Zoning In:Current Topics in Chicago Real Estate

CLE Seminar for In-House CounselJune 8, 2016Chicago, Illinois

Jack LawlorPartnerDentonsChicago+1 312 876 7459john.lawlor@dentons.com

Pat MoranPartnerDentonsChicago+1 312 876 8132patrick.moran@dentons.com

Land Use Innovations andPossible Legal Limitations

2

Jack LawlorPartnerDentonsChicago+1 312 876 7459john.lawlor@dentons.com

• On May 18, 2016, the Chicago City Council adopted a“Neighborhood Opportunity Fund Ordinance” (introduced byMayor Emanuel on February 18) which can ultimately result inover 1,000 additional acres in the existing "DowntownDistrict", primarily to the north, northwest, west and south (the"Downtown Expansion Area").

• The Neighborhood Opportunity Fund Ordinance has aneffective date of June 1, 2016. Its "grandfathering" provisionsappear in Sections 17-1-1500 and 17-4-1007 through -1009.

3

The City of Chicago's "Neighborhood OpportunityFund Ordinance"

Fee-Based Incentive Zoning in an Expanded "Downtown District"

4

5

6

7

8

• The Ordinance replaces most of the existing traditionalarchitectural design-driven floor area density bonuses with a"Neighborhood Opportunity Bonus" incentive fee program.

• The incentive basically offers additional square feet ofpermitted floor area in return for payments to the City bydevelopers prior to the issuance of building permits basedon 80% of the fair market value on a buildable square footbasis of Downtown District land.

• Floor area ratio (also known as "FAR) is, generallyspeaking, the quotient obtained by dividing the City-definedfloor area of a building by the net lot area.

9

•The bonus payments paid to the City, in turn,are to be divided among the following:

• "Neighborhood Opportunity Fund" (80%)

• "Citywide Adopt-A-Landmark Fund" (10%)

• "Local Impact Fund“ (10%).

• Neighborhood Opportunity Fund monies are to be used to revitalize off-site "qualified investment areas", including the development of grocerystores, retail stores and restaurants and the incubation of smallbusinesses.

• The Ordinance states that "the selection of projects will be informed bycommunity-based planning processes, such as Chicago NeighborhoodsNow".

• The Pending Ordinance does not indicate whether this selection occursbefore or after approval of the Planned Development for the proposeddevelopment in the Downtown District.

10

The Neighborhood Opportunity Fund

• Note that any grant of funds in an aggregate amount in excess of$250,000 requires City Council approval; otherwise, funds areadministered by DPD subject to procedures established by rule andsubject to City Council authorization limits.

• The Ordinance authorizes the Commissioner of DPD to enter grantagreements regarding the use of Neighborhoods Opportunity Fundmoney but does not state whether or not the completion of theseagreements is a prerequisite to planned development approval for theDowntown District development in question.

11

The Neighborhood Opportunity Fund (cont.)

• The "Local Impact Fund" must be used for work located within one mileof the planned development site if the Planned Development Ordinanceidentifies specific improvements.

• Otherwise, the bonus payments can be devoted to "eligibleimprovements anywhere in the downtown area..." in "consultation" withthe Alderman of the ward in which the Planned Development is located.

• The Ordinance also states that the developer may elect to make "in kind"improvements itself "on a case-by-case basis in consultation with thealderman of the ward in which the planned development site is located..."

12

The Local Impact Fund

• The Citywide Adopt-a-Landmark Fund may be paid "directly to landmarkproperty owners" if directed by DPD.

• Again, the Ordinance does not state whether or not this must beaccomplished prior to Planned Development approval.

• Although most of the existing architectural design-driven density bonuseswould be eliminated by the Ordinance, involvement in the newNeighborhood Opportunity Bonus Incentive Fee program could enable adeveloper to achieve a higher limit of density than the "as of right"density otherwise provided by the downtown zoning district regulations.

• However, there are "caps" on additional FAR density achieved throughthis new program ranging from 2.75 to 6.4, although there are no“maximum” caps on the floor area bonus that is available in DX-16 andDC-16 zoning districts.

13

The Citywide Adopt-a-Landmark Fund

• The Mayor's office predicts that $40 to $50 million could be generated inthe downtown district to assist development in economically depressedneighborhoods and that 80% of the money raised would go to developretail sales and service uses in underserved communities.

• The remaining 20% would be devoted to be devoted to landmarkedbuildings, neighborhood streetscapes and public transit facilities.

• The City states it will continue to promote good architectural design bymeans of its planned development review and approval processapplicable to tall buildings, waterfront properties, etc.

14

The City's Predictions …

2015 Amendments to the City'sAffordable RequirementsPending Ordinance

15

• 2015 Amendments to the City's Affordable Requirements PendingOrdinance Increase the Cost of Building Residential Projects Containing10 or More Units

• The City's Affordable Requirements Pending Ordinance (the "ARO")applies where an application for a residential development involving 10or more units receives either a zoning change, title to City land, Cityfinancial assistance, or planned development approval in the City'sDowntown Zoning District.

• Ten percent of the residential units have been required to be affordable(20% if financial assistance is provided), although payment of "in lieu"fees into the City's Affordable Housing Opportunity Fund has previouslybeen permitted.

16

2015 Amendments to the City's AffordableRequirements Pending Ordinance

• The City is divided for the first time into three zones for this purpose:"Downtown, higher-income areas, and low-moderate income areas."The City increased the "in lieu" monetary contributions to the City'sAffordable Housing Opportunity Fund to $175,000 in the newdowntown areas, $125,000 in higher-income areas and $50,000 inlow-moderate income areas. Previously, the in-lieu contribution to theCity's Affordable Housing Trust Fund was $100,000.

• For the first time, one-quarter of the required 10% affordable housingunits (or 20% if City provides financial assistance) is required to beprovided as actual on-site housing units, with two exceptions.

17

Under 2015 amendments to the ARO Ordinancewhich are now in effect:

18

A homebuilders association has challengedthe constitutionality of the ARO program. SeeHome Builders Association of Greater Chicagoand Hoyne Development LLC v. The City ofChicago, Case No. 15-CV-8268 in theNorthern District of Illinois, Eastern Division.

19

• The Fifth Amendment to the U.S. Constitution states that private propertywill not be taken for public use without just compensation (U.S. Const.,amend. V.) .

"[t]he general rule at least, is that while property maybe regulated to a certain extent, if regulation goestoo far it will be recognized as a taking".

-- Justice Oliver Wendell Holmes

20

The U.S. Supreme Court's evolving articulation of"Unconstitutional Conditions" to developmentapprovals

The Nollan, Dolan, and KoontzDecisions Articulate the CurrentFederal Constitutional Test

21

• That the land use restriction must advance a legitimatestate interest; and

• That the condition substituted for the regulatoryprohibition must further the same end advanced for theregulatory prohibition.

22

The "Essential Nexus" required by the NollanDecision

• The U.S. Supreme Court concluded that the conditionsimposed on Dolan's permit were unconstitutional becausethe conditions imposed were not roughly proportional tothe impact of the proposed expansion.

• The Illinois Supreme Court, in contrast, has beenconsistent in holding that a condition must be "specificallyand uniquely attributable" to the property in question. SeeAmoco Oil Company v. Village of Schaumburg, 277 Ill.App. 3d 926 (1995).

23

The "Rough Proportionality" Test articulated in theDolan Decision

24

The Koontz Case Adds Further Momentum to theUnconstitutional Conditions Analysis.

Justice Alito's opinion begins with a summation ofU.S. Supreme Court takings law, stating that itsdecisions in Nollan and Dolan, which are said to:

25

"… provide important protection against the misuse of the power of land-use regulation. In those cases, we held that a unit of government may notcondition the approval of a land-use permit on the owner's relinquishmentof a portion of his property unless there is a 'nexus' and 'roughproportionality' between the government's demand and the effects of theproposed land use".

The opinion then cites a variety of cases for the proposition that: "Wehave said in a variety of contexts that 'the government may not deny abenefit to a person because he exercises a constitutional right. ' …Thosecases reflect an overarching principle, known as the unconstitutionalconditions doctrine, that vindicates the Constitution's enumerated rightsby preventing the government from coercing people into giving them up."

26

The Koontz decision proceeds to hold that "government'sdemand for property from a land-use permit applicant mustsatisfy the requirements of Nollan and Dolan even when thegovernment denies the permit and even when its demand isfor money", without ruling on the merits of the case, noting:

27

"Nor does it make a difference … that the government might have been able todeny petitioner's application outright without giving him the option of securing apermit by agreeing to spend money to improve public lands… Virtually all of ourconstitutional conditions cases involve a gratuitous governmental benefit of somekind….we have repeatedly rejected the argument that if the government need notconfer a benefit at all, it can withhold the benefit because someone refuses to giveup a constitutional right."

" …. so-called 'in lieu of' fees are utterly commonplace… and they are functionallyequivalent to other types of land use transactions. For that reason, we rejectrespondent's argument and hold that so-called 'monetary exactions' must satisfythe nexus and rough proportionality tests of Nollan and Dolan".

How Do the UnconstitutionalConditions Tests Apply to theCity's Pending "NeighborhoodsOpportunity Fund Ordinance"in the Downtown Districts?

28

• The "essential nexus" appears debatable. The issue in Nollan iswhether there is an "essential nexus" between the City's conditionand the proposed development.

• Chicago is also subject to the Illinois Supreme Court's "specificallyand uniquely attributable" rule for determining the required nexus, atest much more rigorous than Nollan.

• Given Dolan and the Illinois "specifically and uniquely attributablerule", the City needs to include in its legislative record sufficientprofessional and academic studies establishing both the essentialnexus and rough proportionality demanded by the Nollan/Dolan bodyof case law and by the Illinois Supreme Court's "specifically anduniquely attributable" line of cases.

29

Possible attacks

• The City can vigorously assert that this is a voluntary bonus program and thatalthough the bonus FAR density requires payment, nothing has been takenfrom the base zoning rights enjoyed by the property owner before the newamendment.

• In California Building Industry Association v. City of San Jose, 157 Cal. Rptr.813 (6th Dist. 2013), decided 10 days after Koontz, the California SupremeCourt applied a "reasonable basis" judicial standard rather than theNollan/Dolan test to reviewing a housing incentive program analogous to theProposed Ordinance.

• The California Supreme Court indicated that so long as a permitting authorityoffers a property owner at least one alternative means of satisfying acondition that does not violate the Takings Clause, the property owner hasnot been subjected to an unconstitutional condition. The U.S. Supreme Courtdenied certiorari of San Jose at 61 Cal.4th 435.

30

Possible Defenses

How Will the UnconstitutionalConditions Case Law Applyto the City's Recent Increasesin Affordable HousingContributions?

31

• The Essential Nexus Test - Can it be argued that thereisn't an "essential nexus" for the purpose of providingfunds to stimulate affordable housing where it has beendisclosed that the Chicago Housing Authority has, in thewords of Crain's Chicago Business, "stashed millions inhousing funds"?

32

Possible Attacks

• The judiciary will take into account the extent of the City'splanning and analysis in determining the need for the AROprogram -- possibly taking the size of the CHA's reservefunds into account -- and in addition examine how the Citydetermined the amount of increase needed in relation to aproposed development.

33

The Rough Proportionality Test

• The 2015 ARO amendment eliminates a developer's abilityto discharge its entire ARO contribution by making "in lieu"payments that can result in the construction of affordablehousing elsewhere, instead, it requires a certainpercentage units to be constructed on-site.

• It can be argued that such a provision deprives theproperty owner one of the most important "strands" in the"bundle of sticks" comprising property ownership: the rightto possession. See Loretto v. Teleprompter ManhattanCATV Corp., 458 US 419 (1982).

34

Deprivation of Possession

• Delay

• Possible Corruption

• Abandonment of Sound Planning

• The Danger of Contract Zoning

35

Other criticism of the bonus programs

• Expansion of the Use of Transit Served Locations

• Reevaluation of Planned Manufacturing Districts

36

Other noteworthy zoning developments in Chicago

Stay flexible!Options for today's office tenants

37

Pat MoranPartnerDentonsChicago+1 312 876 8132patrick.moran@dentons.com

In today's tight economy companies are keen to control their occupancycosts. Lease options to "right size" a company's space to its quicklychanging staffing requirements are one part of the solution, but they runcounter to the office building owner’s goal of securing long-termcommitments to a fixed space so that mortgage lenders and investors canrely on predictable and stable rental revenue. This tension has led to thecreation of new types of options and a retooling of some of the traditionaloptions.

38

Overview

• Tenant Benefits

• Secures adjacent space in building which fosters "teaming" and comraderie

• Avoids lost personnel time to travel between elevator banks or to anotherbuilding

• Personnel have same access to tenant's internal amenity spaces (cafeteria,conference center, fitness facility)

• Ultimately avoids costly relocation of whole operation

• Landlord Costs

• Creates "encumbered" space, which is harder to lease and will be leased atdiscount to "unencumbered" space

• Due to "hard stop" the interim tenant can't stay for the long term

• Short-term interim tenant can't make major investment to fit out space

• Options exercisable in less than 5 years are even more detrimental due tointerim tenant preference for at least a five-year term

39

Costs and benefits of tenant options in office leases

• Tenants Had More Static Business Outlook

• Add a fixed amount of space every five years

• "Future is so bright" -- Everyone planned for steady percentage growth

• Renew for five-year renewal terms

• Stay in one place forever!

• Anticipated no dramatic changes in size of offices or optimal office lay-outs

• Landlord Accommodations Were Simpler

• Required "windows" accommodating delays in finding interim tenants

• Size and number of expansion spaces were more limited

40

Traditional options: Expansion and renewal only

• Tenant can periodically downsize ("right-size") as needed:

• Must pay contraction and early termination fees for flexibility

• Fees allow Landlord to recoup unamortized initial improvement allowance,commission, free rent, etc. made on assumption of getting rent for full term

• Typically will include a period of some months of rent to cover loss to Landlordin having to relet the space

• Space given back must be suitable for relet -- top or bottom floor of tenant'slarger space

• Tenant must pay to convert to multi-tenant floor, if applicable

• Sufficient advance notice and at least part of fee paid on exercise

41

The new look: Contraction, early termination andpartial renewal options

• First refusal is more time-consuming since Landlord must first find andnegotiate a third-party deal

• First refusal creates ill-will and "chills" the leasing since space issnatched away from the "winner" who then loses invested time andmoney

• First offer triggered at beginning of Landlord's efforts to market theencumbered space

• Both rights usually "all or nothing" so that a larger deal is not lost

• Rental rate protections:

• Can require a reoffer, before Landlord can offer a lower rent (95% oforiginal offer?)

• Can require a refresh, if Landlord can't find a taker after extendedmarketing period (9 months?)

• Benefits to using fair market rate in first offer rights

42

Who's on first? First refusal is losing playing time tofirst offer

• Very rare to apply a tenant's rental rate for initial space to subsequentexpansion space

• Tenant is a "captive audience" due to its investment in existing space

• Tenant needs protection against Landlord unilaterally setting anarbitrarily high fair market rent

• Use of arbitration clauses to avoid litigation over the "reasonableness" ofa landlord's proposed rental rate

• Benefits of baseball arbitration --

• Limits arbitrator to choice of either Landlord's offer or Tenant's offer

• Encourages reasonableness in pre-arbitration settlement offers

• Avoids "split the difference" arbitration award

• Achieves more accurate result by using expert in rental rates

• Prompt resolution

43

In search of a "fair" rental rate

• Subordinate Rights

• Create a "waiting list" for space that comes available

• Creation of renewal and ROFO rights that only arise if other tenants' fail to exercise

• Enhances Landlord ability to lease encumbered spaces by keeping hope alive forrenewal or expansion

• Poses administrative challenges and increased chances of liability for mix-ups

• Mismatched Lease Terms

• Tenant ROFO options always provide for exercising tenant to lease new space for thebalance of its remaining lease term

• Landlord is offering encumbered ROFO space to the market for shorter term with lessconcessions and lower rental

• Results in a need to "mark up" tenant concessions and adjust the rental rate

• Has led to Increased use of fair market rental rate in ROFO options

44

Special complexities

45

Thank You!We are very interested in your feedback -please take a moment to leave a note about this class and thepresenters on your evaluation form.

Jack Lawlor

Partner

Dentons

T +1 312 876 7459

john.lawlor@dentons.com

Pat Moran

Partner

Dentons

T +1 312 876 8132

patrick.moran@dentons.com