Buyers should be careful when buying an apartment in a mixed use building where the commercial units are separately owned because the offering plan can give unfair advantages to the commercial unit owner. Buyers should be especially wary if the commercial units are retained by the sponsor, owned by an affiliate of the sponsor or have been sold to a third party by the sponsor.
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The most common trick played by shady developers is to retain the commercial unit for themselves, or to sell it to a related party. They’ll then write the offering plan in such a way as to give special rights and few responsibilities to the commercial unit owner.
For example, the below excerpt is from an offering plan for a re-development in Lower Manhattan that came to the market half a decade ago.
Do the percentages allocated to the commercial unit sound fair considering that it occupies the bottom two floors of a ten floor building?
In any budget year, Common Charges may be assessed against the Commercial Unit for the following expenses, only in the percentages provided, and no other expenses that are included in Common Charges may be charged to the Commercial Unit:
(i) 2.2% of each of the following building wide charges: electricity;
(ii) 4.0% of each of the following building wide charges: repairs and maintenance, supplies, payroll and elevator maintenance and repairs; and
(iii) The percentage of Common Interest appurtenant to the Commercial Unit of each of the following building wide charges: insurance, sprinklers, management fees, accounting fees, legal fees and miscellaneous fees.
Sponsors can be really sneaky in order to protect the commercial unit from bearing the brunt of any major repairs. They’re able to do this by inserting language into the original offering plan that puts an upper limit on the amount of money that the commercial unit owner is responsible for when it comes to special assessments.
In any budget year, special assessments may be assessed against the Commercial Unit only in the percentages provided, provided that the Commercial Unit Owner shall the not be responsible for the amount of any individual special assessment that exceeds $10,000.
This can be a real problem if the building needs to levy a major special assessment in order to pay for a new roof or extensive façade repairs. For example, if the building just failed a Local Law 11 inspection and needs to make immediate façade repairs on all four sides of the building, the residential owners will have to subsidize the commercial owner who won’t be paying their fair share!
Unfortunately for residential owners, they typically won’t be able to get around this cap on special assessments simply by increasing common charges to bolster the building’s reserve fund:
In any budget year, special assessments levied to increase building’s reserve fund may be assessed against the Commercial Unit only in the percentages provided, provided that the Commercial Unit Owner shall not be obligated to contribute to any portion of the reserves that are in excess of 10% of the annual Budget, to the extent such excess is applicable only to the Residential Unit.
One of the dangers of buying an apartment in a mixed use building is that the commercial unit owner may use way more than their fair share of any shared utilities, such as water or gas.
For example, what if the commercial unit is leased to an ice cream store that uses a lot of water? If there isn’t a separate water meter for the commercial unit, the residential unit owners might end up subsidizing the commercial unit owner’s extremely high water bill!
See below for an excerpt from a recent mixed use building condo conversion in lower Manhattan.
Note that the condo board is restricted in being able to charge the commercial unit owner directly for utilities used, and that the condo board is only able to be reimbursed per separate meters maintained by the commercial unit owner.
In any budget year, no Common Charges may be assessed against the Commercial Unit for the following expenses, which may not be charged to the Commercial Units in any amount:
(ii) Water charges and sewer rents, it being understood that the Commercial Unit Owner shall only be responsible for the actual amount of water charges and sewer rents attributable to the Commercial Unit, as based on a separate meter reading, and the Commercial Unit Owner shall reimburse the Board for any payments made by the Board to pay such water charges and sewer rents attributable to the Condominium Unit;
(iii) Virtual doorman unless the Commercial Unit Owner elects to utilize the virtual doorman system, in which case it will pay Common Charges in accordance with Section 7.2.1 of the By-laws;
(iv) Structural repairs or replacements with respect to any Residential Common Element; and
(v) Exterminator service contracts, unless exterminator services arc necessitated by the actions or inactions of the Commercial Unit Owner or the use of the Commercial Unit, it being understood that the Commercial Unit Owner shall be obligated to regularly exterminate the Commercial Unit in a commercially reasonable manner.
Condo offering plans are often written in such a way that the commercial unit owner will always have a board seat. For example, one recent condo conversion building’s offering plan states that “at all times the Commercial Unit Owner may, in addition to voting, designate one (1) person to the Board.”
Furthermore, some condo offering plans will go so far as to allow the commercial unit owner to remain a board member even if they no longer own their unit:
Other than members elected by New Sponsor or its designee or the Commercial Unit Owner, no member shall continue to serve on the Board of Managers after he or she ceases to be a Unit Owner or an interested party in a Unit Owner.
Offering plans can also be written by the sponsor in such a way as to make it virtually impossible for the residential unit owners to band together and remove the commercial unit owner’s board member:
Subject to the provisions of the By-laws, at any regular or special meeting of Unit Owners, any one or more of the members of the Board may be removed with or without cause by a majority of the Unit Owners, and a successor may then and there or thereafter be elected to fill the vacancy thus created, except that members elected by New Sponsor and Commercial Unit Owner or its designee may only be removed by New Sponsor and Commercial Unit Owner said designee, respectively, and only such person shall have the right to designate a replacement for any member removed by such person.
Any member of the Board whose removal has been proposed by the Unit Owners shall be given an opportunity to be heard at the meeting. Notwithstanding the foregoing, Board members designated by New Sponsor and Commercial Unit Owner or its designee may only be removed by members other than New Sponsor and Commercial Unit Owner or its designees with cause. In addition, any member of the Board who is designated as such by New Sponsor and Commercial Unit Owner or its designee may be removed by such designating party at any time, with or without cause, and the party making such removal shall have the right to designate the replacement for such member.
Sponsors can write the condo or co-op’s original offering plan in such a way that the commercial unit owner can essentially lease it to whomever they wish. This means that the business you see operating today may be gone tomorrow, and who knows what type of commercial tenant will be there next.
See below for an excerpt from a new condo development’s offering plan:
Pursuant to the terms of the Declaration, the Commercial Unit Owner shall have the right, in its sole and absolute discretion, to use the Commercial Unit for any lawful purposes, except for any Prohibited Uses listed in Exhibit E to the Declaration. The Commercial Unit has its own entrance.
Permissible Use. Current zoning allows for residential use as proposed for the 3rd through top floors, and commercial use below, also as proposed. Commercial use may include retail store, restaurant and office space. Community facility use is also permitted. The proposed use of the Building requires compliance with all zoning and use requirement as of the date of this Report.
Fortunately, many sponsors will include a section in the offering plan where they list prohibited uses. As you can see from the excerpt below, prohibited uses are mostly illegal or extremely unsavory types of activities:
Any use that impairs or threatens the structural integrity of the Building or the life, health, safety, security or protection of Unit Owners, tenants or occupants of Units;
Any use that results in the cancellation or a notice of cancellation of insurance maintained by the Board:
Any pawn shop;
Any dumping, disposing, incineration or reduction of garbage (exclusive of garbage compactors located in or adjacent to the Building);
Any establishment selling paraphernalia relating to the use of illegal drugs;
Any commercial or non-profit establishment of any type or nature whatsoever: (a) the primary purpose of which is to sell, afford or permit on-premises sexual stimulation or sexual liaisons including a massage parlor; (b) which permits or presents obscene, nude or semi-nude performances or modeling; (c) which sells, affords or permits body massages, whether or not of a sexual nature; (d) which sells “rubber goods” or other sexual or erotic products of a type not commonly found in high-quality, national chain pharmacies; (c) which sells, rents or permits the viewing of X rated video, photographs, books or other material; provided, however, that Unit Owners may use or lease portions of their Units to (x) stores or newspaper or magazine vendors who may stock “adult” magazines or books as an incidental part of such store’s or vendor’s business (provided such “adult” magazines or books are discreetly displayed) and/or (y) cafes or store-fronts providing computer use or internet access (provided such services are not principally geared to providing access to pornographic sites) and/or (z) stores or store-fronts offering relaxation or stress-reduction services not requiring the removal of articles of clothing (other than shoes and outerwear);
Any gambling facility or operation; provided, however, that Unit Owners may use or lease portions of their Units to stores or newspaper or magazine vendors who may sell “lotto” or other governmentally sponsored lottery type tickets to the general public;
Any welfare or homeless shelter, soup kitchen, food pantry or settlement house; and
Any facility housing or treating persons guilty of aggravated felonies under Federal law, felonies under New York State law, or Class A misdemeanors under New York State law (hereinafter defined as an “Impermissible Offender”), for the avoidance of doubt, a juvenile offender not adjudicated to be guilty of the aforementioned felonies or a Class A misdemeanor shall not be considered an “Impermissible Offender”).
An original offering plan can give the commercial unit owner the right to renovate, alter or even subdivide the commercial space without needing approval from the condo or co-op board.
Unlike residential owners, the commercial owner might not have to sign an alteration agreement and pay various fees to the building. See below for an excerpt from a recent condominium conversion offering plan:
If not prohibited by the Condominium Act, the Commercial Unit Owner or its designee and its respective successors and assigns shall have the right, without the vote or consent of the Board, other Unit Owners or the representatives of holders of mortgages on Units, if any, to: (a) make alterations, additions, or improvements, whether structural or non-structural, interior or exterior, ordinary or extraordinary, in, to and upon the Commercial Unit; (b) change the layout of, or number of rooms in any Commercial Unit, from time to time; (c) change the size and/or number of Commercial Units by subdividing one or more Commercial Units into two or more separate Commercial Units, combining several Commercial Units (including those resulting from such subdivision or otherwise) into one or more Commercial Units, altering the boundary walls between any Commercial Units, or otherwise, provided the Residential Units, Residential Common Elements and Residential Limited Common Elements remain unchanged; (d) incorporate into any Commercial Unit any of the Commercial Common Elements (whereupon any such Commercial Common Element shall be deemed to be a Commercial Limited Common Element, including, but not limited to, hallway space), provided only that access to any other Unit on the floor is not materially impaired; and (e) reapportion among the Commercial Units affected by such change in size or number, pursuant to preceding clause (d) their appurtenant interest in the Common Element, provided, however, that the percentage interest in the Common Elements of any other Units shall not be changed by reason thereof unless the Owners of such Units shall consent thereto and, provided, further, that the Commercial Unit Owner or its designee and its respective successors and assign shall comply with all laws, ordinances and regulations of all governmental authorities having jurisdiction thereof, and agrees, and shall be deemed to have agreed, to hold the Board and all other Unit Owners harmless from any liability arising therefrom.
This can actually become a nuisance for the residential owners who actually have to live in the building, especially if the commercial unit’s renovation work is extremely loud or otherwise disruptive. See below for an excerpt from a recent new development condo’s offering plan:
Some of the Commercial Unit Owner’s alterations, additions or improvements may result in the interruption of certain building wide services for a period of time. Except in an Emergency, the Commercial Unit Owner shall only be permitted to do such work in its Unit when legally permissible or during the hours of 8 am – 8 pm, Monday – Friday, and 9 am – 8pm Saturdays, excluding recognized federal holidays.
The offering plan may give the commercial unit owner extensive authority to re-write many of the building’s key operating documents. For example, take a look at this excerpt from an new construction condo’s original offering plan:
Subject to the provisions and restrictions in the Declaration, amendments, modifications, additions or deletions of or to the Declaration, these By-Laws and the Residential Rules and Regulations may be necessary, appropriate or desirable in connection with the operation of the Commercial Unit or the subdivision of the Commercial Unit into separate commercial condominium units and/or the offering for sale or lease of all or any portion of the Commercial Unit. In connection therewith, it is contemplated that the Condominium Board, Sponsor, or a Commercial Unit Owner will request or cause the Declaration and these By-Laws to be amended, modified, added to or deleted from and that the resulting provisions thereof may be similar or dissimilar to those affecting the Residential Unit Owners. In the case of any such amendment, modification, addition or deletion that does not adversely affect the Residential Unit Owner or any Residential Unit Owners, as reasonably determined by the Condominium Board, the Condominium Board shall be the attorney-in-fact for the Residential Unit Owners, coupled with an interest, for the purpose of approving and executing any instrument effecting such amendment, modification, addition or deletion.
Disclosure: Hauseit® and its affiliates do not provide tax, legal, financial or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal, financial or accounting advice. No representation, guarantee or warranty of any kind is made regarding the completeness or accuracy of information provided.