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1/1/12-rev. Be sure to check out Beth's Blog and the E-News Archives as well for the latest on lease limitation restrictions. RENTAL LIMITATIONS AMENDMENTS - Are They Legal in California? (And What You Need to Know if You Want to Consider One) İBeth A. Grimm, PLC (HOA/CONDO ATTORNEY, CALIFORNIA]
The goal of a lease or rental limitation is to get and keep the percentage of rentals reasonably low so as to eliminate or at least minimize the problems that can arise as to financing those enforcement-related issues commonly associated with high percentage rental complexes. The following information speaks to the practical and legal ramifications (and pros and cons) of a lease/rental limiting provision. Many associations want to look at proposing these types of regulations to the members. It is good to have the benefit of knowing what issues can arise and how to minimize the risk of a challenge to such a clause.
THE REALITIES: Properties become more difficult to finance if the rental percentage gets too high. Generally, 30-40% is considered high by lenders. When the percentage in an association reaches 50%+ rentals, one is likely to encounter considerably limited financing options. That high a rental percentage may eliminate the option of loans that are made for owner occupancy buyers (FHA) and those generally sold to the secondary mortgage market which includes FNMA (Fannie Mae) and FHLMC (Freddie Mac). This includes a substantial percentage of home loans. This high rental percentage requires potential buyers and owners who want to refinance to look for other financing because many banks and savings and loans package and sell loans to the secondary market.
Many Boards that look at these provisions have also experienced considerable difficulty with tenants. In many cases, owners have not placed responsible tenants, owners have not responded to the Board's communications about problems, or the tenants have ignored the Association rules. Sometimes tenants simply thumb their noses at the Board. Of course this can also happen with owners
Associations all over California have experienced this: the more rentals, the more problems and bad experiences there seem to be. Many boards believe that renters tend to be more problematic, have a different focus and less interest generally with regard to the property. A study done by the Department of Real Estate in California back in 1985 actually shows that developments with a high percentage of rentals tend to have more problems than those with lower percentages so this thinking is not far-fetched or unsubstantiated. And it makes perfect sense that the more transient the resident, the less interest there will be in establishing roots in the community and maintaining the property. Some association Boards have experienced the negative aspects of the "apartment mentality" that comes with some renters that disregard the neighbors and property.
Some boards want to amend the documents to prohibit sales to "investors". This is not the way to go - such a provision would run into all kinds of legal challenges. The way to discourage investors from buying in the development is to seek approval of members to prohibit leasing or renting when a certain percentage of units is already being leased or rented, and/or by requiring residency by a purchaser for a year, two or three, before the purchaser has the option to lease the property.
THE LEGAL QUESTIONS: Many typical questions arise about the legality of lease limitation provisions in California. Information such as contained in this letter should be provided to the owners in the development so that they may become more educated before proposing any amendment that would limit rentals in the development. Boards tend to trust that the members will be as concerned about rentals as they (the Board members) and that owners will be supportive of a lease limiting amendment. My experience is that owners do not always see things from the Board's perspective. In fact, some become hostile at the hint of the possibility that their right to do what they want might be abridged in some way, that is, until they understand the other side of the sword, i.e, the more limited financing options when the percentage of rentals rises.
Is California different than other states?
There is a statute in California which prohibits unreasonable restraints on alienation of property (Civil Code Section 711). Hence, the key to avoiding contradiction of that statute is to propose a "reasonable" restriction. "Reasonable" restrictions include those that are rationally related to the problem you are trying to address, such as preserving the residential quality of the neighborhood and avoiding common problems identified with high percentage rental developments. When proposing percentages for restrictions, considering objective standards such as those set by the secondary lending industry (FNMA, FHLMC, etc.), and finding a sufficient buffer below those standards is a good way of looking at a reasonable limitation. "Grandfathering" and "hardship provisions" are necessities that need to be addressed in such an amendment to make it "reasonable" (in my humble opinion and because of what I have read in decided cases throughout the country). There is also one "unreported" appellate court case in California which, although it cannot be cited as binding authority, raised some new arguments about Civil Code Section 711 and its application in homeowner association situations. I discuss these options in more detail below.
Still, some people question the legality of the lease and rental limitations in California. People without any information about why such a provision would be beneficial tend to have a negative reaction like "why should they have the right to tell me what I can do with my property?" It's an understandable emotion, especially in difficult economic times when people want to keep all options open. Some attorneys will not write them. Some attorneys will tell clients that they are not legal, without even seeking any background research as to what the courts in California or any other state have done with such provisions. Legal advice from providers without the willingness to do the research or the knowledge on this topic is worth little.
THE COURTS OF CALIFORNIA HAVE APPROVED LEASE LIMITING AMENDMENTS
The appellate courts of California have spoken now twice on the issue of leasing limitations in a number of cases and have explained their positions.
Approval of a Total Ban on Leasing in an Affordable Housing Development
A binding California case decision approving a 100% limitation on a project that was built to provide low income housing is City of Oceanside vs. McKenna. (Court of Appeal, Fourth District, Division 1, California, No. D008264, Nov. 22, 1989. Review Denied Feb. 14, 1990.) The court said:
Approval of an Amendment and Reduced Percentage for Approval.
In 2008, September 5, another decision was rendered in Mission Shores Association V. Pheil, 2008 WL 4097269 (Cal.App. 4 Dist.). In that case, the decision of the Court was:
(2) the mortgage holders security was found not to be jeopardized by the amendment; and
(3) a challenge by the owner based on arguments to the contrary failed.
Approval of Amendments Prohibiting Continued Leasing by Investor Owners By Approving a Percentage Limitation Without a Grandfather Clause (pre 1/1/12 of course).
In June of 2010, in the case of Harrison vs. Sierra Dawn Estates, the appellate court by a footnote suggested a different way of analyzing the effects of Civil Code Section 711 with this quotation:
"FN1. Civil Code section 711 generally prohibits unreasonable restraints on alienation. By contrast, Civil Code section 1354 specifically prohibits unreasonable CC & R's.
The Aldersons do not argue that there is any difference between these two standards. Quite the contrary: They assert that Civil Code section 1354 "modified" Civil Code section 711 's "blanket proscription against restraints on alienation ... with respect to common interest developments." Thus, they urge us to review the rental restrictions under the standard of Civil Code section 1354, as set forth in Nahrstedt.
We therefore assume, without deciding, that as long as the rental restrictions do not violate Civil Code section 1354, they necessarily also do not violate Civil Code section 711. (See, e.g., Nahrstedt v. Lakeside Village Condominium Assn., supra, 8 Cal.4th at pp. 381-382 [analyzing reasonableness of CC & R's under standards generally applicable to equitable servitudes].) "
POSSIBILITIES FOR WORDING IN A LEASE/RENTAL LIMITING AMENDMENT:
These are some of the types of limiting amendments that have been approved in California HOAs:
(2) Requiring residency or preventing occupancy by owner/purchaser for one year or more. (The intent here is to discourage purchase by investors who intend to slip a renter right into the property.)
(3) Alternating the right to rent homes so that the percentage is limited but everyone gets a turn.
(4) Setting a minimum rental period to 30 or 60 days to prevent vacation rentals or hotel type of rentals.
All these points are important for purposes of discussion about these amendments. There are many developments in California that want to look at lease limitation provisions, upon hearing that financing units in can be adversely affected by rentals. An Association is justified in presenting such an amendment to the owners for approval.
GENERAL CONSIDERATIONS - INVOLVING OWNERS
A Survey Is A Good Way To Find Out Where Owners Stand. A Meeting Is Even More Provocative.
A survey is included with this article that is designed specifically so that homeowners can provide input to the board. The owners need the information in this article, though, to fully understand the ramifications, so that they can answer with an educated viewpoint. Simply answering the questionnaire without understanding the perceived need, or the potential issues, can lead to skewed results. Many individuals oppose the prospect of any limitation on what they can do with their property, until they understand that the marketplace may create its own limits to what they can do. Besides the financing issues, nuisances have to be disclosed in a sale, and more than half of the disputes Associations bring to me with nuisance issues involve tenants.
I usually suggest a two-three week turnaround time to return the survey and have it considered before any version of the documents is circulated to the membership. Some Boards want to have a town hall meeting to discuss the prospects. This gives the owners the education and time needed to investigate the possible lending issues with a local bank, and nuisance issues with a local realtor. I think it is a good idea to call a meeting to educate the owners and answer questions. Sometimes, there is a good turnout and the owners can get more information, and the board can get feedback from the membership. Sometimes there is a good turnout at the meetings and the discussion can go from heated to rational, uncovering many opinions which were not divulged in the survey. However, I have also been to such meetings scheduled by the Board to see that only one or two people are interested enough in the subject to attend the meeting. I would say based on experience that the meetings are more well attended - and more provocative - in these times, than ever before.
The Economic Downturn Has Created a Difficult Dichotomy.
I have been attending meetings for years to answer owners' and board members' questions about lease limitation provisions. Although as an attorney I remain neutral on them, boards and owners fight like heck to get me to agree with them. These matters can trigger strong emotions. And I clearly see both sides. There are some associations that may not be well suited or that do not need such an amendment because the units are not enticing to investors.
Board members who educate themselves bring to the table good information about the benefits of the provisions; however, in their zest to promote the amendments, sometimes avoid expressing the cons of the amendments. That leaves it to objectors to bring up the other side, and that can make the board look biased and uninformed. Members who make their decisions tend to either focus strongly on the upside (protecting the financing options for resident purchasers and current owners) or the downside (the loss of investor interest), depending on their own personal situation. By the time the parties get to an informational meeting, emotions are running high, and it takes some effort to convince all parties that the bearer of news and information, whether the Board or the attorney - is not the bad "guy". The Boards I have worked with always have had good intentions when proposing that limitations might be considered. But face it, the fear of not being able to rent or sell one's home if an owner finds themselves in unusual circumstances like have to move in with parents (or children) and rent out the unit to make the payments is a prevailing fear in today's climate. What is one way to work with this concern of owners? Consider "Grandfathering" all current owners (which by virtue of the new law happens anyway unless an owner consents to be subject to the new amendment. Another way? Write in a generous "hardship" clause. Of course, these efforts do not as tightly protect the original goal of getting rentals under control. It is a difficult dichotomy, to be sure. It is hard even in a good economy to get owners to understand the value of limiting rentals, without having to deal with the current inner panic many feel in light of the poor economy.
PROS AND CONS
What are the advantages to a lease limitation provision?
2) They can alleviate some of the problems relating to a high percentage of rentals.
3) They may protect the "finance-ability" of units by avoiding some of the constraints of the mortgage markets (like FHA, FHLMC and FNMA) that have restrictions on lending in high percentage rental developments.
4) They tend to attract resident owner purchasers, community, and help protect the residential quality of the development.
What are the disadvantages of a lease limitation provision?
2) They can lead to legal challenges by unhappy owners who want to lease and cannot (although these can often be nipped in the bud by the assistance of an attorney who has worked with these provisions).
3) Extra bookkeeping is required including keeping track of owners and renters and, to the extent the demand arises, adopting a fair means of setting priority for those who want to lease, arranging a hearing process for hardship requests, and setting up a grandfather registration process when applicable.
Although I am commonly asked about this, I know of no statistics that will differentiate between the affects on the "purchase pool" as between the mortgage industry providers like FHLMC and FNMA and the "pool" created by investors, but it is fair to say that FHA, FHLMC and FNMA are and have always been major "players". And in the current climate, it is easy to see that investors are also major "players" as home prices drop. In this economy, this also concerns Boards and owners because when the investor "pool" in any association exceeds 10% of the properties, you can all but kiss the FHA loans and FNMA financing options goodbye.
PRACTICAL CONSIDERATIONS
Obtaining Enough Votes for Passage: Boards need to work to inform the community and make sure it is "on board" (generally favorable) to such an amendment before going to the expense to have one prepared and circulated. Voting must be done by the double envelope secret voting process. Generally, you can count on opposition from a contingent of the community who believe that their rights cannot be affected in this way - that it is "un-American". I have always recommend grandfathering those currently leasing because a right that has been established by action (some of the cases actually discuss "vested" rights as being important). Sometimes I have recommended considering grandfathering all owners simply because the surveys raised considerable opposition on limiting current owners' options. Now the law steps in and forces grandfathering all current owners except when owners consent to having the amendment enforced against them.
The bottom line is that an association needs the support of the community and needs approval - every vote counts.
Hardship Clauses: All provisions need some mechanism to provide relief for exceptions to the limitations so that those members taken by surprise can reasonably deal with them. The provisions I recommend always allow the board to provide a waiver to the limitations for any hardship situation that may require temporary leasing - such as call to military service, a temporary job transfer, or a family illness that forces one to move for a limited period of time, and other unanticipated events like that. The HOA may want to exclude lenders from the requirements if lender approval is needed to pass the measure (see below). Usually the "waiver" period is one year or less, with the possibility of extensions.
Grandfather Clauses: "Grandfathering" means exempting from limitations. They do not need to be written into amendments anymore because as explained, the 1/1/2012 law already effectively provides for grandfathering of all current owners unless an owner signs an informed consent.
Lender Issues: Some documents require lender approval for changes in the leasing rights. It is not easy to achieve lender approval - in fact it is not easy to identify the lenders. However, in one of the cases above you will see the court approved a lease limitation amendment (by allowing a lower percentage of owner approval) where the Board sent out ballots to all lenders with a notice that ballots that were not returned within 30 days would be "deemed approved". It may be important to your Board to identify and discuss any hurdles like this prior to spending the money to have a provision drafted. And if you have to send ballots to the lenders (assuming any are received by someone who takes the time to read them), the provision may bring mixed responses. Because of lender concerns, I often recommend an exception to the quota limitation to give lenders that foreclose time to rent the property out while marketing the property. Any lender rep reading the amendment would probably vote no if there was no such provision that would protect them if they had to foreclose. And those in the know understand also that when a lender delays their own foreclosure process (which might occur if unable to rent the property out during the marketing process) it hurts the association.
Percentage Limitations Recommended: In discussing an appropriate limitation, I find that Boards generally seek a percentage based near or at the current number of rentals. Since Associations are apt to get into a "danger zone" if the percentage is set too high, especially if all owners are "grandfathered", we look at the situation, the type of members, etc. For example, in a community of elderly people, there may be more long-term illnesses to consider. In a younger community, there may be more members being called to reserves duty, or that plan to keep the unit and move up to another at some point, creating an investment property for themselves. In today's economic climate, there may be a desire for a higher percentage to leave room for new rentals. The percentage limitation to be considered is an important part of the equation and each community is different. I have seen various choices, including 0-40% - however, HOA Boards usually settle on something in the middle range.
Extra Administration Duties: Extra bookkeeping work on the part of the Association would be necessary to make sure that its records regarding leased and rented units were up to date. It would require that all homeowners provide copies of existing leases and/or other pertinent information relating to tenants, and would require formal application processes. It would involve some administration and record keeping relating to applications to lease, priority or waiting lists, hardship cases decisions, and followup.
Estimate of Costs To Prepare the Amendment and Ballot:
I hope this information is helpful - included with this letter are: a poll/survey I recommend asking owners to return to provide the Board with important feedback, and a form for the Board to provide feedback to me in the event I am asked to draft the ballot and measure for a vote of the members. (I only do this work in California.) In order to do so, I would need to review the governing documents for the association to find the appropriate location for such an amendment and this form. There is one thing that may affect your decision to put such an amendment to the owners. If lender approval is required there is a whole other discussion needed on how to deal with that. Some documents provide relief by certain wording and others do not. Some Boards ignore lender voting rights and others do not. There are risks and benefits to this as well. If you want a separate opinion on this issue, and review of your governing documents to see what the voting requirements are, the cost would be about $290 - $580 (1-2 hrs) to review the association governing documents and provide feedback. The cost really is determined by how complicated the current documents are. In hour usually is enough time to analyze the provisions and provide pertinent information to the Board.
If the Board votes to approve having such an amendment written, the cost of preparing the paperwork and advising on the voting process is estimated at $1000-$1200 (at $290 per hour, about 3 1/2 hours). The work involves reviewing the existing governing documents to determine where such a provision would "fit", what language might need to be superseded, what the property description is, and the voting percentage required for approval of such a measure. I would be preparing a written ballot for purposes of voting on the measure, the measure itself, and a certificate of amendment for recording purposes, and letter explaining the process of voting and recording.
The proposal does not include writing Election Rules and assumes the Association already has them in place. If you need a set of rules and guidelines for proper voting under the law, the cost is $750 generally, or $500 for HOAs that hire me for this or another project like this one. If you need a meeting with the owners, that would be another hour or so plus travel time (charged at half the hourly rate). Many Associations ask for a meeting with the owners. I attend many meetings in the Bay Area and some in other parts of the State. Special arrangements are made for long distance travel and it can be expensive. A meeting can be very personal, very helpful, and informative as to the process, assuming that you have a knowledgeable unbiased party presenting real information to owners. They like to hear measures explained, discussed and have their questions answered about the amendments. Sometimes owners automatically get suspicious or form opinions based on gut reaction to someone telling them they cannot lease their property. There commonly are owners who are opposed, until a real discussion of the pros and cons educates them and puts them in a more amenable position to vote from an educated perspective.
If a meeting is not feasible because of distance, or paying an attorney to come and talk is prohibitively expensive, I can help with a question and answer document that will help owners understand the measure and get their questions answered.
See attachments and let me know if I can be of help.
PS THE ESTIMATE FOR SERVICES IS GOOD UNTIL DECEMBER 31, 2012
Letter information subject to full rights: İBeth A. Grimm, P.L.C.
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SURVEY (STRAW POLL-NOT A VOTE ON AMENDMENT) OF OWNERS/BOARD
Please read the information included with this poll. It was prepared by an attorney knowledgeable about HOA law.
Yes_____ No_____ or Comment__________________________________________________________________________________________
Would you like the Board to schedule an informational meeting about this?
Would you like to have more information or have an attorney answer questions?
Are you leasing your unit at this time? It is important for us to know because the Board needs accurate information on the current number of rentals to choose an appropriate percentage limitation that takes everyone's interests in the community into consideration.
The Board believes an amendment like this will deter investor purchasers which is the goal - because we want to keep the rentals as low as possible, as explained in the letter accompanying this survey. Do you have any other comments? We are interested in your opinions and thoughts.
We encourage you to contact your local banker and ask if the number of rentals in a common interest development affects financing for a new buyer or refinancing for a current owner.
PLEASE RETURN THIS SURVEY TO THE ASSOCIATION WITHIN 15 DAYS OF THE MAILING DATE TO THE RETURN ADDRESS ON THE ENVELOPE OR GIVE YOUR SURVEY TO A BOARD MEMBER SO THAT THE BOARD MAY PROCESS THE INFORMATION WITH ITS DECISIONS TO BE MADE.
RETURN ADDRESS for survey: _______________________________________________________
İBeth A. Grimm, P.L.C ***
AUTHORIZATION FOR SERVICES FOR BOARD: LEASE LIMITATION QUESTION AND ANSWER (WHAT BETH GRIMM NEEDS TO KNOW TO WRITE A BALLOT AND AMENDMENT) - NOTE THE ASSOCIATION GOVERNING DOCUMENTS MUST ALSO BE PROVIDED.
_____ WE AUTHORIZE YOU TO PREPARE A LEASE LIMITATION AMENDMENT AND BALLOT [check if applicable]
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We would like to have a restriction that purchasers may not apply to lease units until they have lived on premises for at least ________________[STATE WHETHER MONTHS OR YEARS - IF BLANK ATTORNEY WILL ASSUME YOU DO NOT WANT THIS RESTRICTION] subsequent to their purchase.
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_____ We would like a percentage limitation based on the following numbers:
______ limit for # OF LEASED UNITS______# OF TOTAL UNITS in complex
Equals_____ Percent
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LIST ANY ADDITIONAL LIMITATIONS OR HARDSHIPS WOULD YOU LIKE TO HAVE ADDRESSED? (I include sickness of member or family member that requires temporary move, job transfer, armed services, and lenders foreclosure to give lender time and opportunity to sell): Others desired?
_____________________________________________________________________________.
Comments/Questions?_ ______________________________________________________________
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We understand the estimate for reviewing the governing documents, drafting a measure and a Certificate of Amendment for recording purposes, and drafting a written ballot and letter of instruction about what is needed for a proper voting campaign, is 3-4 hours at your hourly rate ($290/hr.) and additional questions and communications could result in extra charges. It is also possible that additional time will be needed if more than one set of documents is included such as a Master/Sub situation or if additional communications or attendance at a meeting are needed. We will provide the governing documents for the association if attorney does not already have them on file.
____________________________________________________________________
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Return to : BETH A. GRIMM. P.L.C., 3478 Buskirk Ave., Ste. 1000
Email: bgcondolaw@aol.com
By Beth A. Grimm, Attorney. host of the website www.californiacondoguru.com; two Blogs: California Condominium & HOA Law Blog, and Condolawguru.com Blog and author of many helpful community association publications which can be found in the webstore on her site. Be sure to sign up for the E-News, a free newsletter sent each month covering the hottest HOA and Condo issues!
İBeth A. Grimm, P.L.C. [CALIFORNIA HOA/CONDO ATTORNEY]
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any people ask me for information about the pros and cons of limiting the number of rentals in any given HOA development, or imposing restrictions like requiring purchasers to reside in the property for a year or more before they have a right to lease it to another. A Board may be interested in looking at a rental/lease limiting provision because of information gathered by attending seminars or reading industry articles. An enlightened Board understands the potential impact of an increasing number of rentals. An owner who works in a lending institution and sees the problems encountered in high rental percentage developments may bring the request to the Board. Anyone in leadership experiencing the common types of problems associated with rentals might bring the request to the Board. On the other side there are those lay people and even legal practitioners that believe these amendments are not legal. The courts have determined otherwise. The legislators of California have acted as well. There is a new law on the books 1/1/12, an addition of Civil Code Section 1360.2, which basically - through legislative language, has opined that owners should know what they are getting into with regard to leasing restrictions when they purchase the property. The new law essentially requires boards, if the members pass a new amendment that prohibits leasing or renting in any way, to "grandfather" all current owners, meaning that the limitation cannot be enforced against them. The board can send out consent forms and ask members to voluntarily consent to the new amendment- but the board cannot force people to sign it. This is not a drastic change for some associations that found they had to "grandfather" all current owners anyway in order to get the measure approved. It will apply to prevent subsequent purchasers from leasing legally if the amendment would prohibit leasing - and it is approved through a valid association election. Any existing prohibitions (before 1/1/12) remain in full force and effect, assuming of course that they were approved by the members and recorded in the association regulatory documents (usually the Declaration or Coop Agreements, not the Bylaws or rules).