The Neighbor Downstairs 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 it is not part of the association or condo, meaning it falls outside of the purview of the board. 

In order to determine what ingredients will work in cooking up a healthy relationship between 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 apartments as common elements," says attorney Marc H. Schneider, managing partner at Schneider Mitola, LLP, which has offices in Long Island and in Manhattan. "The ability to lease these common areas are depending 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 in Manhattan. 

“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?”

Residents might also appreciate a thorough examination of the neighborhood to see what is lacking. “Does the neighborhood have a sufficient number of banks, supermarkets, medical offices and dentists?” says Consolo. “If there’s no florist in sight, then there’s a need that can be met. That type of tenant typically receives the warmest welcome from a condo’s residents.” 

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, founding partner of the law firm Adam Leitman Bailey, P.C. in Manhattan. 

“Typically,” says Schneider, “the 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.” 

Richard Linderman, a partner with the law firm of Ansell Grimm & Aaron, PC in Princeton, illustrates an instance wherein a tenant was not a good fit for a mixed-use property. Let this serve as a cautionary tale: “There was a healthcare clinic on a first floor that catered to a lot of low-income or homeless citizens and, while the association neither could nor wanted to interfere with this business, it took umbrage with clinic clientele lingering outside at street level for hours on end. Board members addressed the clinic directly, asserting that it could not let this happen, and, if it continued to do so, legal action would need be taken, as the commercial tenant was essentially responsible for its customers/patients.”

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 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. It should be noted, however, that, should a tenant be judged as higher risk—Linderman cites restaurants, bars and liquor stores as examples, the former due to potential fires and the latter due to the explicit nature of its business—then that may have an effect on the property’s insurance. “In these types of cases, the association is generally allowed to shift the burden of insurance cost over to the tenant, and there will often be specific provisions in the master deed that provide for this,” he says.

“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,” adds 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.” 

Depending on the type of tenant, there may be additional insurance considerations. “There are some businesses that pose a higher risk,” Consolo says. “Those types of tenants may have fewer insurance companies that are willing to provide them with a policy or, if they do, will do so at a higher premium.”

“Almost all decent commercial leases require the tenant to obtain insurance and many times name the condo as additional insured,” Bailey says. “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. 

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 iron clad 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 to earn as much revenue as possible for their building.

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's easy 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.

Elizbeth Lent is a frequent contributor to The New Jersey Cooperator. Staff writer Michael Odenthal contributed to this article.

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