Mixed Up About Mixed Use

Mixed Up About Mixed Use

We live in a mixed-use condominium. We are trying to determine the allocation of common expenses (the aggregate sum of a condominium’s common charges – the amount of its annual operating budget) paid by residential and commercial unit-owners. How do we do that successfully?

Generally, a condominium’s common expenses are allocated among unit-owners pro rata based upon their percentage of ownership in the condo’s common elements. In other words, if Unit 5J has 1 percent of the condo’s common interest allocated to it, the owner of that unit is responsible for paying 1 percent of the condo’s common expenses. However, this simple formula is quickly abandoned – and things potentially get much more complicated – where commercial units come into play.

Because commercial units frequently do not utilize various parts of a building’s common elements and/or building services, the Condominium Act, New York’s statutory scheme that governs the structure of condominiums, permits a sponsor to vest the board of managers with the power to create “special allocations” of common expenses between residential and commercial units.

A Case in Point

For example, let’s take a 20-story, 100-unit condo with five ground-floor commercial units that opened in 2009. The sponsor has just relinquished control of the board to the residential unit-owners, and, to their surprise, when looking at the association’s budgets over the years, they learn that despite collectively owning 5 percent of the condo’s common interests, they are only paying 1 percent of the common expenses. How can this be? Is it legal, and, if so, is it fair? And, if it’s not fair, what can be done about it?

For starters, it’s legal so long as the right of the board to create “special allocations” is: (i) contained in the condo’s bylaws; and (ii) disclosed as a “special risk” in the condo’s offering plan. If proper disclosure was not made – particularly if there is no provision for the creation of “special allocations” in the bylaws – then the default formula of everyone paying their pro rata share would apply.

In this property, the right of the board to “specially allocate” was adequately disclosed and, as such, is permissible. But is it fair? Upon closer examination of earlier budgets, the newly elected board members were surprised to learn that the commercial unit-owners did not pay for any portion of the salaries or benefits of the building’s staff, no part of the managing agent’s fee, and no part of the costs associated with maintaining the building’s elevator or its amenity spaces (i.e., a gym and a playroom).

When confronted with this seeming inequity, the commercial-unit representative on the board took the position that the previous budgets were perfectly appropriate because the commercial units have their own entrances and cannot be accessed from the “residential section” of the building; they do not use the services of the staff or managing agent; and they do not avail themselves of the condo’s amenities. Why, therefore, should they have to pay for any of these budgetary line items, especially where the existence of the “special allocations” was disclosed throughout the condo’s offering plan, including in the first year’s operating budget, and was mirrored in all subsequent budgets?

Fair Payments

This sounds like, and often is, a recipe for conflict. However, when digging a bit further into the issues and analyzing both sides’ positions, it is possible to arrive at an amicable resolution to this type of problem.

Some of the easier items to address in our hypothetical would be whether the commercial unit-owners ought to be required to pay for those common expenses attributable to operating, maintaining, and repairing the condo’s gym and playroom. Whereas it is exceedingly unlikely that the commercial unit-owners would ever use these facilities, which were undoubtedly intended for the benefit of the residential unit-owners, a “special allocation budget” that contemplated a “zero allocation” to the commercial unit-owners for these line items would not be unreasonable.

Likewise, the salary and benefits of a doorman who works solely in the “residential section” of the building should not be borne by the commercial unit-owners. Accordingly, it would be appropriate to carve out the cost of the salaries and benefits attributable to this building’s doorman from the commercial units’ allocation of common expenses.

By contrast, it would be difficult for the commercial unit-owners to argue that they receive no benefit from the services provided by the condo’s managing agent, residential manager, and porters. However – and this is where things can get a little tricky – should the commercial unit-owners be required to pay their “full share” of these items?

For example, while the porter shoveling snow from the condo’s sidewalks benefits both the commercial and residential unit-owners, most of the porter’s other responsibilities – i.e., cleaning the lobby, residential hallways, dealing with “residential” trash (by law, the commercial unit-owners are required to separately contract for their trash removal), and making routine repairs in residential apartments – only benefit the residential unit-owners.

What may be appropriate, then, is that a portion of the porter’s salary and benefits be attributed to the commercial unit-owners’ common expense allocation; i.e., 40 percent of 5 percent (or a total of 2 percent of that budgetary line item). Inasmuch as the managing agent and resident manager oversee the operation of the entire property, but are largely focused on “residential issues,” it would seem reasonable to attribute an amount closer or equal to their full common interest allocation for these items.

As for items such as the elevator maintenance contract, it would appear that a ground-floor commercial unit with its own entrance should not have to bear any part of this expense. However, the commercial units have mechanical equipment located on the roof of the building and service contractors use the elevators to repair and maintain the equipment. Under such a scenario, it may be appropriate for there to be a small allocation of this item for that.

Everything Adds Up

While some of these examples may seem trivial and not involve “big dollars,” they can and do add up, and, in the event of disproportionate allocations, can affect the values of both the commercial and residential units.

In addition, I have only provided examples of issues dealing with special allocations of the cost of services. It is important to note that similar issues arise with respect to the cost of capital repairs and improvements (i.e., Local Law 11 work, roof replacements, and other capital projects). A condominium’s governing documents will often treat cost allocation provisions differently for repairs than they do for services, creating even more complexity in the budget formation process.

In the building discussed here, the commercial unit-owners were benefitting from an overly generous allocation of common expenses contained in the association’s first-year budget that was created by a sponsor who probably planned to keep the commercial units. He probably hoped to market them as having a very favorable allocation of common expenses and concomitantly low monthly common charges. That said, some of the “commercial unit exemptions” (i.e., the amenity expenses) were appropriate, while others probably needed a rejiggering to reflect actual usage by the commercial unit-owners.

In other words, both sides needed to give a bit to avoid an unpleasant and expensive dispute that could have long-lasting negative effects on the relationship between the commercial and residential unit-owners. And while many condo bylaws have arbitration provisions relating to these types of disputes, reasonable board members, exercising their business judgment (with the help of their managing agent and attorney), should be able to hash out an allocation of common expenses that is fairly and reasonably tied to the actual use and benefit derived from the budgetary item in question. That will be in the best interests of every unit-owner, both commercial and residential.