The concept of condominiums in Illinois was first authorized in 1963 with the passage of the Illinois Condominium Property Act. Subsequently, during the 1970’s a great boom in residential condominium development ensued — both sales and re-sales — that continued with ups and downs into the new millennium. While the drafters of the Act were focused on residential condominiums when writing this legislation, the Act applies to any type of real property. In the last several years, developers and owners have recognized that many of the advantages of owning a residential condominium unit also can be applied to a commercial condominium unit.
Commercial condominiums may be in single-use buildings that are either office, industrial, or retail. They may also be in mixed-use or multiple-use buildings, including office/industrial, office/retail, residential/retail, residential/office, and other combinations. As with residential condominiums, commercial condominiums can be either new construction or conversions of existing structures.
Advantages of Owning
A business owner considering whether to lease a place of business or purchase a condominium unit should consider the following advantages of owning rather than leasing.
First, ownership will give the business owner the opportunity to build equity when making monthly payments, instead of having all the monthly lease payments go to the landlord.
Second, a condominium owner has tax benefits relating to depreciation of the property, which a tenant cannot take advantage of.
Third, ownership of the unit gives the business owner better control of occupancy costs. While the unit owner cannot totally control increases in real estate taxes and condominium assessments, the larger part of monthly payments are in the control of the unit owner.
Fourth, a business owner may be able to purchase a unit in a building or complex with similar or complementary businesses that could enhance business opportunities.
For instance, a car transmission repair business could be located in a strip of condominium units with other businesses that provide other services to car owners.
Similarly, physicians with different (often complementary) types of medical practices could all be located in the same office building, each owning a separate condominium unit.
Many not-for-profit entities can enjoy additional savings by purchasing a condominium for their businesses rather than leasing. These entities can be exempt from real estate taxation. When leasing from a landlord, a not-for-profit cannot take advantage of this exemption; but if the entity owns the real property directly by owning a condominium unit, the entity can realize the real estate tax savings … which could be substantial.
Not For Everyone
On the other hand, some people do not favor commercial condominiums for the following reasons:
The owner is not in total control of the expenses associated with the property.
The association that controls the property as a whole can impose rules and regulations, which may impede the owner’s ability to do business.
If the business outgrows the condominium unit, the owner may be forced to sell the unit in an unfavorable market.
When purchasing a commercial condominium unit, business owners need to pay close attention to the structure of the entity used to purchase the unit. Considerations should be the same as when a business buys an entire building. Business owners should consider setting up a separate limited liability company whose members will be the same individuals who are shareholders of the operating company of the business. There are two primary reasons to use this structure.
First, it will protect the equity in the condominium unit from the claims of the creditors of the operating company.
Second, there are tax disadvantages to holding real estate in a corporate entity, which one can avoid by holding title in a limited liability company.
Most purchasers of commercial condominium units will need to obtain financing. Not all lenders are knowledgeable or interested in providing mortgages for commercial units. So, a purchaser should spend some time at the outset talking to a number of different lenders to find one that has experience in lending to commercial condominium unit owners. Some lenders will finance the purchase of a commercial unit on terms similar to the terms for financing the purchase of an entire building, while other lenders may use more strict underwriting criteria in evaluating whether to make a loan. The more cautious lenders are concerned about the perceived risk that other unit owners will not pay their assessments, which cover their fair share of common area expenses. Such lenders also may question the marketability of the unit in the event of a default, since they believe that there is a smaller market for these units than for a single-user building.
Consider Marketability and Restrictions
The purchaser of a unit also should be concerned with the unit’s marketability, particularly if the purchaser’s business is likely to grow in a short period of time. If the business needs to move to another property, and the unit owner cannot quickly sell the unit, the owner may need to lease the unit to another business. So, the purchaser should carefully review the condominium documents to discover if there are any restrictions on leasing the unit. Also, the purchaser should review the condominium documents, as well as applicable governmental zoning requirements, to identify any restrictions placed on the permitted uses of the property. Any such use restrictions also could impact the marketability of the unit, when selling or leasing the unit.
Some other issues that a purchaser should consider when buying a unit are:
Parking: The purchaser needs to determine whether the unit has any deeded parking or limited common element parking, and, if not, what parking rights the purchaser and its employees have. For those properties which have limited common element parking spaces, a purchaser should inquire as to the fees or chargebacks that are associated with these parking spaces. Also, the purchaser needs to find out what parking is available for clients or customers.
Common area expenses: As part of due diligence, the purchaser should find out what the common area expenses are and if the association’s budget seems reasonable to cover those expenses.
Reserves: The purchaser should also identify what reserves the association maintains to cover unbudgeted items, which may include capital items such as repairs and replacement of roads, driveways, and any shared HVAC equipment that are common elements.
Technology: The purchaser should inquire about various technology issues, such as the availability of T-1 lines and satellite dish installation rights.
Loading Docks: For many businesses loading docks are critical, particularly for industrial and retail properties. A purchaser should identify what loading dock rights are available for its use.
Equipment: Many commercial properties have the HVAC Equipment for each unit located on the limited common elements of the building. A purchaser should identify what the rights and obligations of the unit owners are with regard to these limited common elements.
Signage: Since signage is important in commercial settings, a purchaser should determine all signage rights and obligations.
Access: In many commercial properties vehicular access rights may be an issue. A purchaser should find out how employees, customers, and clients can get from a particular street to the building where the unit is located.
Easements: A purchaser also needs to know if the other unit owners in the building have access easement rights over adjoining property, and if the owners of adjoining properties may have access easement rights over the property where the purchaser’s unit is located.
Developers of commercial condominium buildings are attracted to the condominium structure for many of the same reasons as developers of residential condominium buildings. Whether projects are new construction or conversions of existing buildings, developers have determined that:
They can make more money by selling the units than by leasing them, or
They can make more money by selling the units than by selling the entire building in which the units are contained.
When developing commercial condominium buildings, developers should be sensitive to the issues that concern purchasers in addition to all of the routine matters that developers ordinarily consider in constructing new buildings or converting existing buildings. It is of utmost importance that developers consult with an attorney who is well versed in the Illinois Condominium Property Act and how it applies in the commercial setting. When developers are converting commercial buildings to condominiums, they should also consider the rights of the existing tenants in the buildings. These rights, which include a right of first refusal, are contained in the Act.
As the economy in general makes its recovery, the commercial real estate industry will be a strong and important part of that recovery. One national commercial real estate firm reports that commercial condominium sales in the Chicago area for 2009 approached $80 million. With the many advantages of condominium ownership for various businesses, one can expect that there will be an increased trend in business owners choosing to buy commercial condominiums rather than leasing their places of business.
Originally published in Chicagoland Buildings & Environments (Spring, 2010).