Building Blocks of Mixed-Use Transactions

By: Robert (Bob) H. Voelker
Hospitality Lawyer
April 14, 2008

Some questions that frequently come up in mixed use transactions:

1. What are the benefits and detriments of a mixed-use project? Developers are intrigued by mixed-use projects for several reasons. The combination of retail, office, hotel and apartment uses allows developers to spread the risk associated with softness in any one particular real estate market. High land costs and shared infrastructure (e.g., parking garages, utility lines, backup generators) can be spread over more uses stacked vertically. In addition, for-sale components of the project (or components that upon lease-up can be easily monetized and sold) allow early returns on/paybacks of debt and equity. The mixture of uses also creates synergisms where residential and office create captive customers for retail stores and restaurants. 
2. Should we use a condominium regime or airspace parcels to create the separate uses? The answer is largely dependent on what is permitted under local law. Some states (like California) recognize conveying property by three-dimensional airspace parcels (basically two dimensional survey metes and bounds descriptions with upper and lower elevations -- similar to three dimensional jigsaw puzzle pieces). However, most states (like Texas) only accept two dimensional conveyances, such that airspace parcels must be artificially created by a condominium regime filed in the deed records by the property owner. Although it is possible to use condominium regimes in states that allow conveyances by three-dimensional airspace parcels, many states require costly and time consuming registration and regulatory approval of condominium regimes, but allow non-residential (commercial) condominium units (e.g., hotel, retail, office) to be transferred via airspace parcel deeds without any regulatory registration or approval. An example is helpful: the mixed use project contains a hotel, retail and residential condominium units and we want to create this project in California and Texas. In California, we would create the three uses by airspace parcels and convey these parcels to separate entities, a hotel entity, a retail entity and a residential entity. The residential entity would then prepare a condominium regime, seek regulatory approval and then file the condominium plan. In contrast, in Texas we would create a master condominium regime with 3 commercial condominium units – hotel, retail and residential – and then create a sub-condominium regime for the residential condominiums.
3. When are restrictive easement agreements (REA’s)used and when are condominium declarations used to govern the relationships between the various uses? This question is tied to question 2 above. Among other provisions, condominium declarations and other condominium documents define the “common elements” in the condominium regime and rules and regulation governing their use. A simple deed of an airspace parcel does not normally contain any discussion of the common elements, such that REA’s are needed to create the rights of and rules governing the parties use of common areas. 
4. In a vertical mixed-use project where the uses are stacked and owned by different parties, how do the parties work together in developing the project? The co-developers should seriously consider hiring one architect for the entire project, or at least granting one of the architects the authority and responsibility to act as lead architect in integrating all of the plans, and sharing some of the critical engineering design firms (e.g., mechanical/electrical/plumbing and structural) will also facilitate plan coordination. In general, the developer with the use that has the highest cost should take the lead in design and construction. For instance, a mixed use development with a hotel over ground floor retail should be primarily led by the hotel owner, although the negotiating process over building design, cost and construction is much more interactive as the parties ultimately need to coexist for the duration of the project. The process of moving the project from conception through design, value-engineering, construction documentation and construction management is very similar to a dating-to-marriage relationship, where there are common interests early on but no commitment, and as the relationship proceeds there are rough spots but more commitment. As long as the parties are dedicated to the project and willing to make sacrifices and compromises to reach the end goal, the project will proceed. I typically document this arrangement with a “Cooperation Agreement” that provides that the parties will work together within certain time frames to take the project from conceptual design to schematics, design development and construction documents based on a set development schedule, sharing costs along the way. 
5. If there are shared components in the project, how can one party be assured that the other party will pay for and build their component? To the extent that there are “joint improvements” or shared components of the project (e.g. utility lines, underground parking garages, loading docks), at closing and commencement of construction the parties and their lenders and equity partners will want to be assured that the other party will pay for and build their portion of the joint improvements. The funds for the joint improvements or letters of credit backing up the parties obligations should be escrowed at closing. In addition, the joint improvements should be constructed by one contractor under a separate construction contract, and the parties should have “self-help” rights to utilize the land or parcels owned by and the escrowed funds of the other party if that party does not build its portion of the joint improvements. 
6. How are development and construction costs divided up between the parties? Determining sharing ratios for the joint improvements is more art than science. The construction contract for the joint improvements should require the assistance of the contractor in determining a reasonable allocation of these costs (which is necessary to determine the collateral to be posted by the parties, as described in 5 above), and on more complex mixed-use projects the parties should consider hiring a third-party construction cost consultant to work with the contractor and the co-developers to perform this cost allocation. 
7. Who should maintain the joint improvements and other common elements and who should pay for this maintenance? The condominium documents and/or REA’s should establish the party responsible for maintaining each of the joint improvements and other common elements. Typically the co-developers will hire third parties to perform the maintenance, and the agreements with these third parties should contain look-back provisions where the maintenance company assists the parties on an annual basis in determining a reasonable allocation of the maintenance costs based on the parties relative use of the joint improvements and other common elements.