the sale and purchase of real property.