Zoning Due Diligence
Zoning and land due diligence is an important task for any proposed commercial or investment real estate acquisition. Zoning laws, which are constantly changing, dictate how a site can be used and impose size and location limits on structures. Lenders, insurers and buyers want to ensure their real estate investment is well protected and seek to have zoning due diligence undertaken as part of their decision-making process. Proper zoning due diligence requires expert knowledge of the detailed workings of zoning by-laws; legal non-conforming use application; survey and site plan interpretation; and, building permit issuance. Lakeshore Group has an established and recognized Zoning Due Diligence platform known as “ZeDD” which many companies, lenders and their legal counsels rely on to satisfy their acquisition investigations.
Lakeshore Group’s ZeDD services are designed to reduce risks associated with zoning and development approval compliance by uncovering issues prior to purchase closing, title endorsement or mortgage advancement.
The Importance of Zoning Due Diligence in CRE Transactions
Zoning due diligence and zoning compliance is an increasingly important issue for commercial lenders, title insurers, lawyers and purchasers. Zoning due diligence is critical to ensure that properties being purchased, insured or financed, and the current uses and tenants in place as well as prospective uses, are compliant, or can be made compliant, with in-force municipal zoning by-laws. Non-compliance in these areas can greatly affect property value, development potential, debt service ability and insurable risk.
CRE lenders need to ensure that the value of the property is correct and that the purchaser can operate the property in a manner that will allow the debt to be serviced. Title insurers must understand their risk and create appropriate exclusions in their policies or endorsements. CRE lawyers do not want to expose themselves to litigation by not paying close enough attention to zoning among the wide variety issues typically associated with a transaction. The purchaser does not want to buy an overvalued property that he cannot resell, successfully redevelop or operate as desired with expected income.
While title insurance is a valuable tool in dealing with some risks associated with CRE transactions, such insurance does not cover all areas of zoning non-compliance or issues related to non-conformity respecting a buyer’s intended uses. It is also important to note that title insurance will not prevent a lender from bringing suit against a lawyer for failure to disclose material information that would have affected its decision to issue a mortgage.
Thorough zoning due diligence will reduce the risks for all parties involved in a CRE deal.
Regardless of a property’s age or size, it must conform to current zoning regulations which are constantly being adopted, amended and varied by a municipality. This is an important consideration for any real estate transaction as, for example, a property which was in compliance 5 years ago is not necessarily in compliance today. Without proper investigations, there is significant increased risk that an undiscovered zoning violation or area of non-conformity will result in a substantial delay for closing, surprise costs following closing, the inability to generate expected revenue, fines, litigation and/or diminished property values.
Zoning Compliance – The Moving Target
Leasing Activities are also Affected by Zoning
Zoning due diligence is not only important for purchase and sale transactions, but for leasing activities as well. For tenants that require municipal licences to operate (e.g. car/truck rental agencies, restaurants, drug stores, hair salons), the licensing process often entails zoning compliance confirmation for the entire site, not simply the premises to be occupied. Under such circumstances, the licences required for operation will not be granted if the property’s zoning compliance is at issue. Also, while a prospective tenant’s use may be permitted by the applicable zoning by-law, the tenant may need to comply with the performance standards attached to that use (i.e. maximum permitted floor area, minimum dedicated parking, maximum selling area, maximum seating area, prohibited outdoor selling area, etc.). If the performance standards cannot be met, obtaining occupancy and building permits will be difficult or impossible. Some permits may be issued only to be later revoked once the items of non-compliance are discovered.
General Development Compliance Principles – “Use” vs. “Improvements”
Zoning compliance deals with two general components: 1) the property’s use and 2) its improvements and physical characteristics. Property use conformance examines all uses that operate on the premises. An as-of-right use is typically permitted without any supplemental approvals. Other uses can be permitted with special conditions, zoning variances or special exceptions within by-laws. Property improvement compliance establishes whether the improvements comply with all of the zoning by-law’s performance standards. Such standards vary between municipalities, but often include items such as: minimum lot size, minimum frontage, maximum building coverage, maximum floor-area ratio, maximum selling area, landscape buffers, building height, property line setbacks and minimum parking space counts and parking stall size.
Zoning compliance may be specific to certain tenant types. For example, a site may allow medical office, business office and retail uses, but each of these uses requires differing amounts of parking per square foot and each use may be limited by a floor area cap. For by-laws constructed in this manner, a property’s level of zoning compliance will change every time a tenant expands or new tenants move in. Additionally, variances granted for a particular use or activity may only be in place for a specified period of time from the date of approval (e.g. 3 years for the operation of a garden centre or for the allowance of off-site parking). If such approval has expired but the use for which it was granted is still in existence, new, otherwise compliant, tenants may be prevented from being able to obtain occupancy permits.
Legal Non-Conforming Uses – Less comfort than you might think
Dealing with a property which currently has “legal non-conforming status” only provides comfort to a purchaser if he/she intends to never make any changes to the tenant mix or site improvements and only if site improvements are never substantially damaged or destroyed (e.g. by flood, wind or fire). Improvements destroyed or substantially damaged by wind, fire or floods may not be permitted to be rebuilt without compliance with current zoning standards.
Thorough zoning due diligence will determine a property’s legal non-conforming status and the standards that will need to be complied with if property changes are made in the future. Such changes may be prohibited and will require the seeking of variance, zoning amendment and/or site plan approvals from the municipality which are often time consuming, costly and involve the input of and fees associated with various consultants (traffic engineers, landscape architects, civil engineers and land use planners). One must also keep in mind that municipal approvals are not guaranteed simply because applications are made. There is always a risk that an approval needed will not be granted by the authority in question.
Complex Development Control Layers – Look Beyond the By-law
A complicating factor in zoning due diligence investigations is that a property may have multiple in-force zoning layers, as well as separate plans and agreements registered on title which run with the land. For instance, a registered site plan agreement is a governing document in the case of an approved built development which often contains specific requirements beyond the applicable zoning by-laws. Such specific requirements often cover landscaping, parking layout, garbage and loading enclosures mpliance assists all parties involved in the transaction to determine if the subject property fully complies with the applicable requirements and whether there are or will be deficiencies that will have to be brought into conformance. This is vitally important in the case of multi-tenant buildings with vacancies that a new purchaser wishes to fill.
Multi-tenanted properties tend to have more complex zoning compliance issues than single-tenanted or owner-occupied buildings. However, this is not always the case. Looks can be, and often are, deceiving.
Municipal Compliance Letters – Watch for the Hidden Risks
Many lenders, lawyers, purchasers and title insurers may rely on the information obtained from a public official, or on copies of building permits issued or certificates of occupancy granted as confirmation of compliance. Such reliance has inherent risks. Municipal compliance letters or memorandums from the municipality are often incorrect or incomplete and heavily qualified (for example, the qualification will direct that the person enquiring must satisfy themselves notwithstanding what the municipality’s report states). In addition, municipalities most often will not review as-built topographic surveys in order to render compliance information. Municipal databases regarding permits issued and zoning compliance are typically not based on the current structure and tenant mix on a property. Changes made to the property and tenant types by an owner subsequent to the original zoning approval and/or building permit issuance will often not be reflected in the City’s database. Permits, memorandums and certificates, as well as compliance letters, are also routinely revoked by the municipality if they are improperly issued. Improper issuance typically comes to the attention of the municipality when owners seek permits or variance approvals for unrelated building improvements or when other tenants apply for occupancy permits.
The heavy lifting for determining compliance is ultimately left to the lawyer, purchaser or lender.
Lawyers and other real estate practitioners in the CRE area, whether acting for a lender, vendor or purchaser, can expose themselves to liability as a result of wading unintentionally into zoning compliance issues. You should remain mindful of the case law respecting the carrying out of proper zoning due diligence. Some cases worthy of review are:
Fohrenkamm v. Plaxton (1973): Depending upon the nature of the retainer, a lawyer may be liable for failing to make appropriate inquiries concerning zoning compliance
Bosworth v. Professional Syndicated Developments Ltd. (1979): Where an agreement of purchase and sale is conditional on lands being zoned for a particular use, the purchaser’s lawyer will be expected to determine the correct zoning of the property.
Nielsen v. Watson (1981): A lawyer may be negligent if problems raised by a survey are not investigated.
Davenport v. Stakiw et al. (2007): Lawyers and real estate agents involved in the same transaction may all be negligent for not making appropriate zoning inquiries regardless of whether they act for the vendor or purchaser.
Case Law – Have you “stepped in it”?
Concluding Observations from Our Practice
Parties to a transaction would be wise to obtain full understanding of the current zoning compliance status of the property, the permissions and restrictions associated with uses which are presently operating on the premises as well as those which may be sought for the property in the future. Purchasers should also understand the costs and risks associated with attempting to secure zoning approvals or variances to correct deficiencies. These costs are often substantial enough to negatively affect the economics of the deal.
The commencement of zoning investigations required as part of a lease or sale transaction should not be delayed. The zoning due diligence process can take several weeks to complete depending on the type of property and complexity of zoning layers involved. If left too late, your closing may be delayed or the deal may fall through.
The findings of a zoning due diligence review can significantly affect price, hold-back amounts, closing timeframes and terms (i.e. requirement for seller to correct compliance issues) and decisions to lend or extend title insurance.
Established in 1994, the Lakeshore Group provides independent and expert zoning due diligence services to CRE lawyers, lenders, purchasers and title insurers.