Mixed-Use Projects: Knowing Occupancy From Use

By Jeff Bennett

You see it in nearly every new urban development project from the Pearl to Orenco Village, to the new Villebois in Wilsonville — the mixed use block. They have trendy streetscape and architecturally charged buildings. Some have retail on the first floor, offices above retail and housing above the offices. Some are no holds barred — any use, anywhere, on any floor. Everyone from mayors to developers and from architects to end users love mixed use. It represents new urbanism. It represents a reduced commitment on the automobile. It represents increased value. And, it carries potential liabilities that, given the newness of this trend, are just beginning to surface.

The attraction of mixed use development centers on flexibility of use. The zoning usually allows a broad range of uses. The first owner may use the space for a dental office, the second a retail boutique and the third a residential flat. Developers charge for, and purchasers or tenants pay, a premium for the flexibility. It often is a prime sales or marketing tool for the space. That flexibility has built into it, however, a tension that lurks only inside the four walls of what is built. Let me explain.

The zoning code regulates the use can be made of these structures. Building codes (addressing fire, life and safety issues) regulate the improvements that must be installed to allow occupancy of these structures. Thus, even though a wide range of uses may be allowed by zoning law, safety law dictates that the space cannot be occupied for those uses unless very specific improvements are made that make the space safe for that use.

Intuition tells you that more protection needs to be built into a space that is used for a restaurant than one used for you or I to live. Windows need to be more sturdy, doorways and stairways more wide, and wall thickness more substantial (to retard fire from moving from one space to another). Ever wanted to have a bathroom at home look like the one at work? Probably not.

So, the potential legal rub comes from the differences created in the realm of "use" versus "occupancy." When a mixed use building is first built, one of two things occurs. The developer either builds out the space to meet a specific initial user's requirements or, if there is no pre-sale or pre-lease, builds out the space to minimum occupancy standards. Potential liability for the developer is different in each scenario. But, in either case, liability will be based on representations made by the developer to the initial user. Let me set the stage.

Brokers market mixed use buildings aggressively. Here's what a typical pitch will sound like:

"This space can be used for almost any use compatible with development in the neighborhood. You can live in it, have a home office in it, a pure office, retail, restaurant, gallery, you name it. The only thing you can't do is industrial — no warehouse, manufacturing, assembly, hazardous use, that type of thing. And, we'll build it out to meet any use you can imagine. Resale is no problem. Although this space is priced to reflect this total use flexibility, it is that flexibility that will retain and probably enhance its value. Unlike other real estate, which can be used for a narrow range of uses, this property can be marketed to any non-industrial user. Your use will not dictate future uses."

Project brochures may not be this aggressive, but most indirectly say the very same thing, and create the same potential liability.

In the "specific user" scenario, the developer's liability is fairly limited. Since the build out meets the first user's needs, there will be no disconnect between what was promised and what is delivered in the way of occupancy. Thus, liability will be limited to the disconnect between occupancy representations made to the first buyer and occupancy needs of the second buyer. If the space was sold with a representation that the space not only could be used for multiple purposes, but also could be occupied for multiple purposes, trouble is brewing. Here's the problem.

Unless there is no change in use, the first build out seldom will be adequate for a subsequent occupancy. New plans will need to be prepared and approved, and new construction will be required. If the use is more intense, the construction costs can be substantial. As a consequence, a subsequent buyer will offer less for the space because she must incur these expenses. So much for stability in value. If the developer represented the space could be occupied for multiple uses and it can't be without making costly modifications, the developer may be liable for misrepresentation. It could be on the hook for the decreased property value or for the construction costs the initial owner incurs to assure that its buyer can obtain an occupancy permit. The damages escalate if the second user actually moves in before learning that these improvements are required. It happens, and the damages can be significant.

The developer can manage this exposure by making sure that representations made by its brokers and in its marketing materials are limited to flexibility of use, not flexibility of occupancy. And, if the issue arises, the brokers need to be prepared to make the distinction between flexibility of use and flexibility of occupancy. This is a simple, but important, solution.

In the "non-specific user" scenario, the liability includes that identified above and then some. If the first user has not been identified when the space is built out, the developer often builds to what I will call the least intensive use (residential falls into that category). In that situation, even the initial user may need to make substantial modifications to the space to meet fire, life and safety requirements before it may occupy the space. If the need to make such improvements was unknown to this user when the space was initially sold, the owner will have paid full price for the space and be facing substantial additional costs just to occupy it. So, in addition to the liability first referred to above, the developer also may have liability for misrepresentation equal to the initial user's costs to occupy.

This liability also can be managed. However, it requires a concerted effort to say and disclose in writing precisely what level of improvements have been built and what occupancy level is permitted. Documentation also should disclaim any representation in regard to occupancy and warn the buyer to check with local building authorities to determine what additional building improvements may be required to use the space for its intended use.

Developers and brokers focus on flexibility of use in promoting their mixed use buildings. They need to make sure they don't forget that occupancy is the key to the end user and that representations concerning use can ripen into unintended representations about occupancy that can cost them money down the road. Making the distinction between them is the key to managing that liability.

This article is intended to inform the reader of general legal principles applicable to the subject area. It is not intended to provide legal advice regarding specific problems or circumstances. Readers should consult with competent counsel with regard to specific situations.

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