3-D approach to mixed-use developments

Analyze, segment the site to capitalize on intensification opportunities
Tuesday, March 12, 2013
By Michael Brooks

Mixed-use development is integral to intensification and the growing movement in North American cities to promote transit and pedestrian-friendly neighbourhoods and urban nodes. It’s also in sync with developers’ conventional objective to attain the highest and best use for a site.

Increasingly, this means thinking in 3-D: horizontally, vertically and segmenting by use. Retail may be the highest and best use at the first/upper basement, ground and mezzanine levels, while the highest and best use for the next several floors could be office, hotel, institutional/government or multi-family residential (either condominium/strata title homes or rental apartments).

The best use of a backstreet frontage may be utility rooms, loading, storage and management offices. The best use of a ravine frontage might be luxury condominium. The whole site, both horizontally and vertically, needs to be analyzed and segmented to capitalize on intensification opportunities.

Yet, in contrast to development trends, developers themselves have become more specialized. In the 1980s, there were many fully integrated companies that could deliver retail, office and/or multi-family residential. Today, with the exception of a few large public real estate players and real estate subsidiaries of pension funds with a wealth of in-house resources, many companies will need to form partnerships to cover off all the skill sets required.

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.

Beyond downtown, intensification can also be a way to maximize value. The owner of a strip shopping centre, for example, might consider adding a level or two of retail to their site and, perhaps, building a parking garage to meet any increased parking requirement as a result. That same owner might also consider selling off a portion of the land area on the shopping centre for a multi-family project, thus, creating a captive audience for its stores.

On the zoning front, most municipal governments are comfortable with horizontal severances to separate ownership of parts of a development in an urban area. This is not a new practice and has been approved for many projects beginning in the 1970s, including the Hudson Bay Centre and Queens Quay in Toronto. Similarly, residential condominiums with ground floor retail are now relatively common.

Non-condominium strata title developments differ in that positive obligations – such as an obligation to pay money or fix/maintain something – do not bind future owners and are therefore only enforceable against the original parties to the contract. Ontario’s Condominium Act has a statutory regime to ensure positive obligations do run with the land but 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 owners of a strata title mixed-use project always have privy of contract with their vertical or horizontal future neighbours in the same project.

Strata title and shared uses in a high-density environment may spread risk and enable different uses to coexist even where the development of individual segments are done by specialists. The easements required to develop strata title depend on who is going to own what space and what facilities.

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-use projects. Each owner within that development will need to be sure it has support from the structure below it, access to loading, parking, the street, the fire and life safety system and panel, and core building amenities such as a the transformer room, together with the ability to move and change its equipment and facilities over time.

When constructing a mixed-use project, particularly if one use is on top of another, it will be preferable to use a single architect and general contractor. Depending on the degree of separation of uses, it may be possible for each party to have separate architects and general contractors but the risk of dispute in such a scenario will be higher.

A cost-sharing agreement 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 two 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.

If a cost-sharing agreement can be reached prior to commencement of construction and a single general contractor is used, the general contractor could be instructed to split the invoices to each owner based on the agreed cost-sharing principles to facilitate the bookkeeping.

It is critically important that cost allocation disputes not be allowed to arrest development during the process. Any disputes 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.

There should be some statements to anticipate permitted and prohibited uses in each space to minimize the risk of future conflict. 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 nuisances that ought to be constrained such as those that may generate odour, noise, vibration or humidity.

Parties may wish to constrain others’ hours of operation or they may want to prevent uses that are incomparable with the brand of the owner or the clientele of the use. Notably, 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 space for a nightclub.

Operational arrangements
In some cases where there are multiple owners in a vertically stratified development, HVAC 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 case, 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.

Post-construction, a shared services or reciprocal operating agreement is typical. 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 it’s put on the market; 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.

Homeowner dynamics
When an upper level owner is a condominium, there will almost invariably be additional issues that bear because it mixes people’s homes with commercial uses. Homeowners are generally not there to object to the development in the pre-construction stage but those same owners can make life post-construction difficult, potentially with concerns 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, 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 goods 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 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.

Michael Brooks is the real estate practice group leader at Aird & Berlis LLP.

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