Legal Agreements for Mixed-use Projects

Anyone considering developing a mixed-use project should be aware of these key legal, design and management considerations.

MIXED-USE development projects of all types – including urban infill projects, transit-oriented developments and walkable lifestyle communities – have taken hold in urban centers and suburban areas across North America. Millennial consumers, as well as downsizing retirees, increasingly favor living within walking distance of stores, their favorite cycling and barre classes, restaurants and cultural venues, rather than having to drive to homes at the distant reaches of urban sprawl.

Paul N. Dubrasich

Local governments love mixed-use development for a variety of reasons. They put less pressure on infrastructure cost than more sprawling development, create accessible job opportunities, reduce traffic and help stimulate local commerce. Developers are responding to the evolving demographics and environmental forces driving these types of developments, not just in the urban core, but also in outlying areas, especially on sites close to public transportation.

What Is Mixed-use Development?

“Mixed use” is a generic term for real estate projects that combine two, three or more product types. They often incorporate both residential and commercial components into a single building or podium structure. The different components of a mixed-use project are typically owned and operated by different entities, with interests that are not always aligned. This means that the legal, entitlement and management issues that are common to all developments must be examined even more closely in mixed-use developments. They may impact the project in a variety of ways, including the following.

Subdivision and Ownership

More often than not, building components in a mixed-use project are designed to be owned separately. A multifamily company may own the market-rate apartments, while a tax credit entity may own the affordable units. A block of residential units may be sold as condominiums, while retail, office, hotel or garage components may be operated by companies specializing in these uses. In these cases, the components of the project must be legally subdivided. This can be done either by dividing the project into condominium blocks or, if allowed by the state and local jurisdiction, creating a vertical airspace subdivision.

The differences between condominium projects and vertical airspace subdivisions are subtle but significant. The management of condominium projects is usually highly regulated by state statutes, while vertical airspace subdivisions may not be. Condominium projects are governed by declarations of covenants, conditions and restrictions (CC&Rs) that create a management board and establish strict assessment requirements and use restrictions. A vertical subdivision is more likely covered by a reciprocal easement agreement (REA) that may be less formal but also addresses cross easements, management and cost sharing for the project as a whole.

Entitlements

Whether it is comprised of condominiums or vertical airspace parcels, the mixed-use development of the future will increasingly offer – or be located close to – live, work, play, shop venues in an all-inclusive setting. With brick-and-mortar retail suffering at the hands of e-commerce, stores may be downsized, specialized and/or narrowly focused on serving local residents and workers. Restaurants or hotels, rather than stores, may serve as project anchors, along with the residential units.

From an entitlement standpoint, developers must always contend with governmentally imposed conditions such as affordable housing, prevailing wage, energy efficiency, traffic management and sustainability requirements, to name just a few. Mixed-use development, however, adds another element of complexity, because it involves potentially incompatible uses in a confined area. Obviously, a nightclub or saloon may be unsuitable immediately below residences. Even restaurants may require special easements through the building for proper ventilation, odor mitigation or pest control. This is where REAs and CC&Rs come into play. Use restrictions in these documents must be strict enough to appease residents but flexible enough to make retail and other commercial spaces marketable.

Management

The differing interests of residential and commercial owners can lead to conflicts in management control, use restrictions and association dues. Simple concepts like the design review for project alterations or collection of reserve funds for future capital repairs or replacements can be a matter of dissent between commercial and residential owners. Who controls management and decision-making within the project is key, and the REA or CC&Rs need to carve out veto and special voting rights for decisions that impact one type of use in a material way. This is, in practice, not always a flexible decision, because condominium laws in many states require strict protections for residential owners that sometimes simply don’t fit in the commercial or retail context.

Parking

Parking is almost always a concern in new mixed-use projects. The amount of allowable and/or required parking may be impacted by many factors, including supply and demand, local zoning and proximity to public transportation. How parking is allocated and whether it is assigned or unassigned, self-park or valet, free or fee-based, operated by a private company or an owners association, are all questions to be addressed early in the planning process. Trends such as the increasing use of electric and, in the future, driverless vehicles, as well as car-sharing and ride-hailing systems, also need to be taken into account.

Security

Mixed-use developments typically are designed to attract the public to their retail and commercial components but should also provide adequate privacy and security for residential owners and tenants. This should ideally include separate ingress and egress for residents. Developers should consider whether parking areas will be segregated or gated and whether common areas and amenities will be made available to users of different project components. Adequate lighting not only makes common sense, but may be a risk-management necessity to avoid future design liability.

Sales and Risk Management

In practice, commercial and residential properties are marketed differently. They are appraised by different methods and measured by different standards. They are sold under different types of sales contracts. This, however, is not always possible in mixed-use developments, because sales and marketing laws in many states do not distinguish between residential properties and mixed-use properties that include residential uses.

While retail and other commercial properties are rarely the subject of protracted construction defect litigation, this is not necessarily true when they are part of a larger mixed-use development that includes residential uses. From a risk management standpoint, developers should be vigilant about maintaining adequate insurance for completed structures. They are well advised to establish both construction claims procedures and alternative dispute resolution processes in all sales contracts, both commercial and residential.

All In

Well-designed mixed-use developments are essential to the revitalization of urban and, increasingly, suburban areas. They can, on a large scale, create vibrant and fulfilling living environments for both young and older residents. The rewards can be maximized by developers who pay close attention to the legal, design and management challenges associated with residential and commercial owners existing in close proximity and sharing the responsibility for property maintenance, security and operations.

Paul N. Dubrasich, partner, Cox Castle Nicholson LLP