Mixed used development is on the rise throughout North American in urban areas. Many municipalities now wish to lever existing transportation networks and infrastructure, and avoid expensive urban sprawl, by increasing densities in urban areas. Intensification in turn enables and encourages mass transit which in turn reduces reliance on the automobile which in turn may result in more walkable cities and less air pollution. Cities today are focused on the creation of urban bike lanes, reduced facilitation of downtown parking lots (and long commutes) and the encouragement of mass transit. I call it the Europeanization of North American cities. Why? Because many European city cores pre-date the automobile, and already encourage bicycles, mass transit, and walkability. That’s why most of us love touring European cities.
Thinking in 3D
Back to North America. As buildings go up and sites become more dense, developers have to consider the highest and best use of their site horizontally, vertically, and segmenting by both. The highest and best use of the ground floor may be retail. Indeed it may be retail on the first basement level and on the mezzanine level. The highest and best use for the next several floors maybe office, hotel, institutional/government, or multi-family residential (either condominium/strata title homes or rental apartments). The best use of a backstreet facing part may be utility room, loading, storage, and management offices. The best use of a ravine facing part might be luxury condominium. The whole site, both horizontally and vertically, needs to be analyzed and segmented.
As developers think about highest and best use on an individual site, planners in turn want to encourage live, work and play environments possibly on a single site but certainly over a vicinity or precinct in an urban area. They want a mix, including public amenities such as parks and walkways.
Staffing/Collaborating for Mixed Use Capability
In the 80s there were many fully integrated developers who could do it all: retail, office, multi-family and indeed condominiums. In the 90s, particularly with the growth of REITs, many real estate entities began to specialize. They specialized in retail or office or multi-family or just condos and might have even specialized geographically. Today, some of the largest public real estate companies and real estate subsidiaries of pension funds may be able to staff up to be able to confidently develop retail, office, hotel, condominium or rental multi-family in house, but that is the exception. For many companies, they will need to partner up with other companies with different skill sets and experience in order to maximize the value of a site and in order to ensure the highest and best use of that site, on a 3 dimensional basis. Similarly, even urban sites that aren’t downtown may look at intensification as a way to maximize value. The owner of a strip shopping centre, for example, may consider adding a level or two of retail to the site and perhaps building a parking garage to meet any increased parking requirement as a result. That same owner may also consider selling off a portion of the land area on the shopping centre for rental, multi-family or condominium so as to build in a captive audience for its stores, again perhaps on the basis of it also building a parking garage to supplant parking spaces lost as a result of the sale of part.
In some cases a company may have the site but not the skill to develop mixed use. In other cases a company may have the skill but not the site. Collaborating may enable mixed use developments and the maximization of profit, given demand and supply in each sub segment in the 3D development, benefitting all parties involved. A win-win with potentially significantly reduced risk. At the time of writing, air rights in the City of Toronto are going for between $60.00 and $85.00 a buildable square foot compared to $25.00 to $30.00 less than seven years ago.
The Regulatory Function
Most cities in Canada are comfortable with horizontal severances in order to separate ownership of parts of a development in an urban area. This is not a new practice since this was being done for many projects in the 70s, including Hudson Bay Centre and Queens Quay in Toronto. In addition, condominiums with ground floor retail is a relevantly common site today.
The main difficulty lawyers have with non-condominium strata title developments is the fact that positive obligations do not run with the land and are therefore only enforceable in contract against subsequent owners. A positive obligation, for example, could be an obligation to pay money, or fix/maintain something. The Condominium Act has a statutory regime to ensure positive obligations do run with the land. Accordingly, in non-condo strata title arrangements, lawyers need to construct a regime of permitted transfers, rights of first refusal to purchase adjoining lands, and mandatory assumption agreements to make sure that owners of a strata title mixed use project always have privy of contract with their vertical or horizontal neighbours in the same project. Strata title and shared uses in a high density environment may spread risk may enable different uses to co-exist even where individual owners are specialists. The easements required to develop strata title depend on who is going to own what space and what facilities, equipment and building amenities are located either in someone else’s space or on the other side of someone else’s space, requiring access. For upper level uses, there should be a general easement for support from lower level uses and there should also be a general easement, if not specific easements, for fresh water lines, drains, natural gas, hydro, HVAC systems, telecommunications, pedestrian access, loading access, and parking access to name a few.
Choice of Architect and General Contractor
When constructing a mixed used project, particularly if one use is on top of another, it will be preferable to use a single architect and a single general contractor. Depending on the degree of separation of the uses, it may be possible for each party to have separate architects and to use a separate general contractor but the risk of dispute in such a scenario will be higher. Developing the reference plan of strata title and assigning the part numbers to owned and easement pieces is a key and important element in the development of mixed used projects, since each owner within that development will need to be sure that it has support from the structure below it, access to loading, access to parking, access to the street, access to the fire and life safety system and panel, access to core building amenities such as a the transformer room, together with the ability to move and change its equipment and facilities over time.
Cost Sharing Agreement
A Cost Sharing Agreement is the agreement that specifies, prior to commencement of construction, who will be responsible for what cost, both hard and soft, in the development and construction of a mixed use, mixed owner project. Disputes may arise in determining who should pay for what cost. It is important to have a detailed understanding of the construction budget before negotiating cost allocation. Some general principles and rules of allocation between 2 or more owners of a mixed use project might include:
- each party shall be responsible for the cost of constructing and building out its own space;
- for shared structural supports and walls, those costs could be divided up on the basis of the relative gross floor area of each space; and
- with respect to HVAC equipment and other shared equipment, the allocation could be done on the basis of benefitting party by one measure or another.
It is important to remember that there may be subjectivity in the allocation of certain costs such as the responsibility for the roof. Should it be at the cost of the upper strata title owner only? The strata dividing line separating an upper level owner from a lower level owner could be the midpoint of the dividing slab, and the cost apportionment could follow the title line. On the other hand, the cost apportionment could be separate from the dividing line and be based on the lower surface of that dividing slab, especially if it has to be unusually thick given the weight of the upper floor uses or the need to transfer structural support to an outside beam. On the other hand, one could argue the floor slab should be entirely the lower floor owner’s cost if the upper floor owner is paying for the roof.
If an agreement can be reached prior to commencement of construction through a Cost Sharing Agreement, and a single general contractor is used, the general contractor could be instructed to split the invoices to each owner in order to facilitate the bookkeeping.
It is critically important that cost allocation disputes not be allowed to arrest development during the process. Any disputes of about who should pay for what costs should be deferred to the end and the parties should continue to pay based on the Cost Allocation Agreement even if they dispute their obligation to pay.
It is also necessary in mixed use developments for there to be some statements as to anticipate permitted and prohibited uses in each space in order to minimize the risk of conflict down the road. For example, a retail use may not want competition above it, below it or beside it and so an agreement may restrain adjoining owners from leasing to a competing use. There may be other nuisances that ought to be constrained such as those that may generate odour, noise, vibration or humidity. There may be some common area conflicts such that each party wishes to constrain the other’s hours of operation. There may be branding or ethical risk that needs to be eliminated by preventing uses that are incomparable with a brand of the owner or the clientele of the use. By way of example, the owners may wish to prohibit an adjoining owner from selling pornographic material, providing body rub parlour or escort services, selling alcohol or cigarettes, or leasing to a “head shop”, or even, back to the issuance of nuisance, leasing space for a nightclub.
In some cases where there are multiple owners in a vertically stratified development, systems can be almost completely separated so that each party can be responsible for its own. In other cases it may be more economical and prudent to have a single shared HVAC system in which cases the costs of repair, maintenance and replacement of that will be an ongoing shared cost based on a specific cost sharing principle. Generally, fire and life safety panels will be shared in a vertically mixed development.
Reciprocal Operating Agreement
It is typically in most mixed used projects to have a shared services or reciprocal operating agreement post construction. This agreement will set out in detail responsibility for maintenance repairs and replacements for any common areas, requirements for joint building insurance and perhaps separate individual insurance on each owner’s premises, the right of first refusal to purchase an adjoining owner’s interest if its put on the market at any point and time, perhaps restrictions on street level and building top signage that may be installed, restrictions on uses as set out above, the creation of an insurance trustee regime for major damage that might occur, and a governance process setting out regular meetings and perhaps the creation of an annual budget for shared facilities and common area maintenance repair and replacement from time to time.
Upper Level Condominium
When an upper level owner is a condominium, there will be additional issues that bear on the development. The key element here is that you are mixing in people’s homes with commercial uses so the dynamic will change. Those homeowners are generally not there to object to the development in the pre-construction stage, since the condominium has not been built and the units have not been sold yet, but those same owners can make life post-construction difficult. They will be quite concerned about noise, odour and other nuisances around them. It is wise to put in an acknowledgement in purchase and sale agreements with condominium buyers regarding any adverse impacts of the development or adjoining uses on their use and enjoyment of their units in the future. In Ontario, Sections 111 to 113 of the Condominium Act gives the right of a new condominium board to terminate certain agreements as of right, such as a property management agreement, an agreement to terminate an agreement providing for provisions of good and services or facilities to the corporation and, with a court order, to terminate cost sharing agreements. These rights must be carefully reviewed to ensure that any reciprocal or cost sharing agreement entered into with a condominium developer can withstand a challenge by the new condominium board after the turnover meeting.
Financing Strata Titles
In addition to the foregoing, when each owner has their own separate financing to arrange, matters can get complicated as each lender will wish to review all major agreements including the cost sharing agreement as well as the ongoing shared facilities or reciprocal operating agreement to make sure they are fair and reasonable.
Mixed Use Developments are complicated but workable, and can result in greater profitability with lower risk in developing certain sites.