Managing the Complexities of Mixed-Use Developments

Robert P. Friedman

The recent resurgence of mixed-use developments, particularly in urban communities, has been spurred by the shortage of housing, the growing need for affordable housing, and the tepid demand for retail (due largely to changing spending habits and the growth of internet commerce). In fact, in many jurisdictions it is difficult to pursue entitlements for commercial uses without including apartments as a component of the process; and while mixed-use development has a long history, as with most aspects of real estate development, it involves more challenges and complexities than it did in the more distant past.

In the author’s experience, most mixed-use projects involve retail and residential components with the residential piece accounting for a majority of the square footage—and, in most of those cases, more than half the value. The fact that a project is mixed-use impacts each aspect of the development process, including: (1) zoning and land use, (2) design and integration of the dual uses, (3) financing, (4) construction, (5) management, and (6) sale.

Besides the obvious need to ensure that both uses are allowed under local zoning laws, the developer (or developers if the development of each use is divided) will want to ensure each use is on a separate legal parcel—which, among other things, preserves the option of financing or selling at different times. If the project’s ownership is bifurcated by use, it is also critical that the zoning and land use process is carefully coordinated.

Part and parcel of completion of land use and zoning approvals is designing an integrated project that also addresses the unique concerns of each user.  Whether the project is constructed vertically (e.g., a multi-story building with retail on the ground floor and apartments and/or condominiums above and parking likely below grade) or with separate structures at ground level, issues involving access, security, co-existing design, and rules and regulations relating to operation must be compatible.

In most cases, the design process takes place in two phases, with the first sufficient to facilitate land use and zoning approvals, and the second addressing design concerns with more specificity as part of the final design necessary for construction, loan approval and ultimately marketing for lease and/or sale.

Financing Concerns

Even if one developer is responsible for the entire project, because not all lenders have programs for both residential and commercial loans or, in many cases, the most desirable loans for each use may be offered by different lenders, the developer(s) must be prepared to facilitate an inter-creditor agreement with and between the two lenders as part of construction financing that addresses how the progress of the work will be monitored, the necessary funding for both uses and any common areas, cure rights, removal of the contractor (and/or developer) if warranted, and the like.

These same issues intensify if the project has two developers who, unless one has a substantially bigger piece of the project, will each prefer to assume responsibility for supervising construction (including the professional consultants) and the lender/borrower relationship because as a rule these interested third- parties strongly prefer dealing with one source. The lender (or lenders) particularly want comfort that decision-making involving the two developers can be resolved without sidetracking or delaying the completion of construction.

Permanent financing will likely be less complicated because construction will not be involved but is typically still more complex, especially if amenities and/or parking are shared, or if the project (or a portion thereof) is subject to a ground lease.  An otherwise successful project need not be defeated if it involves two different end uses and/or common area improvements as long as the documentation clearly defines (and limits) the responsibilities of the multiple decision-makers during the construction phase.

Once the project is completed, the documentation must address: (1) rights of access—typically through a recorded reciprocal easement agreement, (2) obligations and rights of use—usually in a recorded declaration of covenants, conditions, and restrictions, and (3) management—through the promulgation of rules and regulations and/or a management association to take responsibility for services and amenities as well as repairs and maintenance including a mechanism for collecting and maintaining the funds to do so.

If each use is on separate legal parcels, the owner (or owners) should be able to freely convey the uses separately unless a different understanding has been reached at the outset of the venture and is contained in a document (preferably recorded against title).

As is evident even from this summary, adding a mixed-use component to a development project always makes it more complex (and therefore more challenging). Given the current policies and economic realities that make mixed-use projects a more desirable alternative in many cases, developers will need to be resourceful and creative if they are to be successful.

Robert P. Friedman with Carlton Fields’ Los Angeles office has a legal career spanning more than four decades advising commercial developers, property owners, and tenants in a variety of transactional real estate and business matters.