mixed-use development: structuring air rights...

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Presenting a live 90-minute webinar with interactive Q&A

Mixed-Use Development:

Structuring Air Rights Condominiums and

Other Common Interest Community Regimes Selecting the Optimal Legal Structure, Addressing Core Drafting

Challenges, and Minimizing Potential Construction Defect Claims

Today’s faculty features:

1pm Eastern | 12pm Central | 11am Mountain | 10am Pacific

TUESDAY, AUGUST 30, 2016

Robert P. Detrick, Partner, Husch Blackwell, Denver

Douglas M. Irvin, Of Counsel, Ballard Spahr, Washington, D.C.

Emily J. Vaias, Of Counsel, Ballard Spahr, Washington, D.C.

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Selecting the Optimal Legal Structure, Addressing Core Drafting Challenges, and Minimizing Potential Construction Defect Claims

▪ August 30, 2016 ▪ ▪ Ballard Spahr LLP ▪ ▪ Husch Blackwell ▪

Mixed-Use Development: Structuring Air Rights Condominiums

and Other Common Interest Community Regimes

Prepared and Presented by:

Douglas M. Irvin, Esq. 202.661.2272

[email protected]

Emily J. Vaias, Esq. 202.661.2239

[email protected]

Robert P. Detrick, Esq. 303.892.4448

[email protected]

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Mixed Use Development: Structuring Air Rights Condominiums and Other Common Interest Community Regimes

A. Zoning considerations and options for subdivision of air rights and horizontal developments

B. Types of common interest developments: condominiums, planned communities, and reciprocal easement agreements (“REAs”)

C. The air rights condominium as an ownership and development vehicle

D. Structuring air rights condominiums and planned communities to address the challenges of mixed-use development: you have to keep them separated

E. Addressing the for-sale residential component of a mixed-use development

F. Defending builder contracts from purchaser termination claims

G. Construction defects claims—what’s going on behind the curtain

H. Legislative responses to abusive construction defect claims

I. Drafting strategies to discourage construction defect claims

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A. Zoning considerations and options for subdivision of air rights and horizontal developments

1. Division of Land through Subdivision Process

2. Reasons to Avoid Subdivision

3. Alternatives to Subdivision

B. Types of common interest developments: condominiums, planned communities, and reciprocal easement agreements (“REAs”)

1. General Characteristics: A group of property owners, residential, commercial or both, that are governed by a common scheme of rules (usually a recorded Declaration, Bylaws and/or REAs) intended to regulate the relationships of the owners and their use of individually and commonly owned property within the development.

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B. Types of common interest developments: condominiums, planned communities, and reciprocal easement agreements (“REAs”) (continued)

2. Condominiums.

(a) Condominiums are distinguished by the ownership of real estate in common by a group of Owners. When a Condominium is created, the property is divided into units, each of which is owned in fee simple by an Owner, and the Common Elements are owned as tenants in common by all unit owners.

(b) Common Elements may sometimes have their use restricted to particular Owners (examples include balconies, patios, and garage spaces) as "limited" or "restricted" Common Elements. The drafter usually has great deal of flexibility in how the units and Common Elements are defined.

(c) The responsibility for and the control of the Common Elements are vested in the Condominium Association.

(d) Condominiums are highly regulated. The formation and sale of Condominium Units is the subject of extensive legislation in nearly every jurisdiction, including the requirement to register a Public Offering Statement prior to offering residential units for sale.

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3. Planned Communities (or Homeowners Associations).

(a) Homeowners Associations are found in situations where a group of property Owners need to, or wish to, act in concert in order to own and operate common facilities or to establish a set of common guidelines for ownership within a group of separately owned properties.

(b) A Homeowners Association can be distinguished from a Condominium in that its members do not own property in common. Common Areas are owned in fee by the legal entity that constitutes the Homeowners Association.

(c) Examples of the purposes for which Homeowners Associations are formed include:

(i) Ownership of common facilities – The ownership, maintenance and operation of common facilities such as open space, swimming pools, hiker/biker trails, storm water detention areas, and recreation facilities.

(ii) Exterior maintenance of Owners' properties – The HOA can provide painting, lawn maintenance and other services to Owners. Popular in “turn-key” projects where Owners wish to perform little maintenance themselves.

(iii) Restrictive Covenants – Enforcement of Restrictive Covenants to promote the appropriate use of the common areas and to protect the “character” of a community, typically including architectural controls.

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4. Reciprocal Easement Agreements (“REAs”).

(a) When an REA is used, there usually is no common property ownership among the participants. Common interests are regulated through agreements and easements that run with the land.

(b) Control and responsibility under an REA is often vested in a single participant.

(c) Enforcement of an REA can more difficult than with other Common Interest models because there may be no statutory funding or enforcement mechanism, as there is with a Condominium or Homeowners Association (these issues must be specifically addressed in the REA).

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C. The air rights condominium as an ownership and development vehicle

1. What is an air rights condominium?

(a) Everyone is familiar with traditional subdivisions - typically created by a record plat prepared and recorded in accordance with local zoning ordinances. Common law concept - each lot owner owns the land from the center of the earth to the heavens.

(b) Condominium statutes allow the property owner to divide this traditional property interest into separate ownership units, which are typically stacked. Good example is a typical high-rise condominium in which each unit corresponds to the separate dwelling unit conveyed to each unit owner.

(c) Condominium statutes are generally very flexible regarding how a “unit” may be defined. For example, Chapter 4.2, Section 55-79.41 of The Virginia Condominium Act defines “land” to include the following: “Parcels of airspace constitute land within the meaning of this chapter.”

(d) For purposes of our discussion today - an air rights condominium is one in which the “units” are cubes of airspace that are intended to include structures, or portions of structures, within the cube unit (as opposed to a traditional condominium unit that is located inside of a residential structure). Each such cube unit generally corresponds to the differing proposed uses of the structures, or portions thereof, such as “Residential Unit” “Retail Unit” “Office Unit” and “Parking Unit”.

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C. The air rights condominium as an ownership and development vehicle (continued)

2. In many mixed use developments the preferred transaction structure is and air-rights condominium which permits a fee simple purchase of air rights. This structure is generally preferred by institutional debt and equity partners, and provides for a wider range of capital sources for the project.

3. A Ground Lease structure is an alternative that could be considered - but is generally not desirable if there is a for-sale component.

4. In many (if not most) jurisdictions the air rights condominium is the only means to divide air rights into separate ownership units, which may be separately owned and financed. However, some jurisdictions allow air space to be subdivided using a record plat or other administrative filing (e.g., DC & Arlington County,VA).

5. If “vertical” or air rights subdivision is allowed then an REA structure is possible as an alternative to an air-rights condominium. REAs are frequently used by commercial developers and property owners in more traditional settings (e.g., retail malls and shopping centers) that do not involved “stacked” ownership to address operation and maintenance issues among the property owners. If you do not need (or want) to use a condominium structure then an REA could be used if your jurisdiction allows the creation of air rights lots.

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6. Although in some cases parties express a preference for an REA (usually because of familiarity with the format), an REA is not really superior to a condominium structure. Issues of operation and maintenance of a commercial property are typically complex (“too complex” is sometimes an argument used against the condominium structure) which results in a complex REA.

7. A distinct advantage of the condominium structure is that the condominium plats give you an opportunity to address structural complexities graphically on the plats which results in an easier to understand ownership structure and allocation of rights.

8. Hybrid is possible: “de minimis” condominium plus REA. If an REA approach is for some reason required (have had this as a result of party preference) then a condominium can be used to simply establish the air rights units, and then these units may be subjected to a separate REA. In this case the “de minimis” condominium has no real operational role in the property.

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9. Examples of mixed-use developments.

(a) Historic precedents: Annapolis MD; Place Des Vosges, Paris France.

(b) Modern examples: Bethesda Row, Montgomery County, MD; Annapolis Towne Centre, Annapolis, MD.

(c) Air-Rights Condominium Plats: Washington Harbour Condominium, a relatively simple example of an air rights condominium. Includes 2 air rights units: ‘PARKING FACILITY UNIT” and “RESIDENTIAL UNIT”. Example plats show: multiple levels; designations of “common element” features, e.g., stairwells, lobby area, pool & roof top amenities; subdivision of “RESIDENTIAL UNIT” into individual dwelling units.

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Example Mixed Use Development: Annapolis, MD

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Example Mixed Use Development: Place Des Vosges, Paris France

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Example Mixed Use Development: Bethesda Row, Montgomery County, MD

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Example Mixed Use Development: Annapolis Town Centre, Annapolis, MD

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Example Mixed Use Development: Washington Harbour Condominium

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D. Structuring air rights condominiums to address the challenges of mixed-use development: you have to keep them separated

1. Creation of “cube” units allows for the separate ownership and financing of air rights.

2. Complex air rights developments are typically multi-year efforts. Condominium statutes allow for phasing, so the cube units can be created in phases to match the development and construction schedule of a project. The initial units can be used to secure acquisition and construction financing on a phase by phase basis.

3. The condominium structure is a good means (particularly when coupled with clear and detailed condominium plats) of addressing site-wide issues of operation and maintenance. Shared amenities and building components (e.g., parking areas, courtyards and plaza areas, roofs, storm water management facilities, etc.) can be easily shown on the plats and responsibility for maintenance assigned.

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D. Structuring air rights condominiums to address the challenges of mixed-use development: you have to keep them separated (continued)

4. Each unit is assigned a percentage interest which defines the unit owners’ ownership interest in the common elements, and their responsibility for common expenses. The obligation to pay assessments is typically lien supported.

5. The condominium provides a structure for addressing casualty and condemnation. The condominium association is typically assigned responsibility for obtaining and maintaining property and liability coverage, and for adjusting claims if and when they occur.

6. Public - Private Partnerships: The air rights condominium structure provides a good means for addressing special issues that arise in public private partnerships. Public entities typically do not want to be treated the same as other owners in the air rights development. Because the publicly owned space will be defined as a separate cube unit, it becomes fairly straight-forward to establish special provisions for that unit.

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D. Structuring air rights condominiums to address the challenges of mixed-use development: you have to keep them separated (continued)

7. For example, public entities may not want to be involved in the day to day operations of the condominium. The condominium documents can be structured to establish the public entity as a “silent partner” that participates only in major decisions, such as document amendments or material capital improvements.

8. Public entities also typically want some type of control over the level of assessments (if any) that may be imposed against their units. The condominium instruments can establish assessment caps and exemptions.

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E. Addressing the for-sale residential component of a mixed use development

1. Air rights projects typically include a residential component, both rental apartment and for-sale condominium.

2. The for-sale component will typically be established as a separate “sub” condominium regime within the cube “RESIDENTIAL UNIT” established by the master air rights condominium. The for-sale component will be covered by a registration application, including a public offering statement, for example in Virginia filed with the Virginia Department of Professional and Occupational Regulation (Common Interest Community Board).

3. It is important that the public offering statement and other disclosure materials for the for-sale component clearly describe the overall master air rights condominium and the relationship of the “sub” condominium to the master.

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E. Addressing the for-sale residential component of a mixed use development (continued)

4. The establishment of “cube” units at the master air rights condominium level provides the opportunity to shield the master developer from potential warranty liability associated with for sale condominiums. The cube “RESIDENTIAL UNIT” will typically be owned by a separate special purpose entity specifically formed to develop and sell residential condominium units. For example, the Virginia Condominium Act generally provides for a 2-year warranty against structural defects applicable to the units and common elements given by the “declarant” of the for-sale units. If the units are created and sold by a separate special purpose entity, then it will be this entity that gives the unit and common element warranties.

5. Governance issues are very significant. Condominiums are typically governed by a board of directors that is elected by the unit owners. The master air rights developer wants to avoid a scenario in which residential unit owners can control the operations of the air rights condominium. While tempting, it is not advisable to completely deny the for-sale residential unit owners any say in the operation of the air rights condominium. The best approach is to grant the for-sale unit owners the right to elect a designated number of directors (which should constitute a minority of the board) and to grant the commercial unit owner the right to elect a majority.

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E. Addressing the for-sale residential component of a mixed use development (continued)

6. In addition to voting control, it is usually desirable to include specific protections and disclosures regarding the commercial activities within the condominium, particularly with regard to retail users (e.g., restaurants and bars). For example, it is typically desirable to include specific limitations on the ability of the air rights condominium to adopt rules or otherwise take actions that would have an adverse impact on the retail unit owners or users. Also, the public offering statement should include prominent disclosures regarding potential retail uses and the possibility that unit owners will experience noise, smells, traffic, etc. associated with these uses.

7. Divide & Conquer - it is also usually desirable to create parallel but separate governance structures within the air rights condominium, e.g., a “Commercial Section” and a “Residential Section”. Each section has its own executive committee, budget and enforcement authority within their respective sections. This can help to minimize undue interference by the residential owners in commercial operations. The master board is relegated to dealing with issues of site-wide importance, such as adjusting a major casualty to the property.

8. Conversion condominium - consideration should be given to subjecting any rental component to a “shelf” condominium for purposes of minimizing the impact of statutory provisions designed to apply to rental facilities that are “converted” to a for-sale condominium. This is typically accomplished by subjecting the rental facility to a condominium regime prior to the offer or rental of any units within the rental facility.

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F. Defending builder contracts from purchaser termination claims

1. In times of market down turn builder’s typically experience increasing contract rescission rates. This was particularly true in the post-2007 market where some projects experience rescission rates in excess of 30%. Knowledge of potential contract rescission claims is easily obtained and widespread. See e.g., Looking for Loopholes, Washington Business Journal, July 20, 2007.

2. Incomplete Disclosures – may mean contracts are unenforceable. Purchasers are entitled to complete disclosures and updates. Applicable Condominium and Homeowners Association Acts have specific disclosure requirements that must be followed.

3. Consumer Protection Act violations – statutes typically proscribe unfair or deceptive trade practices. Violations can lead to enforcement actions and sanctions by local government authorities.

4. Doctrine of Mutuality - A contract that does not impose a binding obligation on both parties is illusory and may be deemed invalid for lack of mutuality. Excessive limitation of purchaser remedies in the event of seller default can render the contract illusory. Contract drafters must avoid the temptation of “over zealous” provisions in favor of seller.

5. Federal Interstate Land Sales Full Disclosure Act (“ILSA”) - Registration or exemption is required. ILSA generally applies to the sale or lease of lots in a subdivision by making use of interstate commerce or the mails, and unless the sale or lease is exempt under ILSA, the developer must register the subdivision with HUD. “Improved Lot” exemption typically used for fee simple lots located in a Homeowners Association, and requires that dwelling unit be completed within 2 years of purchaser’s execution of sales contract. Recent amendments to ILSA have generally exempted for-sale residential Condominium projects. Remedies for failure to comply include the right of purchaser to rescind their contract within two years of signing.

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Construction Defect Claims

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What’s going on behind the curtain?

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Using common interest community statutes to

create “class action” construction defect claims

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Construction Defect “Class Actions” Via Common Interest Community Statutes

Collateral Damage

1. Condominium development significantly decreased

- Avoid litigation

- Insurance too expensive

- Easy to switch to less risky product type

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Collateral Damage

2. Fewer Affordable Housing Options

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Collateral Damage

3. Skyrocketing Rental Rates

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Collateral Damage

4. Hostages

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Collateral Damage

4. Hostages

• No Say

• Difficulty Refinancing

• Difficulty Selling

• Special Assessments!

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Claims Instituted by the Board

1. UCIOA • Section 3-102(a)(4) – The Assn may engage in litigation, arbitration or

administrative proceedings on its own behalf or on behalf of two or more unit owners on matters affecting the CIC.

• Section 3-102(b)(2) – Except for the limits permitted by Section 3-124, the declaration shall not limit the power of the Assn to engage in litigation, arbitration or administrative proceedings, except: • The Assn shall comply with Section 3-124 , and • The Board shall notify owners of the proceedings.

• Section 3-124 – The Assn can not institute proceedings until 45 days after giving notice of the construction defects to the Declarant or other party the Assn seeks to hold liable. The Assn may institute a proceeding by vote of the Board, and the determination may not require a vote by any number or percent of unit owners as a condition to institution of a proceeding.

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2. Fiduciary Duties of Board Members

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2. Rip It to Shreds

Rip Her to Shreds

Rip Her to Shreds

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4. The Pitch

• Defects Could Exist Everywhere

• Right to Sue

• Fiduciary Duty

• Engagement Letter

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Legislative Responses to

Abusive Construction Defect Claims

Means:

• Plat or Map Notes

• Local Ordinances

• State Statutes

Requirements:

• Right to Repair

• Arbitration

• Notice to Owners

• Other

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Drafting Strategies to

Discourage Construction Defect Claims

• Right to Repair

• Informational Notice to Owner’s Prior to Vote

• Owner Vote

• Arbitration

• No Changes Without Declarant’s Consent

• Separate Declaration

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