As Connecticut's real estate market recovers, our developer and lender clients should benefit from recent amendments to the Connecticut Common Interest Ownership Act ("CIOA" or the "Act") which are designed to encourage the use of the Act in nonresidential developments.
These amendments to the Act offer extremely flexible safe harbor rules for developers and lenders alike. We think all commercial developers--strip mall, retail mall, industrial park and other commercial projects--should consider the advantages of organizing their projects as common interest communities and offering the individual units for sale:
- Immediate ability to cash out. Depending on the creditworthiness of each occupant/buyer and the developer's cash requirements, the developer will be able to sell the units and cash out immediately, while retaining a management contract, ground lease or other economic benefits unique to that project.
- Pass-through of tax benefits. The user/purchaser will be able to take advantage of depreciation and other benefits of real property ownership.
- Fractionalized debt in the case of long-term tenants. Even where the developer does not wish to fully sell its interest, or some or all of the users do not wish to buy, each unit can be financed with a separate loan. Again, depending on the creditworthiness of individual buyers and the terms of the particular deal, this may permit a lender to approve larger loan-to-value ratios for the individual units than might be the case if the lender offered a blanket mortgage on the entire development. In addition, a developer may be able to finance portions of its project at an earlier stage of the rent up process. Both outcomes should enhance the developer's cash flow.
Other Advantages. These benefits can accrue without any of the restrictions that once existed for commercial developments under the Act. The amendments to the Act give developers and their counsel these choices:
- No subdivision approval for selling these commercial units is necessary. By using an air rights boundary definition of units, the land underlying the units need not be divided. Only the air above the ground is divided. It is within this air space that individual buildings or rentable spaces are located. Footings and foundations below ground become limited common elements to the units which they support.
- Cross-easements for parking accomplish the identical results as in a rental structure.
- Total freedom of contract. The standard rule remains that CIOA does not apply to a nonresidential project, unless the documents elect coverage under the Act. With the new amendments, we now generally recommend subjecting nonresidential projects to the Act because CIOA provides both flexibility and certainty for developers and lenders. The Act provides great flexibility in deciding which provisions of CIOA the developer and lender apply to their nonresidential project. Thus, the parties can tailor the applicable statutory provisions to the project's needs. Specifically, the statute provides a sweeping safe harbor for the developer to use powers of attorney or other devices to enable any outcome which is agreeable to the developer and its tenants and purchasers. The only restriction is that against unconscionability.
- Long-term project control. CIOA also provides a safe harbor for developers who wish to maintain long-term management contracts, ground leases and other agreements between the developer and community association as a means of securing long-term income streams. This is a different result than in residential projects, where the association has a statutory right to terminate such contracts, and where turnover of control from the developer is required. The degree of control is not regulated in the commercial context, and is based on the relative bargaining power of the developer and his tenants and purchasers.
Zoning laws will always be with us and will continue to apply in every commercial development, whether structured for rental or sale to occupants. However, use of the many tools offered by CIOA should make development of any commercial project more flexible, and result in enhanced net income for our clients. The firm's Real Estate Development practice group welcomes the opportunity to work with its clients to implement these exciting new tools.