ASSOCIATIONS, CC&RS, TITLE ENDORSEMENTS – OH MY!

The Major Issues Faced Along the Yellow Brick Road of Purchasing an Industrial Condominium Unit from the Developer

By: Jenna Guggenheim, Greenberg Glusker

As we all learned in high school physics, every action has an equal and opposite reaction, and Newton’s law is certainly applicable in real estate.  For example, while there has been a recent downturn in the once-hot residential condominium market, there has been a strengthening of another related market: industrial condominium construction and conversion.  Developers are finding that business owners like the idea of building equity and maintaining stable operating costs. Landlords are interested in the truly passive income stream that comes with the ownership and leasing of an industrial condominium, and parties with 1031 money are piqued by a property interest that serves to diversify their real estate portfolio as well as provide a price point that may be needed to round out their tax deferred exchanges.  Another big factor is that the availability of small free-standing buildings (for example, in the 5,000 to 10,000 square foot range) is limited and if one is looking to buy a building in that size range, often the best choice is a condominium rather than fee ownership of a small building. 

Even with the recent interest in industrial condominiums, however, there is often a knee-jerk negative reaction by many potential buyers to owning an industrial condo instead of their own free-standing building.  Issues often raised range from a lack of independence felt by condominium owners to the unfamiliar ownership structure and governance that comes with an industrial condominium.

The following are some of the major issues that a potential purchaser of an industrial condominium unit should be aware of as well as a look at some of the negative aspects often raised in connection with this type of real estate.

What are you getting? What are you responsible for?

The first question that should be asked when looking into buying an industrial condo is: what is included in the purchase?  Do you simply own the interior air space of the unit? What about the exterior walls and common walls? The roof? The answers to these questions will be closely tied to the determination of what parts of the property are common to more than one unit owner and which parts are not.  Typically, the ownership includes a cube of air space within the condominium, an undivided interest in the common area and possibly an exclusive easement for exterior storage or vehicle parking. Elements such as common and exterior walls and the roof will typically be owned by the condominium association.   

Of course, the determination of what you own as a part of your condominium is closely related to what you, as the owner of the unit, are responsible for repairing, replacing and maintaining.  For example, if your ownership interest includes the roof, you will likely be responsible for its care and replacement.  If you do not own the roof, the condominium association will be responsible for its repair, maintenance and replacement obligations and will pass the associated costs along to the unit owners as a part of the assessments levied by the association.  Often the air-conditioning equipment is in the roof and is likely the condo owner’s responsibility regardless of whether the roof is owned by the association or the condo owner.

CC&Rs and Bylaws of the Association

Perhaps the most important document a potential purchaser of an industrial condo should carefully review during the due diligence period is the Declaration of Conditions, Covenants and Restrictions that are recorded against the condominium project.  This document governs the relationship among the owner’s association and all of the condominium owners.  Typically, the CC&Rs (as they are commonly referred to) include provisions (i) allowing the association to levy assessments (both regular assessments and special assessments for capital improvements and other non-routine charges), (ii) establishing easements for repair and maintenance obligations, common areas and utilities, (iii) establishing architectural and design control mechanisms, and (iv) setting forth the voting rights of the unit owners (and the developer while it remains an owner of one or more of the units). 

Potential buyers should also review the bylaws of the condo association to become familiar with how association board members are elected and how the association is governed.  A careful review of the association budget should also be performed.  This will indicate what items are included in the regular assessments and how much the assessments are or were for the year of the budget provided.  The Buyer should also consider whether the estimated periodic assessments are too low.  If so, the budget will likely need to be amended and the assessments increased.

Potential buyers should always include a provision in the purchase agreement requiring delivery by the seller of an estoppel certificate from the condo association.  Among other things, this will set forth the current amount of assessments and certify that the seller is not currently in default under the CC&Rs.  While this is arguably more important when purchasing the unit from a third party, rather than the developer, potential buyers should obtain this in either case.

Property Taxes

There are a couple of considerations relating to property taxes when purchasing an industrial condo unit from the developer.  Since the condo project may have been recently created and the final subdivision tract map recently recorded, the assessor may not have issued separate tax bills prior to your purchase.  This is something that should be discussed with the selling developer since he or she has had to deal with this issue on every unit sold .  Consequently, the proration method should be documented clearly in the purchase agreement.  Typically, the CC&Rs will include a provision stating that if the project has not been divided into separate tax parcels and there is still a blanket tax bill for the entire project, the association will be responsible for payment of the property taxes and the unit owners are required to pay the association for their proportionate share of the total amount prior to delinquency.  The potential Buyer should be sure that the developer has the financial capability to do this.   

Title Insurance and Endorsements

Just like any other purchase of a real property interest, the buyer of an industrial condo should obtain title insurance and the purchase agreement should make the title company’s irrevocable agreement to issue it a condition to the closing.  If there is a loan involved in the potential buyer’s transaction, obviously there will also be a lender’s policy of title insurance required.  Title companies may not require an ALTA survey in order to issue ALTA coverage for the purchase of an industrial condo unit from the developer.  One reason for this is that the CC&Rs typically establish easements for encroachments throughout the project.    

Potential buyers of industrial condo units should also carefully consider which endorsements to request from the title company, since there are unique endorsements applicable to condominiums.  Two of the most important are:

- CLTA form 116.2 which is comparable to a “same as survey” endorsement, however, this endorsement insures that the exterior dimensions of the unit are the same as the recorded condo map, rather than a survey; and

- CLTA form 100.19 which insures the condo unit owner against loss caused by a present violation of the CC&Rs.

With these suggestions in mind, a potential buyer should always consult with his or her title officer to determine the cost of each endorsement, determine availability of specific endorsements, and inquire as to other possibly beneficial endorsements not listed above that may be applicable to the particular industrial condo unit involved.

Assignment of Warranties/Guarantees

If you are buying an industrial condo from the developer, this typically means that it was recently constructed.  Included in most construction contracts between developers and general contractors are warranties and guarantees given to the owner (in this case, the developer) by the general contractor.  These warranties and guarantees will generally be subject to construction defect laws as well as an express survival period during which time the owner can require the contractor to correct the deficiencies in the work. 

During the negotiation of the purchase agreement, a potential unit purchaser should require that the developer deliver a non-exclusive assignment of warranties and guarantees contained in the construction contract (and any other agreement).  The developer will insist that this assignment be non-exclusive because (i) other sophisticated buyers of the units may ask for this assignment, and (ii) the condo association will also need to be assigned these guarantees and warranties not only because it will be the owner of the common areas in the industrial condo project, but because the association will likely be the entity through which unit owners will enforce their rights against the contractor.

Frequently Raised Negatives

There are various negative aspects which should be considered before purchasing this type of real estate.  First, for the amount and type of space (often just a shell) being purchased, the per square foot price can be high; often higher than a free-standing building.  Second, some purchasers feel that the condo ownership structure prevents them from being in control of their own destiny as they can be at the mercy of the CC&R’s, the association, other owners and even the developer while it still owns one or more of the condos.    In addition to restrictions on an owner’s use, there are rules and regulations pertaining to such things as, landscaping and what exterior modifications are permitted.  In addition, buyers are often hesitant to be involved with an association because they or someone they know have a nightmare story about dealing with one in the past.  Sometimes, difficult persons and neighbors who own other condos in the development can become an impediment to getting on with the business of the day.  Finally, there are often complex provisions in the CC&Rs, such as the damage and destruction provisions, that are not easily understood by laypeople.  Potential buyers should consider these negatives and factor them into their decision to purchase.

These are just a few of the main issues that are faced and should be thought about by any potential purchaser of an industrial condominium.  As always, each deal is different and will bring up new and interesting issues to ponder. 

About the Author

Jenna Guggenheim is a real estate associate with Los Angeles-based law firm Greenberg Glusker.  She specializes in a broad range of real estate matters including purchase and sale, financing transactions on the borrower and lender sides and leasing transactions for both landlords and tenants.  Ms. Guggenheim can be reached at (310) 201-7453 or JGuggenheim@greenbergglusker.com.