Techniques For A Developer To Structure “For-Sale” Apartments In A Leasehold Project Joshua Stein Here’s how a ground lease—and a leasehold condominium—can provide a solid foundation for a “for sale” apartment development. IF AN APARTMENT PROJECT relies on a ground lease structure, can the developer sell individual apart- Joshua Stein, ment units to individual owners? Or does the use of a author of ALI-ABA’s “A Guide to Ground single ground lease for an entire building (or for the apart- Leases (With Forms and Checklists),” is a real estate and finance partner with Latham & ment component of a larger building) preclude individual Watkins LLP, and a member of the American apartment sales? College of Real Estate Lawyers. His articles on These questions cause concern and trepidation ground lease financing, leasehold mortgagee protections, and other commercial real among lawyers and their clients in structuring develop- estate topics have been widely published. ment projects from coast to coast. That’s particularly true For copies of many of them and information for mixed use or government-assisted projects, or other about his book on ground leases, visit www. real-estate-law.com. The author acknowledges projects driven by nonprofit owners. with thanks the contributions of his clients The answers to these questions are not simple, but who asked the questions that produced a developer and its counsel will usually like the answers. the memos that became this article (and consented to publication of this article); This article offers some analysis, suggestions, and options his partners Richard L. Chadakoff, James I. for anyone trying to structure a for-sale apartment build- Hisiger, Bruce P. Shepherd, David M. Stewart, ing that uses a leasehold estate as its legal foundation. and Leonard A. Zax; Donald H. Oppenheim of Meyers Nave PC, Oakland, California; and Rather than seek to define a single “best way” to structure his editorial assistant, Michael D. Mosley. a project of this type, though, the following article only Copyright © 2007 Joshua Stein. offers some suggestions and ideas to consider and discuss in structuring any particular project, and introduces some issues counsel will need to consider. This article starts from the following set of somewhat typical facts. The Practical Real Estate Lawyer | 51 52 | The Practical Real Estate Lawyer May 2007 A non-profit institutional property owner (the • Long-term ownership. Owner wants to ensure that “Owner”) owns land (the “site”) near its main cam- it has a long-term ownership interest in the pus headquarters. Both the headquarters and the site, so that “we will never have to assemble it site are prime coastal locations, with commanding again”; ocean views and excellent transportation. They • Adverse legislation. Owner fears legislation that represent about a third of Owner’s entire real es- would entitle holders of long-term leaseholds tate portfolio. to acquire the underlying fee estates based on Owner takes a very long-term view of its real considerations of “fairness,” “public policy,” estate ownership, a commercial activity that it re- and the like. Owner is well aware of Hawaii’s gards as secondary to its charitable, educational, various “leasehold conversion” statutes, which governmental, public service, or religious goals (its allowed ground tenants to acquire the underly- “mission”). Today, Owner does not believe it needs ing fee estates at prices that allegedly reflected their fair market value. Owner does not want the site for its mission. At some point in the dis- to find itself the victim of the next such legisla- tant future, Owner may very likely want to expand tive improvement of land tenure. (This article its headquarters onto the site or construct related discusses the Hawaii experience below, along facilities on the site, such as a conference center, with the court cases that validated it); library, athletic field, or special-purpose facilities, to • Control. Given the site’s proximity to Owner’s try to better serve its mission. main campus headquarters, Owner wants to The site was not easy to acquire. Owner wants prevent site occupants from taking actions to retain unquestionable long-term control of the that could cause controversy, embarrassment, site. For the moment, Owner wants to develop on annoyance, interference, or bad publicity for the site a mixed-use commercial project (the “proj- Owner, or would disserve Owner’s mission. ect”). The project will contain a high-end mall; Therefore, Owner wants some ability to con- parking; rooftop parks; an athletic club; quasi-pub- trol what people do on the site; lic circulation areas; residential towers (the “Tow- • Marketing. Any ownership structure for units ers”), each, if possible, containing for-sale apart- should pass without objection in the unit mar- ment units (the “units”); a supermarket; a high-end ket (including the market for unit mortgages), wine bar; and other facilities. so Owner will not find its marketing program This article explores Owner’s agenda and goals, impaired as a result of the unit ownership some ownership structures that Owner might con- structure; sider for the Towers and the units, and some (but • Future community relations and public relations. certainly not all) advantages, disadvantages, and Owner wants to avoid future financial sur- practicalities of those various options. prises for owners of individual units (the The article concludes by suggesting a path “unit owners”), because these may produce Owner might best take for the project, although bad publicity and complaints, or even politi- any other option suggested here may also make cal pressure within Owner’s various internal sense for any particular project. constituencies. • Mission-related use. Owner may want to retain OWNER’S GOALS • In defining any ownership some units for purposes related to its mission, structure for the units, Owner wants to achieve at such as to provide housing for its leaders, visit- least these goals: ing scholars, or management; “For Sale” Apartments | 53 right to terminate a Tower lease. That fact • Simplicity. To the extent that Owner can keep should, in and of itself, mitigate most concerns the site’s ownership structure simple—with and risks (particularly to a mortgage lender) as few layers, moving parts, and documents that arise from using a ground lease in place as possible—this will save money; reduce the of fee ownership. (To a mortgage lender, the likelihood of inconsistencies, mistakes, and single most important attribute—and peril issues; prevent delays; and help Owner achieve — of any ground lease consists of the fact that its other goals. the landlord can terminate the ground lease In considering how to structure the project, Owner for default.) Even without the risk of prema- will need to consider each of these goals as well ture termination, though, a ground lease still as some others (in particular, tax issues, which this has an expiration date—a date when every- article totally disregards). thing ends and everything reverts to the land- POSSIBLE OWNERSHIP STRUCTURES lord. As long as the parties can plan for the • Owner might consider one or more of these expiration date and it can’t come by surprise, ownership structures. they ought to be able to live with it; • Casualty and condemnation. Although a Tower Whole-Building Ground Leases lease will be terminable on casualty or con- (“Tower Leases”) demnation, these termination rights will Owner could ground lease each Tower to an contain typical lender protections. Also, each Owner affiliate (a “Tower Tenant”). Each Tower Tower lease will strongly lean toward recon- Tenant would ultimately both: struction and restoration regardless of the • Subject its interest in its Tower lease to a con- scope of any casualty or condemnation. This dominium regime; and bias is quite common in mixed-use projects, • Assign its Tower lease (whether before or after both leasehold and fee-owned; and condominiumization) to an “Association.” • Fully financeable. The Tower lease terms will (As a variation, Owner might enter into a single facilitate both financing of the entire leasehold Tower lease for all Towers with a single Association. (e.g., by the Association, if state law facilitates In that case, however, extra issues and complexity it) and financing by individual unit owners. within the condominium might outweigh the ben- Some of the preceding characteristics of the Tower efits of a single Tower lease.) Purchasers would buy lease would make sense only for a nonprofit Owner units within the condominium regime that governs of the type assumed here. A private sector investor their Tower. Tower leases could include any or of might not tolerate such terms. the following elements, all as appropriate under the circumstances: Single-Unit Ground Leases • Prepaid rent. Some or all rent could be prepaid; Owner could lease each unit to its unit owner • No adjustment. The rent will not be subject to by entering into a separate ground lease with each future adjustment, or any future adjustments unit owner, on the same terms as the Tower leases, will be minimal and predictable. No surprises; as applied to individual units (the “unit leases”). • No termination. Upon any tenant default, the Unit leases could include these elements: landlord will have meaningful remedies • Role of Association. All unit owners—as tenants against the Association and even against unit under unit leases—would appoint the Associa- owners, but those remedies will include no tion as their agent for all dealings with Owner. 54 | The Practical Real Estate Lawyer May 2007 Association would handle billing (if any) and Cooperative Corporation (a “Co-op”) all other aspects of the landlord-tenant rela- Each Association could consist of a co-op, tionship. But any unit owner would be respon- which would hold its own Tower lease and then is- sible only for its own defaults; sue corporate shares and proprietary subleases to • Combination.