Establishing Separate Ownership in a Vertical Mixed Use Project

Developers of urban mixed-use projects must answer the question of how to distribute complementary land uses throughout a project.  Residential, retail, commercial and other uses can reside on a single parcel, or they can exist on separate adjacent parcels in close proximity to each other.  Both alternatives must contend with California’s subdivision and condominium laws in order to establish separate ownership interests for purposes of sale and financing.

A horizontal mixed-use project is one in which a variety of different uses — residential, retail, office, hospitality, entertainment — are constructed on separate adjacent parcels. Each building has a separate land use and each building can be sold and financed separately because it exists on a separate legal parcel.  The project is considered mixed-use because different land uses are established immediately next to each other in a mixed-use district or perhaps in a town center.  The subdivision of horizontal projects follows a straightforward procedure, whereby a project applicant files an application for a tentative map for projects consisting of five or more parcels and an application for a parcel map for a project consisting of four or fewer parcels.

A vertical mixed use project is one in which the land uses exist on the same lot and in the same building.  For example, such a project might have ground floor retail and residential uses on the upper floors.  In a more sophisticated example, a developer could have a multi-level, below-ground parking garage, a transit stop on a separate level below ground, a hotel in the first dozen floors of the building above ground, and residential condominiums on the upper floors of the same building.  A vertical mixed-use project is routinely more difficult to design, construct, sell, lease and finance.  However, developers may choose to develop a vertical mixed-use project because of the physical constraints of the site, land use regulations, private development restrictions or the needs and desires of co-investors.

In California, separate ownership of the individual uses within a vertical mixed use project may be established in two ways.  Separate legal three-dimensional spaces can be created under California’s Subdivision Map Act (the “Map Act”).  Alternatively, “separate interests” can be created under California’s common interest development law, the Davis-Stirling Common Interest Development Act. (“Davis-Stirling”).

The Map Act applies to divisions of “land” — and the definition of “land” under California law includes airspace above and three-dimensional spaces below the ground (“Land . . . includes free or occupied space for an indefinite distance upwards as well as downwards, subject to limitations upon the use of airspace imposed, and rights in the use of airspace granted, by law.” Civil Code section 659.)  With limited exceptions, the creation of five or more parcels or units, whether above, at or below the ground, requires a tentative map and a final map, while the creation of four or fewer parcels or units requires a parcel map.

A two-step process is required for the creation of separate three-dimensional spaces under Davis-Stirling.   First, the legal parcel that will be divided into three-dimensional units must be legally created under Map Act.  This can be done by a final map or a parcel map.  On the approved parcel map or final map, the maximum number of units must be described.  In addition, a perpetual estate or an estate for years in the remainder (such as a common area) must be held by the owners of undivided interests in common or by an association, and the duration of the estate in the remainder of the property must be the same as the duration of the estate in the three-dimensional units (often fee simple). This latter requirement can be satisfied by establishing an unincorporated property owners association or by the formation of a separate nonprofit corporation created to comply with the requirements of Davis-Stirling.

The second step is to “describe” the three-dimensional units on a condominium plan or plans, pursuant to the requirements and procedures set forth in Davis-Stirling.   A condominium’s separate interests and undivided interest in any common area need not include the ground or be physically attached to it except for certain easements for access and support.  As a result, the ground can be separated in ownership from the airspace above it, and the airspace can be divided into condominiums.

Forming a vertical mixed-use project pursuant to this two-step method is preferred.  The first step establishes the boundaries of the lot and the maximum building intensity on the parcel, whether in terms of dwelling units, commercial density, or both.  The second step, which often occurs later in time, gives the developer flexibility in siting the buildings and improvements after the subdivision map has been filed.

It is not a good idea, however, to simultaneously apply for a Map Act subdivision and condominium plan under Davis-Stirling.  If the condominium plan must be amended after approval, amendments may also need to be pursued to the final map or parcel map under the Map Act, which can be time consuming and may require a public hearing. Developers of high profile or controversial projects rarely desire the attention that comes with a public hearing on their project, particularly after it has already been approved.

Subterranean parcels can also be tricky.  A close read of the Map Act suggests that below ground “parcels” should be created by parcel map or final map, not by condominium plan.  Government Code section 66427, which allows for division by condominium plan under Davis-Stirling, refers to “buildings or the manner in which buildings or the airspace above the property shown on the map are to be divided.” Counsel should be consulted before relying on the use of a condominium plan to establish separate ownership and financing of below ground facilities.

After the separate ownership interests are created, the next step is to prepare legal documents governing the relationship among the various owners.  For example, owners will need reciprocal easements for various purposes, such as ingress, egress, utility access, support, and maintenance.  The owners will need to establish mechanisms for use of common areas, and sharing the costs of maintaining, repairing and operating common areas.  What’s more, responsibility for future compliance with laws, as well as capital repairs, replacements, and improvements must also be allocated among the various ownership interests.  These understandings are typically memorialized in a reciprocal easement agreement (“REA”) or covenants, conditions and restrictions (“CC&Rs”).

Creation of separate ownership interests in a vertical, mixed-use project raises many regulatory issues.  The Map Act and Davis-Stirling are two of the laws that apply to such subdivisions.  Other state laws, local plans and city and county ordinances may also apply.  Developers should consult with counsel to determine how to best proceed.

Legislative Changes to CEQA Ease Requirements for Urban Infill Projects

California lawmakers further streamlined the environmental review of infill residential, mixed-use and “employment center” projects under a new bill passed at the end of the legislative session in September.

By way of background, all development projects must comply with the California Environmental Quality Act (“CEQA”) prior to project approval. Under CEQA, state and local agencies must identify the significant environmental impacts of a proposed development project and avoid or mitigate those impacts, if feasible.

Senate Bill 743 was initially intended as a CEQA streamlining bill for a new sports and entertainment arena for the Sacramento Kings, an NBA team at risk of being lured away by another U.S. city. Legislative leaders and the business community have been asking for broader CEQA reform, because the environmental review process is time-consuming and fraught with litigation risk for developers and local governments. After last minute talks among the Governor and legislative leaders, the bill was amended to begin to ease requirements for certain classes of urban infill projects statewide.

The most significant changes:

Inadequate parking and aesthetic impacts cannot be used to challenge a project under CEQA if the project is “on an infill site within a transit priority area.” An “infill site” is a previously-developed lot in an urban area or a vacant lot largely surrounded by urban uses. A “transit priority area” includes any area within a half mile of an existing or planned “major” transit stop. As stated, this exemption applies only to challenges brought under CEQA. A project must still comply with other existing (or future) laws that apply to aesthetic or parking impacts. There is also a backdoor for a CEQA challenge based upon “impacts on historic or cultural resources” that result in a significant impact.

New guidelines will be developed to determine the significance of transportation impacts of projects in transit priority areas. These new guidelines must promote the reduction of greenhouse gas emissions, the development of multimodal transportation networks, and a diversity of land uses. To that end, OPR must recommend potential metrics that move away from the level of service standards most frequently used in traffic studies and instead focus on vehicle miles traveled, vehicle miles traveled per capita, automobile trip generation rates or automobile trips generated, among other metrics.

Automobile delay, “as described solely by level of service or similar measures of vehicular capacity or traffic congestion,” shall not be considered a significant impact on the environment under CEQA. This is a huge benefit for project proponents, since many projects wrestle with traffic delay issues at intersections near or adjacent to their proposed projects. Some land use practitioners may point out that the state’s Office of Planning and Research (“OPR”) may promulgate regulations that limit the scope of this carve out in “locations specifically identified in the guidelines, if any.” However, State Sen. Darryl Steinberg has indicated his desire to see OPR move away from level of service standards and the Governor is likely on the same page, which should influence OPR’s rulemaking. In addition, any rulemaking must comply with California’s Administrative Procedures Act. OPR’s rules will need evidentiary support if it makes distinctions between “locations” and the metrics applicable to different locations. We will have to wait and see how OPR handles these issues when the regulations come out, but if specific locations are identified, expect APA related litigation. In the meantime, developers and land use practitioners should note that air quality, noise, safety, “or any other impact associated with transportation” may still rise to a level of significance and be the subject of a CEQA challenge.

The adequacy of parking for a project shall not support a finding of significance. Presumably, this exemption applies to “transit priority areas,” but does it also apply to “employment center projects” and “infill site[s]” that are also a subject of the “section”? Does it apply more broadly to other projects? This provision of the bill is going to need clarification or it will be litigated.

Residential, employment center, or mixed use development projects in a specific plan area in which a prior environmental impact report (“EIR”) was prepared are eligible for a new CEQA exemption. The exemption applies if (i) the project is in a “transit priority area,” (ii) the proposed project is consistent with a sustainable communities strategy or an alternative planning strategy for which the State Air Resources Board has accepted a metropolitan planning organization’s determination that greenhouse gas emissions targets will be achieved, and (iii) subsequent or supplemental environmental review is not required because of significant new information or substantial changes must be made to the prior EIR’s environmental impact analysis. This provision further eases the requirements that apply to projects that fit within California’s land use/transportation planning legislation focused on reducing greenhouse gas emissions in the state.

Review of “environmental leadership projects” returns to the superior court, as well as appellate court, but both rounds of review must be completed within 270 days. The bill fixes a prior legislative attempt at CEQA litigation streamlining that sought to skip trial court level proceedings for certain consequential development projects certified by the Governor. That law was held unconstitutional earlier this year.

Certain streamlining provisions to CEQA were added for the benefit of a planned entertainment and sports center project in the City of Sacramento. The Legislature continues its practice of granting special exceptions to CEQA for high profile, litigation likely projects.

These changes to CEQA will greatly assist the urban infill projects that qualify. In particular, the elimination of parking and aesthetic impacts as grounds for a CEQA challenge in urban infill areas is particularly welcome. New traffic metrics will bring significant changes to how traffic engineers, land planners and counsel analyze projects and present them in CEQA documents. For developers of projects in infill locations, thoughtful strategic analysis of this new law and its carve outs with counsel is essential.

U.S. Supreme Court Rules Government Can Be Guilty of Taking When Denying a Land Use Permit or Requiring Monetary Payment as a Condition of Approval

Land developers will find it easier to challenge coercive exactions and unreasonable impact fees requested by governmental authorities during the land use permitting process in the aftermath of the U.S. Supreme Court’s decision in Koontz v. St. Johns River Water Management District, 570 U.S. ____; 133 S.Ct. 2586 (2013).

The Court held that a demand for property from a land use permit applicant as a condition of approval can constitute an unlawful taking even when the government denies the land use permit. It does not matter that the governmental decision-maker might have been able to deny the application outright in the exercise of its discretion. The critical inquiry is whether the proposed condition of approval has a “nexus” and “rough proportionality” between the government’s demand and the anticipated effects of the applied-for land use. If the project applicant rejects the proposed condition because it does not meet the “nexus” and “rough proportionality” tests, the project applicant can bring a lawsuit claiming the government’s condition is tantamount to a taking of its property.

The Court also held that a local government’s demand for money – for example, impact fees – must satisfy the “nexus” and “rough proportionality” tests. In so holding, the Supreme Court took its takings jurisprudence beyond physical or regulatory takings of private property. This portion of the Court’s holding is extremely important because, as local governments find themselves with less money for capital improvements and operations, governmental decision-makers have been tempted to solve fiscal shortfalls with impact fees. The Koontz decision should limit the size of impact fees so that such payments are more closely related to the environmental impacts of development.

The facts of the case were straightforward. Koontz applied for permits to develop a portion of his property from the St. Johns River Water Management District. The District required permit applicants who desired to build on wetlands to offset any environmental damage that might be caused by the proposed development. Koontz offered to deed to the District a conservation easement on nearly three-quarters of his property as mitigation. The District refused Koontz’s offer, stating that it would approve his requested land use permit only if Koontz (1) reduced the size of his development and, among other things, deeded to the District an even larger conservation easement area or (2) hired contractors to improve District-owned wetlands several miles away. Believing the mitigation required by the District for his proposed development was excessive, Koontz filed suit claiming the District’s action was an unreasonable exercise of the District’s police power constituting a taking without just compensation.

The trial court agreed with Koontz, finding the District’s demands failed the requirements of Nollan v. California Coastal Comm’n, 483 U.S. 825 (1987), and Dolan v. City of Tigard, 512 U.S. 374 (1994). In Nollan and Dolan, the Court established the rule that government cannot condition the approval of a land use permit on the owner’s relinquishment of a portion of his or her property unless there is a nexus and rough proportionality between the government’s demand and the effects of the proposed land use. The Florida District Court of Appeal affirmed. However, the Florida Supreme Court reversed on the basis that (1) the District denied the application and (2) a local government’s demand for impact fees cannot give rise to a takings claim.

Justice Alito’s opinion for the U.S. Supreme Court reasoned that the unconstitutional conditions doctrine prevents the government from coercing people to give up their constitutional rights. When the government makes extortionate demands in the land use context, the government violates the Fifth Amendment’s Takings Clause “not because they take property but because they impermissibly burden the right not to have property taken without just compensation.”

The Court’s decision will have significant repercussions in permit negotiations and land use litigation at the federal, state and local level. Land developers will have an incentive to document conditions proposed by governmental agencies that may appear to be excessive mitigation in light of a project’s development impacts. Government staff may be reluctant to offer proposed conditions or comment on a developer’s offer of mitigation, fearing that staff are creating a record for future land use litigation. Staff will also have an incentive not to disclose proposed conditions until later in the application review and approval process, perhaps as late as immediately prior to submission to decision-makers in a staff report or other transmittal required pursuant to public meeting laws.

We will likely see an increased emphasis on collecting and analyzing data to properly characterize the potential impacts of a proposed development. Government staff will have an incentive to take their time and be cautious in the design of mitigation measures based on reasoned analysis and the best available science. As a result, project applicants can expect further delays in permit processing as impact studies and reports designing recommended mitigation measures are prepared prior to a formulation of the final conditions of approval. To protect themselves against Koontz litigation, government decision-makers will likely approve a variety of mitigation alternatives in the hope that at least one survives Nollan/Dolan scrutiny.

In California, the Koontz case raises the issue of the appropriate level of scrutiny that a court must use when evaluating the constitutionality of impact fees. In Ehrlich v. Culver City, 12 Cal.4th 854 (1996), the California Supreme Court used different tests to determine the constitutionality of project-specific impact fees as opposed to broadly applicable development impact fees.

A project-specific impact fee is one that is created and sought to be imposed specifically to address the environmental impacts of a particular development proposal. The Ehrlich court applied the Nollan/Dolan analysis to a recreation fee that Culver City sought to impose because the proposed development project was eliminating recreation opportunities in the area.

Broadly applicable development impact fees are enacted by a legislative body in anticipation of new development in a geographic area (sometimes over the entire jurisdiction or more often over a portion thereof) for the purpose of achieving a public policy objective. In Ehrlich, the California Supreme Court declined to apply the Nollan/Dolan test because Culver City’s public art fee was broadly applicable to most new development projects in the City, like other development standards.

Because the Koontz majority opinion does not distinguish between these two types of impact fees, it is questionable that the California Supreme Court’s application of a lesser level of scrutiny to certain types of impact fees in Ehrlich is still good law.

New ADA and Energy Use Disclosure Requirements for Commercial Property Owners

Beginning July 1, 2013, owners of commercial property in California will need to comply with new disclosure requirements when entering a new lease, amending a lease, or when owners sell or finance a commercial building.  The first disclosure requirement relates to disability access and the other requirement relates to a building’s energy use and consumption.

Certified Access Specialist Disclosure

Under California SB 1186, commercial property owners must include a disclosure in all commercial leases or lease amendments stating whether the property has been inspected by a certified access specialist and, if so, whether the property is in compliance with construction-related accessibility standards.   A certified access specialist (also known as a “CASp”) is a professional certified by the State of California to assess commercial properties and their compliance with federal and state disability-related laws and regulations.  After an inspection, the specialist issues a report which identifies areas of non-compliance with accessibility standards.  The report can be used by property owners to create a practical and financially reasonable plan for fixing problems in advance of litigation.

While the CASp disclosure in leases and lease amendments is mandatory, property owners are not required obtain such inspections.  The new law provides incentives, however, to having the building inspected.  Property owners who timely correct ADA violations identified in a CASp report or have had their property inspected by an approved inspector prior to being served with a complaint by an ADA plaintiff can be eligible for reduced statutory damages or a 90 day stay of proceedings in the event of a lawsuit.   The stay is granted to give the owner the opportunity to correct accessibility issues and dismiss the lawsuit.

Energy Use Reporting

Another California law, known as AB 1103, provides that prior to the leasing, sale or financing of an entire commercial building of more than 50,000 square feet (the requirement hits smaller buildings in 2014 – all the way down to 5,000 square feet on July 1, 2014!), the landlord, seller or borrower is required to disclose energy use data for the building for the prior 12 months, together with information regarding the building’s operating characteristics and ENERGY STAR Energy Performance Score.  To comply, building owners are required to open an account for the building at the ENERGY STAR Portfolio Manager Website, operated by the US EPA, no later than 30 days prior to the date the disclosure is required.  Under the law, once an account is opened, utility companies are required to provide energy data within 30 days of the date of the request.   Then, the owner must log back in to the account, complete a compliance report, and download certain Energy Use Materials for disclosure to the prospective tenant, purchaser or lender.   The disclosure requirement applies to virtually all commercial building use types.

The ENERGY STAR Portfolio Manager is a free online software tool that allows property owners to track and evaluate energy consumption in light of the occupancy of the building in specified land use categories.  A building is given a score on a scale of 1 to 100.  A rating of 50 means that the building performs at the midpoint when compared with similar buildings.  The Portfolio Manager uses national weather data to compare buildings in similar climates, so that buildings in locations that have snow in the winter and high humidity in the summer are not are scored against buildings in temperate climates. A building that scores 75 or above qualifies for an ENERGY STAR certification.  Because the consequences of having a poor score can have consequences in attracting tenants that have green building requirements, it is important for property owners to retain knowledgeable staff or consultants to handle the inputs into the ENERGY STAR database.  Even small mistakes can affect an overall score considerably in the wrong direction.

The new law will allow tenants, buyers and lenders to compare a building’s  performance with other similar buildings.  In addition, the disclosure requirement provides more information than a disclosure of monthly utility bills, as is typical when tenants evaluate utility pass through expenses, buyers estimate future operating costs in their pro formas, or when lenders evaluate which assets have a better ability to maintain profitability and support loan repayment.  On the other hand, the cost and expense of complying with the law’s new disclosure requirement is an added cost of doing business as a commercial property owner in California.