Commercial Tenants in Residential Buildings The Neighbor Downstairs

We all hope for good neighbors when we move into a new building or community. The same is true for commercial properties in residential buildings. Making a good match, one that benefits both the commercial tenants and unit owners, can go a long way in creating a harmonious and happy building. 

There are a number of different scenarios that involve the presence of a commercial entity within a residential building. The condo may have been set up to include a mix of residential and commercial units or spaces. These commercial spaces would have been intended as spots for businesses from the outset. In another scenario, someone else may own the first few floors of the building and they are not part of the association or condo, meaning it falls outside of the purview of the board of trustees. 

What’s Allowed

In order to determine what ingredients will work in cooking up a healthy relationship among tenants, residents, and board members, everyone involved should have a good handle on what is allowed and not allowed by the building’s governing documents. 

“In condos, most governing documents refer to space other than apartment units as common elements," says attorney Marc Schneider, managing partner at Schneider Mitola, LLP, a Manhattan-based law firm. "The ability to lease these common areas is dependent on the governing documents. Sometimes when the condo is formed, the documents will say there are 'x' number of units for residents and 'y' amount of space for commercial tenants.”

Beyond the governing documents, Schneider says it is also important to make sure that the legal right to rent space exists from the municipal perspective. If boards want to rent out to a restaurant, for example, they need to make sure they understand the details, like how many parking spots would be required based on the number of seats the restaurant will have. “You need to make sure that the board has the power to lease the space for what it wants to lease the space for,” Schneider says.

In the Market 

If commercial tenants are allowed and welcomed, boards and residents should recognize the pros and cons of certain types of renters. “The right type of commercial tenant for a particular building depends on many factors,” says Faith Hope Consolo, chairman of The Retail Group with Douglas Elliman Real Estate, which has an office in Greenwich, Connecticut.

“There’s no one formula when it comes to putting together the ideal tenant mix, or selecting a business for the ground floor of one’s property. Looking closely at the demographics is always a good start. Is the building mainly occupied by millennials who are on the go and looking for fast, healthy eats, trendy hot spots and socially-conscious fashion brands? Or is it filled with young families who are shopping for little ones in addition to themselves and crave a Starbucks after taking their wee ones to a class at Gymboree? Perhaps it’s home to mature baby boomers who have more sophisticated retail needs and tastes and are looking for luxury and convenience? Or, as it is in many cases, is it a mix of all of the above?”

Having a tenant who is committed to a good and healthy working relationship can help as well. “The best commercial tenant pays its rent on time and is extremely quiet without a lot of foot traffic,” says attorney Adam Leitman Bailey of the law firm Adam Leitman Bailey, P.C. in Manhattan. 

“Typically,” Schneider says, “the most ideal tenants are the ones that don’t generate a lot of noise. A satellite dry cleaner—the kind that doesn’t do the cleaning on site—or a drug store as opposed to a restaurant with live music. We’ve had lots of experience with restaurants and noise problems, not just from the music but from venting equipment. Odors, too, can be a problem, and vermin. You want something that doesn’t generate noise, odors, or rodents.” 

Consolo agrees. “Restaurants and general food-based businesses that require ventilation and air conditioning are the most challenging for co-op/condo boards, managers and restaurants,” she says. “If done correctly, they can be a great amenity, but more often than not, the building is subject to high noise levels from background music inside the space and noisy patrons, even if the venting and A/C are fine. The same business that poses a challenge for a resident is the same one that can cause headaches for a board or management team.”

Scott Eriksen, a partner with the law firm of Perkins & Anctil, P.C. in Westford, Massachusetts, cites an example wherein an applicant for a commercial space in a non-vertically-integrated community wanted to establish a doggy day-care outfit. ”From a noise perspective, as you can imagine, that just would not be a good fit,” he says. “As well as you can run such an operation, there’s still going to be noise; there’s going to be barking. And even with the restrictions that we imparted, there were people home during the day that just didn’t want to hear ancillary dog barking. Ultimately a board has to draw a line in the sand and say ‘we’re afraid we can’t authorize that use here.’”

Eriksen also observes that, in many cases, zoning laws regulate the nature of which commercial tenants may occupy space in a mixed-use property, eliminating some of the need for an association to hem and haw over what type of business would mesh with its particular aesthetic. “In these mixed-use zones, typically uses are restricted to businesses that can easily co-exist with residential tenants,” he says. “You're not going to be able to, legally, operate a slaughter house in a mixed-use zone. Typically, you’re dealing with retail spaces or professional offices that would be authorized to operate in this capacity.”

Like in any good relationship, it is helpful for the board or manager and the business owner to have a few conversations before entering into any sort of agreement. It also helps enormously to have an attorney who specializes in this type of service to oversee creation of the lease. “For a condominium, many of the commercial spaces have been sold to a private person or company,” says Bailey. “Hopefully the corporate documents allow for the residential building to have some authority over many of the company’s operations.” This includes a say in opening and closing times, signage and the number of people allowed to enter the entity at one time. 

How much say the building’s board of trustees has in the lease can depend on the market conditions. “The better the market for the owners, the more restrictions the tenant will have to accept,” says Bailey. “The lease negotiation will depend on the desirability of the address of the location and the availability of space in the market. Less inventory and a more desirable location will result in the ability to place more restrictions and limitations.” 

Insuring Success

Most unit owners aren’t interested in a vanguard choice for a commercial space.  A reliable coffee shop or a nice gym might sound more appealing than a trendy bistro that’s getting written up by all the papers. Board members, though, will need to work with their attorneys, insurance representatives, and potential lessees to make sure that all matters of insurance are examined and squared away before finalizing any deals. 

“In a mixed-use building, it is customary that the commercial user hold their own general liability insurance, and that the policy names the condo as an insured party,” says Consolo. “To protect itself, a building should spell that out as a requirement within the lease contract. The document should also note the amount and type of insurance needed to protect the building in the event of a fire or other liability issue, including replacement costs, public liability, rental loss and more.” 

“Almost all decent commercial leases require the tenant to obtain insurance and many times name the condo as additional insured,” Bailey concurred. “The condo should also obtain additional insurance to cover any shortfall between the two insurances. Also, it is quite common for a commercial tenant’s insurance to lapse. So not only should the building require the tenant update the building with any insurance changes or cancellations, it should have additional insurance for protection.” 

There may be other types of insurance conditions as well. “The types of businesses in a mixed-use co-op or condominium building may have an impact on D&O and general liability insurance costs,” says Consolo. 

Eriksen notes that this is rare, however. “I would venture that most permitted retail, commercial or professional uses would not dramatically impact insurance,” he says. 

Managing Relationships

Even in the best of tenant-landlord relationships, conflicts both large and small can arise. The board can help manage those relationships by laying out expectations and guidelines clearly and early on. Prospective points of contention should be addressed before a lease is even signed. “Parameters—hours, noise level, building access—should be ironclad and the contract written out by an experienced real estate attorney,” says Consolo. “The course of action for any non-compliance should be clearly spelled out as well, prior to proceeding with a lease.” 

Should alterations to the rental space be required, it is also best to discuss those issues upfront as well. Prospective tenants should “submit plans of alterations they are planning so that they can make sure those plans won’t cause problems,” says Schneider. “They also should determine who is paying for utilities and the metering of the utilities.” 

An item that boards should address prior to even beginning discussions with prospective tenants is price. “The board should always seek professional advice when trying to determine what a space is worth,” says Schneider. “Make sure you get what you are entitled to.” Boards should always keep in mind their fiduciary responsibility is to try to earn as much revenue as possible for their building community.

For the vast majority of buildings, the mix of commercial and residential properties results in a happy co-existence that brings valuable services to residents. It is difficult not to love the idea of not having to ever leave the building to get to the gym or that great new restaurant everyone has been talking about. With proper management of expectations and adherence to the rules, it is a win-win for all involved.  

Elizabeth Lent is a freelance writer and a frequent contributor to New England Condominium. Staff writer Michael Odenthal contributed to this article.

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