Use Caution When Considering Leasing Unused Common Space
By Andrea Brescia
With the rise of mixed-use spaces, the convenience—and financial benefit—of having a popular bakery or a national bank locked in for a 10-year, income-generating lease may seem like an attractive option for a common area that’s going largely unused in your community. But proceed carefully: A steady stream of income from potentially high rents comes with a lot of advance planning and possible barriers that include issues with legality, zoning, governing document restrictions, and accommodations for persons with disabilities. If your association is looking for new and creative ways to generate more revenue, can it lease underappreciated common area space to a commercial tenant as a way to add convenience to your members and income for your association? And what do you need to know in order to consider this transaction?
We’ll outline some of the major considerations below. There’s a lot of groundwork to cover, and you must consider whether the time, effort, and cost it will take to potentially rezone the area are worth any financial gains you might expect to receive from leasing the space to a commercial tenant. We’ll help you weigh the feasibility and avoid serious pitfalls when exploring the idea of leasing unused common areas to generate revenue and add a potentially convenient service to your association.
Check Your State Statutes
First and foremost, you must check your state law to confirm that what you’re proposing is legal. “While alternative sources of revenue are always a popular topic, the leasing of common elements, at least under Florida law, may present some challenges,” says Joseph E. Adams, a Florida attorney. “Although the condominium statute permits an association to lease common elements, a clause in the statute states that the common elements are to be made available to unit owners for the purposes intended,” he says. So the next step in a state like Florida is to make a close examination of the governing documents to see how the common areas are intended to be used.
Many governing documents and covenants provide that the common areas are to be maintained for the use and benefit of the homeowners. Changing this purpose, even if the space isn’t actually appreciated and used by the members, might not be as simple as it would appear, even if the proposed project garners favor from the membership and could be an alternative revenue stream for the association.
“It really depends on the laws of your particular state and what your governing documents provide,” agrees New Jersey attorney David Byrne. He has come across associations changing the use of a common area, although not for commercial use. He cites an example where a condo association had extra space in the stairway that was connected to a line of units. The association sold 99-year leases to the space so that the unit owners could break down the walls and expand their units. But providing an additional asset to owners is an easier change to pull off than leasing to a commercial interest, which comes with a host of other considerations discussed below.
Review Your Governing Documents
In California, as in other states, the association is limited in what it can do with its common area by its governing documents. Sandra L. Gottlieb, a California attorney, notes that the articles of incorporation may limit what the community can do with its common area, and the CC&Rs could state that the board can use the common area for the benefit of all of the homeowners or third parties subject to homeowners’ approval—typically by a minimum margin of 662/3percent. According to Gottlieb, unless your governing documents say otherwise, which many do, provisions in the articles of incorporation or in the director’s duties may state that the common areas must be used for the benefit of the association and its members. In California, “changing the use of property in such a way as leasing it to a business could result in the taking of a benefit for some of the homeowners but not for all, which is a big no-no,” she says.
In contrast, properties designated as mixed-use space leave common areas intact. “Lots of community associations are being built with mixed-use space that’s not infringing on the common areas of the HOA,” says Florida-based attorney Ellen Hirsch de Haan. But, she adds, if you have a piece of unused land that you want to build on for the purpose of leasing it to a business, that would be a material alteration, and a large percentage of the owners would need to approve it. “It’s not very likely to happen,” she cautions. “Owners often don’t want the traffic of the public.”
Hawaii attorney Richard Ekimoto says that in most residentially zoned properties in his state, you can have certain types of “residential ancillary” provisions to the residential use, such as a convenience store or something similar. And in many states it’s possible to amend the governing documents to permit a use change, unless there’s a state law that prevents that action. “If your state requires a designated purpose for common areas to be stated in the governing documents, then that at least raises the issue of whether or not you can deprive the owners of access to those areas,” he says. “Renting out the rec center on a permanent lease would raise issues. A lot of use changes depend on the state statute and case law.”
Anticipate Zoning Issues
The next step is to understand the work involved in properly designating the space for commercial use according to your local zoning or building codes, which can be a time-consuming process. Since the area is residentially zoned, this means converting the space for retail or business use in order to permit commercial operations either by getting a variance from the current zoning for a special use or rezoning the property altogether.
According to Adams, the zoning designations for most residential condominiums limit the use of the common elements to purposes ancillary to residential use, such as recreational, maintenance, and administrative facilities. “Use of common areas for a gift shop, for example, would probably require a special exception to the zoning laws in many cases,” he says.
Ensure ADA Compliance of Public Space
If you determine that you’re within your legal rights and compliant with your governing documents to change the use of a common area, you need to consider new requirements that will be imposed on the actual space. By far, the biggest challenge to converting your space from association use to commercial use—which is public use—is bringing the area into compliance with the Americans with Disabilities Act (ADA). By designating this area as a public space, the association will need to make the property accessible to persons with disabilities.
“We worry every day about whether some action will trigger ADA compliance. When you change the structure, it could dramatically change the community and its requirements to comply with the ADA, which could have a significant financial impact,” says Gottlieb, adding that the ADA generally doesn’t apply to a homeowners association unless you’re inviting the public into the facility. Once you’ve invited in a third party, you’ve opened the door. “A board would have to weigh—significantly—the income stream and other benefits that could arise from the proposed project against the potential liability that the association could be exposed to in now having to comply with ADA requirements,” she says.
In addition to the space that would be designated for commercial use, the association would also have to provide ADA accommodation now for its common areas. Besides removing architectural barriers, there are other requirements to consider that go beyond mobility disabilities and include installing raised letter signage and water fountains for visually impaired persons, as well as appropriate accommodations for the hearing impaired. It’s important to work with someone who has experience meeting ADA requirements: What looks acceptable to you might pose a hazard or be inaccessible to someone with a disability. You must now think about every area differently. For example, if you’re providing parking for people to get to the business, the path along which the public will walk must be evaluated for compliance. In essence, every area that the public will now enter must be made accessible to persons with disabilities. Remember that even though the business is leasing a designated space, the public areas or common areas that the public will now use to reach that business remain under association control.
Consider Tax Implications
While a steady stream of income seems appealing, talk to your CPA about what the rental income would mean for your association. “The association should consider the tax implications of rental income, including whether the amount of non-assessment income would disqualify it from filing tax returns available only to associations, which have preferred tax structures,” says Adams.
According to Ekimoto, most associations have non-membership income, and this type of income doesn’t necessarily change the tax filing. But it does mean that you have to address the fact that you’re generating income outside of assessments. Again, he stresses talking to a CPA. “At least in Hawaii, there would be some excise tax implications and income tax implications,” he says.
Insure the Association—and the Tenant
As the landlord, the association must require its tenants to have insurance and indemnify the association in the event of damage or loss. In the same way, the landlord, or association in this case, would also have its own insurance policy. But if an association decides to become a landlord and lease to a third party, the association should also buy insurance to cover the tenant as a precaution. Ekimoto warns that while you can contractually bind the tenant to have insurance and provide proof of insurance, it’s still possible that the insurance could lapse for lack of payment, or that the coverage isn’t sufficient, so you want to make sure that the association is protected.
Monitor Safety Concerns
In opening the association up to the public, the obvious consideration is ensuring the security of the members and property, especially if you have a gated community. “If you’re going to have a business in the community, it changes the nature of traffic and who is coming into the property. You must consider security and liability issues,” says Ekimoto.
Gather Your Team
Throughout this process, you’ll need to gather your board, association attorney, and tax accountant, who will each have a role in determining if your project meets state law and is covered under your governing documents. After passing that gate, you’ll need to investigate whether the project can be ADA compliant and financially sound, and gain the approval of your membership. If it does, your next call should be to a commercial real estate broker who will be able to guide you through the process of selecting a suitable tenant and creating a commercial lease—one that includes language that protects your association and members from unwanted nuisance. (See “Find the Right Commercial Tenant for Your Association,” on p. 0.)
Finally, if the obstacles of leasing your unused space to a commercial entity prove impossible in your state, or just financially daunting, consider other revenue streams like renting your rooftop to cellular towers, which can generate several thousand dollars a month, or creating rental storage units for homeowners in less trafficked common areas—which might avoid some of the trickier issues of leasing to a third party—and provide a sought-after amenity for owners who could use more space for that extra pair of skis.
Andrea Brescia is a New Jersey-based editor who writes for housing-related publications and organizations.
Joseph E. Adams, Esq.: Becker & Poliakoff, Fort Myers, FL; JAdams@beckerlawyers.com
David Byrne, Esq.: Ansell Grimm & Aaron, P.C., Princeton, NJ; firstname.lastname@example.org
Richard Ekimoto, Esq.: Ekimoto & Morris, LLLC, Honolulu, HI; email@example.com.
Sandra L. Gottlieb, Esq.: SwedelsonGottlieb, Los Angeles and San Francisco, CA;
Ellen Hirsch de Haan, Esq.: Wetherington Hamilton, PA, Tampa, FL; firstname.lastname@example.org