Operational Challenges in Mixed-Use Projects Session Sponsor Ross Painting has been creating happy customers throughout the San Francisco Bay Area since 1986. Family owned and operated, we are large enough to take on large projects, yet small enough to provide outstanding personal service. We take great pride in providing quality painting, managing our projects and impressing our clients! www.rosspainting.com © 2017 CACM Law Seminar Operational Challenges in Mixed-Use Projects Presented by Northern California: Tom Connell, CCAM-PM.HR & Alex Noland, Esq. Introduction Mixed-use projects are appealing to the marketplace. They allow residents to walk from their unit and go shopping, or to a bar or restaurant, without having to get in their car. These projects can have greater curb appeal than a typical residential building, as they not only conserve valuable land resources by vertically stacking residential and commercial/retail uses, but can also brighten communities and add urban vitality. More and more developers are constructing mixed-use projects in both urban and suburban areas, bringing activity and a stronger sense of neighborhood to the surrounding area. That said, mixed-use projects present unique issues for community managers that are not encountered in solely residential projects, such as permitted commercial uses and related nuisance factors relating to those uses, segmented use and architectural provisions, differing maintenance responsibilities for the different unit types, and complications related to assessments and cost centers. Effectively managing conflicting residential and commercial interests in these projects can be a challenge, as the desire of residents to live in peace competes with the desire of commercial occupants to operate a business for profit. This seminar will assist managers working with mixed-use project associations to: (1) understand how to address differing use restrictions, architectural control guidelines, maintenance responsibilities, cost centers, and owner priorities and needs; (2) develop policies and procedures to address differing residential and commercial rights and obligations; (3) identify whether permitted uses are being conducted in commercial units and how to address potential use violations; and (4) handle complaints between residential owners and commercial owners. Differing Owner Rights and Obligations It is important for managers of mixed-use projects to know from a legal standpoint how to address differing use restrictions, architectural control guidelines, maintenance responsibilities, cost centers, and owner priorities and needs. In addition, for an association subject to a reciprocal easement agreement or mutual benefit agreement (or similar document), the manager needs to understand the rights and obligations of both the association and the other party(ies) to the agreement and the mechanisms and procedures for addressing disputes about agreement provisions and compliance. Use Restrictions An association’s CC&Rs will describe what commercial uses are permitted in commercial units, and what types of commercial uses are not permitted. Often, there will be restrictions against such businesses as bars/cocktail lounges; arcades, bowling alleys, billiard parlors, or theatres; any establishment related to adult entertainment; any business related to illicit drugs; gambling houses; health services facilities offering overnight care; lodging houses; funeral homes; and denominational places of worship. The permitted uses will also depend on local zoning ordinances or planning codes and any special conditions that may be imposed by the local planning department, as well as regulations of the local department of public health. Commercial owners are generally allowed to divide their space without permission, and they may be permitted to use sidewalks as outdoor seating space. In that case, however, voting rights and assessment obligations of the owner of the commercial unit would general remain the same. Further, there is generally a restriction contained in mixed-use CC&Rs relating to the permitted hours of operation for commercial units, as well as specific provisions to help ensure that there is not excessive noise, light, smoke, or vibration from the commercial unit that would disturb residential owners. © 2017 CACM Law Seminar. All rights reserved. 1|Page Operational Challenges in Mixed-Use Projects Commercial units will often be excluded from certain general use restrictions in the CC&Rs (which thus apply only to the residential units), as well as any operating rules adopted relating to those restrictions. Such exemptions often include, among other things, the following items: (1) leasing restrictions, and approval and notice requirements relating to leases and tenants; (2) use of power equipment/tools, vehicles, storage of potentially hazardous materials; and (3) restrictions on floor coverings, sound transmission, and certain “nuisance” activities. Architectural Control Guidelines With respect to architectural and design control, commercial owners/units are generally not subject to the architectural control provisions of the CC&Rs, and do not require board/architectural committee approval to make unit modifications. For example, commercial owners are often granted leeway to modify their space, move/add/remove walls, and move or relocate utilities within the commercial unit without permission; this means that a single commercial owner can subdivide the space into several commercial spaces with different tenants. However, commercial owners will still generally be required to obtain approval for any modifications affecting structural elements of the building or the use of the common area by residential owners, and, while reasonable conditions may be placed upon such modifications, often such work cannot be disapproved. Maintenance Responsibilities Maintenance obligations will be more complex in a mixed-use project than in a purely residential project, as a commercial owner generally has a different maintenance role than that of the residential owners. For example, commercial owners may be responsible for any commercial common-only areas, while the association may be responsible for residential and shared common areas. There may also be additional maintenance responsibilities not contemplated under the CC&Rs relating to the commercial unit that need to be delegated. Scheduling maintenance can be one of the biggest problems in a mixed-use building. This is because different parts of the building are accessible and occupied during different times of the day. When inspections, maintenance, or repairs need to be done on facilities serving both the residential and commercial components, or facilities serving only one component but located within the other component, trying to work out the logistics of access into units and limited common areas be a challenge. This will require timely communication and effective coordination with the impacted owners. Cost Centers and Expenses The calculation of assessments is often more complex in mixed-use projects as there can be shared costs for all owners as well as cost centers specific to residential owners only and specific to commercial units only. The separation and unequal allocation of costs can be due to certain portions of the common area being limited to use by only commercial or residential owners, differing maintenance/repair obligations and ownership interests, and different insurance requirements. Common examples of cost centers include residential area common expenses, commercial area common expenses, shared/general common expenses, security/patrol and other personnel expenses, and parking/garage expenses. Sometimes the costs are allocated equally among the units participating in the cost center, and other times the costs are allocated on a variable basis (such as by unit square footage or number of assigned parking spaces). In particular, utility costs can be an issue if there are shared utility services, such as water, electricity, or refuse collection. If there are utility costs paid by the association that benefit both the residential and commercial components, the CC&Rs should address how the cost of shared utilities are to be allocated between residential and commercial owners in light of their level of consumption. If that allocation is not clear in the CC&Rs or seems unreasonable, it would be prudent to advise the board to consult with the association’s legal counsel to determine a resolution to the issue. © 2017 CACM Law Seminar. All rights reserved. 2|Page Operational Challenges in Mixed-Use Projects The presence of commercial uses within the building may significantly increase the cost of insurance for the association. This potential impact on insurance premiums should be recognized in the allocation of insurance costs between the residential and commercial owners, and will hopefully be addressed in the CC&Rs. In addition, having businesses on the property creates special risks not present in all-residential condominium projects, such as injury to customers/patrons and loss of business revenue when a business must close as a result of fire or other casualty or to accommodate common area repairs. To avoid a situation where the association governing a mixed-use project is sued by a customer/patron of a commercial unit, or by the commercial unit owner or tenant themselves, the commercial owner (and, as applicable his or her tenants) should be required to obtain their own insurance for these risks, and to provide proof to the association that the insurance is in place. Whether the association has the authority to require specific insurance will be dependent on the provisions of its CC&Rs. Owner Priorities and Needs There are conflicting goals for the residential owners and the commercial owners. Commercial owners are interested in operating for profit, and may not be cognizant of (or care about) some of the externalities of their business operations. On the other hand, residential owners want to be able to enjoy their homes without unreasonable disturbances; while governing documents for mixed-use projects generally state that there may be additional nuisances arising from the mixed-use nature of the project, that does not allow commercial owners to cause unreasonable nuisances. The association/board need to balance these interests and ensure that governing documents are consistently and timely enforced. In a mixed-use project, each residential owner and each commercial owner is entitled to the rightful enjoyment of his or her unit – residential owners are entitled to a livable environment in the residential units, and commercial owners are entitled to operate business profitably in the commercial units. The natural tension between residential owners and commercial owners can be minimized when the critical issues facing a mixed-use project are addressed by carefully written and detailed CC&Rs. Reciprocal Easement Agreements and Mutual Benefit Agreements Sometimes, instead of having a mixed-use project organized under a single association, there will be two or more separate associations/developments with their own governing documents but with joint obligations and rights under a recorded document such as a reciprocal easement agreement or a mutual benefit agreement. In effect, this arrangement accomplishes many of the same things as a single combined association, but there is a more distanced relationship – both legally and philosophically – between the residential owners and the commercial/retail owners. When a commercial parcel is not a part of a residential association contained within a mixed-use project, the association is much more limited in its enforcement rights with respect to the commercial operation. Development of Policies and Procedures The development of policies and procedures to address differing residential and commercial rights and obligations is important in a mixed-use project. A commercial owner’s interests may not align with those of residential owners (or the association’s board of directors). The association should establish clear guidelines and rules regarding potential problem areas so that it is clear to the residential owners (and commercial owners) what their rights and obligations are. In particular, parking rules for shared lots/garages and guest/customer parking, as well as rules detailing the common area use rights of the residential owners and commercial owners and nuisance restrictions, are important. © 2017 CACM Law Seminar. All rights reserved. 3|Page Operational Challenges in Mixed-Use Projects Nuisance Factors Problems can arise that involve trash, smells, traffic, and noise transferring from one use of the building (a bustling restaurant or store) to another (residential units). There may be situations in which the association needs to bring in an acoustical consultant to help address noise and vibration issues (i.e., mechanical equipment on a roof above residential units that serves the commercial units can produce vibration that enters the residential units below). And, in mixed-use buildings with restaurants, it will be crucial that the commercial owners and occupants take sufficient measures to eliminate odors from both food and trash and properly store and discard food items and waste. Parking Parking is another common issue that arises for mixed-use projects. Shared parking, whether on-grade or in the building, is often separated in a mixed-use project, and an association has to be vigilant about policing parking restrictions. Too often, people come into a store or restaurant in a commercial unit and want to park as close as they can – sometimes parking in a resident’s space. This results in the resident coming home from work or elsewhere to find a commercial customer/patron parked in his or her parking space, even though near the space there is a sign that says “Residents Only”. In the converse, sometime residents will want to park their vehicles in parking spaces designated for commercial units or allow their guests to do so for sake of ease, which impacts the ability of the commercial unit operator to accommodate parking for his or her customers/patrons. CC&R Amendments and Rule Changes The developer of a mixed-use project will often plan at the outset to sell the residential units and hold on to the commercial units as investment property. That being the case, the developer’s attorney may (and likely will) write the governing documents in a manner that includes minimal to no CC&R provisions regulating the use of the commercial units and essentially giving the association no authority over commercial unit operations. That becomes a problem with no easy solution when commercial unit operations are causing a nuisance to the residential owners but the commercial units are being used in a manner that complies with the CC&Rs, leading to potentially no technical violation to pursue and enforce. Commercial owners also benefit from protections in the CC&Rs that protect their business interests. There are generally provisions stating that sections of the CC&Rs or Bylaws related to the commercial units may not be amended without the express written permission of the commercial owner, and this limitation can make it difficult to pass amendments, which would impact a commercial owner in some way. This also means that amending and restating the governing documents may be very difficult if not supported by the commercial owner. The same situation often applies with respect to an association’s operating rules; rules and regulations that purport to bind the commercial units generally require the consent of the commercial owner to be bound by such rules and regulations. Designated Board Seats Many mixed-use bylaws grant the owners of the commercial unit either a designated seat on the association’s board of directors, or an advisory or ex officio position on the board in which the commercial board member is entitled to receive notices of and attend board meetings and participate in board discussions but not vote. When addressing is type of board position it is critical to determine how election or appointment of the commercial seat is intended to occur (particularly with respect to California’s statutory secret ballot voting procedures for association elections), and who is qualified to serve on behalf of the commercial owner. Additionally important is the determination of what sort of issues may arise if a representative of the commercial owner is not seated in its designated position; for example, the bylaws or CC&Rs could state that any action taken by the board without proper notice to the advisory or ex officio commercial board member shall be of no force or effect. © 2017 CACM Law Seminar. All rights reserved. 4|Page Operational Challenges in Mixed-Use Projects Verifying Commercial Use Compliance A manager should know how to identify whether permitted uses are, in fact, being conducted in the commercial units in a mixed-use development. A set of CC&Rs for a mixed-use project will usually include a list of certain uses that are not permitted in the commercial units, such as nightclubs, amusement arcades, adult bookstores, massage parlors, blood banks, funeral homes, betting and gambling establishments, denominational places of worship, cannabis dispensaries and smoke shops, etc. In addition, commercial uses must also comply with applicable zoning ordinances and any special conditions imposed against the project, as well as local health codes. And, with respect to restaurants and bars, there may be special provisions relating to the serving of food and/or alcohol and the type of food or bar operation that is allowed under the CC&Rs. Beyond permitted and prohibited commercial uses, another significant issue is whether the CC&Rs contain restrictions on the days and hours of operation of the commercial units, particularly when it comes to restaurant and bar operations, due to the noise and lights, among other things, that these operations can cause in the evening hours. There may be different hours as to when the interior unit space can be open for business and when a patio or sidewalk areas adjacent to the unit and used for service can be open for business. Also, the CC&Rs may prescribe certain hours (and areas) for deliveries to commercial units. Some CC&Rs contain provisions regulating the use of amplified or recorded music and television transmissions in the interior and outdoor areas of a unit. Other items like signage, window displays, lighting, awnings, horizontal sign extensions, and window appliques may be regulated under the CC&Rs. In the restaurant and bar context, there may be CC&R provisions relating to venting and ventilation systems, grease traps/interceptors, and chemicals and hazardous materials. Lastly, there may be minimal lease restrictions (i.e., only requirements that leases for a commercial unit be in writing and state that the lease is subject to the association’s governing documents), but there will often be no right of the association to restrict the leasing of any commercial space. An association’s manager and board need to be familiar with these use covenants, conditions, and restrictions, as the association will be responsible to enforce them in the event of a violation. When a question arises as to use compliance, verification may require a unit inspection, or research into local zoning codes and/or possibly local health codes. For example, in San Francisco, owners of properties zoned for industrial/agricultural use cannot grow medical marijuana unless the owner also has a licensed retail business where the marijuana is sold (i.e., marijuana cannot be grown and sold wholesale). If an association is going to take the position that the use of a commercial unit is not permitted, it will be prudent for the board to seek the advice of the association’s legal counsel in advance to ensure that the board and association are in a defensible position. Handling Complaints Between Residential and Commercial Owners As with other nuisance disputes, an association should ideally attempt to resolve commercial unit nuisance issues informally at first or through other methods designated in its alternative dispute resolution policy, as may be applicable, and proceed to court as an absolute last resort. The nature of mixed-use projects creates tensions between residents and commercial occupants, particularly between residential owners and restaurant and bar operators; even in a well-run restaurant or bar, there are a lot of issues that can arise, such as odors, vermin, noise, etc. The primary challenge for the board of directors, management personnel, and residential owners of a mixed-use project is that they do not have much say or control over activities conducted in the commercial units. And, at the end of the day, the residential owners purchased their units knowing (or at least being on record notice by way of the CC&Rs) that there are commercial uses in the project that are reasonably expected to, or likely will, cause certain nuisance factors to the residential units. © 2017 CACM Law Seminar. All rights reserved. 5|Page Operational Challenges in Mixed-Use Projects Drag Queen Pillow Fighting and Jell-O Wrestling The Plaza at Five Points Condominium Association in Sarasota, Florida sits atop the now defunct Ivory Lounge nightclub. Starting in 2013, condominium residents started complaining that club noise was keeping them up at night, and the owner of Ivory Lounge countered that he had done everything possible to keep the sound from his club from bothering the residents. In January of 2014, the association pressured the City of Sarasota to revoke Ivory Lounge's business permit, claiming the club was operating as an “adult business” by staging drag queen pillow fighting and gelatin wrestling events. The association’s complaint targeted the club's customers, saying that they were not “mature or educated” and not keeping in line with the description of the business permitted under Ivory Lounge’s conditional use permit. The owner of Ivory Lounge claimed that he felt some of the older residents in the building resented his customers — most of them younger people — regardless of how loud the music was. The city found no basis for the association’s claims, and did not pursue any action against the club. The association’s residents also pressured the owner of the commercial space to break the club's lease, and filed numerous unsubstantiated noise complaints with the Sarasota police. The attorney for the owner of Ivory Lounge acknowledged that the association’s residents have a right to complain about whatever they want, but that the association’s residents (including some board members) were carrying out a plan to hurt the business operations of the club, made complaints that they knew were false, and were motivated by dissatisfaction with the content of the club’s music and the nature of its clientele. The residents of this association were unwilling to try and live as neighbors with Ivory Lounge, due in part to personal biases and in part to not wanting to accept that their association was part of a mixed-use situation. Hans' Bier Haus In 2010, a Houston, Texas bar was in a much-publicized battle with residents of a condominium association. The noise dispute arose between the residents of the association and the open-air beer garden located below the residential units. Some residents living above Hans' Bier Haus went from making noise complaints about the bar to actually spraying water and throwing ice blocks and raw meat down onto the bar and its patrons, as well as making personal attacks and assaults against them. Eventually, the bar owner won in court, and was found not to have created an unreasonable nuisance. Dispute Resolution Options The advice to give to a board of directors whose association is embroiled in anything that could lead to something similar to the Ivory House or Hans’ Bier Haus situations should be to set a meeting and have everyone try to talk like neighbors. There are methods an association’s manager can pursue to try and help ease tensions between residential and commercial owners, such as the following ideas: 1. Educate the residential owners about the allowed uses and operations in the commercial units, and help the association stay within the authority that its governing documents provide. Residents should be reminded that the association and its board of directors only have the control granted to them in the governing documents, and that they were on notice of the (potential) commercial uses and related issues when they purchased or moved into their units. 2. Work collaboratively with both the residential owners and the commercial owners to try and resolve sensitive and “hot” issues. One option that may work is to have the board form a committee comprised of representatives of both the residential and commercial units to evaluate and provide guidance and advice to the board on those issues. © 2017 CACM Law Seminar. All rights reserved. 6|Page Operational Challenges in Mixed-Use Projects 3. Involve the commercial operators/occupants with the residents. A way in which to foster a proactive working and living relationship between the residential and commercial owners is through communication and social events. For example, a commercial owner running a restaurant in his/her commercial unit could be encouraged by the board to attend and supply some food for the association’s annual meeting and to send around a coupon to the residents at other times during the year. Such actions by the commercial owner can create goodwill with the residents that may help diminish complaints by residents about the restaurant being a little loud on a given evening. If all else fails, the association’s board should consider the nuisance provisions under the CC&Rs and whether the association should request internal dispute resolution (a meet and confer) with the owner of the commercial unit at issue or alternative dispute resolution (mediation). Of course, it would be prudent for the board to consult with the association’s legal counsel before pursing either of these options to confirm the rights and obligations of both the association and the commercial owner in the matter at hand. Conclusion Complicated situations will often arise at mixed-use projects with respect to nuisance factors and building operations, and differing owner uses and interests introduce complexity into association governance. This complexity can make the determination of the various rights and obligations of owners in the project more difficult to ascertain. Dealing with and managing these competing interests requires a firm grasp of the various provisions of the association’s governing documents and an understanding of the legal implications of those provisions. The best way to avoid issues related to the mixed-use nature of a project is to be aware of the rights and obligations of the residential owners, the commercial owners, and the association itself, as well as understanding how to prepare appropriate policies and procedures and how to address commercial owner and residential owner violations. Being proactive in creating policies and procedures for a mixed-use project can help to balance the potentially competing interests that arise as a result of having both residential and commercial uses in a shared building. This will help prevent issues and disputes from arising and escalating between the residential and commercial owners, which in turn will help promote harmony within the community and reduce association legal costs. © 2017 CACM Law Seminar. All rights reserved. 7|Page
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