Real Property Law

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An Alternative to Renting or Leasing Commercial Space: Office Condominiums
Mark S. Carlquist, Attorney at Law, Los Gatos
E-mail: mark@carlquistlaw.com

Commercial Condominiums ­ An Emerging Trend
Lease vs. Ownership
Developers Respond to Demand
Condominium Association and Governing Documents
CC&Rs for Commercial Property Not Residential
Exclusive Use Common Area
Conclusion


Commercial Condominiums ­ An Emerging Trend
In California, and in many other states, the concept of commercial condominiums is not a new one. Business owners have sought to purchase office, medical, or industrial space in condominium complexes for many years. Paying principal and interest rather than rent can be advantageous to a business owner. The ability to convert the interior space in a manner most conducive to the particular business is also appealing. In addition, unlike the commercial tenant, the condominium owner is not at the mercy of a changing rental market within the local economy. In short, the condominium owners can work where they want to work, in spaces of their own design, enjoy tax advantages and never have to leave their property at the whim of a landlord. Also, the residual value of the unit serves to further fuel demand for commercial condominiums.

Lease vs. Ownership
Paying rent often leaves the tenant wondering how much "bang" they get for their rental "buck." At the end of the lease term, the business owner is faced with either negotiating an extension or venturing out into the local rental market. The tenant will benefit if the local market is soft. However, if the local market is strong for the type of use sought, the tenant loses out. A strong market for a particular type of use will most likely result in the tenant increasing its "rental" line item in budgets for the next 3 to 5 years ­ the standard lease term desired by commercial landlords.

Developers Respond to Demand
In response to the demand for commercial condominiums, developers are gearing up to be on the leading edge of this emerging trend. Developers are looking at two products: (1) new construction of commercial condominium complexes and (2) conversion of existing commercial structures to condominiums. The developer has the option of delivering in "shell condition" which allows the buyer/owner to control the improvements to the interior space and tailor the structure and layout of the new office to their business.

Ralph N. Borelli, of Borelli Investment Company, San Jose, California, has been active in developing both new commercial condominiums as well as conversions. "Clearly, with continuing low interest rates, there has never been a better time to consider purchasing business space, rather than leasing it," declares Borelli. "Also, tax benefits offering substantial monetary incentives are driving demand for commercial condominiums in California beyond supply."

Tax incentives, together with other attractive and practical features of owning rather than leasing, may solidify the demand for commercial condominiums well into the future. Interest deductions and the ability to depreciate are at the top of the list of tax incentives.

Condominium Association and Governing Documents
The condominium development is maintained by an association consisting of condominium owners. In governing a condominium association, the members will look to the association’s Bylaws and more importantly, the association’s Covenants, Conditions and Restrictions (CC&Rs). The CC&Rs are critical to the effective governing of an association as they represent a predetermination of the rights and duties of the property owners and the association itself.

CC&Rs for Commercial Property Not Residential
In California, many of the commercial condominium CC&Rs are often too similar to their residential cousins which can be problematic. The factual circumstances and potential problems in a commercial setting can be very different from those of a residential development. Since the board members will look to the CC&Rs for guidance in resolving problems, the CC&Rs must be drafted properly in the context of the commercial setting. Using residential CC&Rs as a template in drafting commercial CC&Rs will prove troublesome for the unknowing attorney. Since CC&Rs are generally recorded (thereby showing up on a title report), amendments must also be recorded. The attorney (or worse, his successor) may have to draft amendment after amendment to conform to the needs of the association in governing the condominium development.

Exclusive Use Common Area
California Civil Code, Section 1351, states that "A condominium consists of an undivided interest in common in a portion of real property coupled with a separate interest in space called a unit…" In addition to a separate interest in the unit and the undivided interest in the common area, Civil Code, Section 1351(f) defines "Exclusive use common area" as "a portion of the common area designated by the declaration for the exclusive use of one or more, but fewer than all, of the owners of separate interests and which is or will be appurtenant to the separate interest or interests." An exclusive use common area may well be required based on the needs of the project. For example, a unit owner will generally want the parking stalls adjacent to the unit. This parking area would be defined as exclusive use common area for that unit. Another example would involve computer, telephone wiring or other office installations in the floor, common walls, or above the ceiling in the unit. In each instance, the CC&Rs must be drafted so as to address the specific needs of the condominium project relating to common area exclusive use.

Conclusion
The obvious question is: will the demand for commercial condominiums be sustained in the future? When the developer establishes a sales price for a condominium unit, market forces (what a willing buyer will pay a willing individual condominium owner) may or may not be the guiding factor. This question will be answered by future resales when market forces will determine the sales price. Although the upfront costs (purchase price) of condominium ownership may be higher than leasing, the long term benefits (i.e. better control, tax benefits, and residual value) associated with condominium ownership might be the determining factor in sustaining demand.

 

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Office Leasing: Drafting and Negotiating the Lease