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3/22/10-rev. Be sure to check out Beth's Blog as well for the latest on lease limitation restrictions. LEASE/RENTAL LIMITATIONS AMENDMENTS - ARE THEY LEGAL IN CALIFORNIA? (AND WHAT YOU NEED TO KNOW IF YOUR HOA WANTS ONE) ©Beth A. Grimm
The goal of a lease or rental limitation is to get and keep the percentage of rentals 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, you are 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. And some association Boards have experienced the negative aspects of the "apartment mentality" that comes with some renters which include disregard for neighbors and property.
THE LEGAL QUESTIONS: Many typical questions arise about the legality of lease limitation provisions in California. I always suggest to a Board that the information in this letter should be provided to the owners in the development so that they may become more educated and comment 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.
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). I discuss these options in more detail below.
Some people question the legality of the lease and rental limitations in California. Some attorneys will not write them. Some attorneys will tell clients that they are not legal, disregarding seeking any background information as to what the courts in California or any other state have done with such provisions. Legal advice from providers without the educated backup information or knowledge on this topic is worth little.
The Courts of California Are 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:
"Courts have recognized the unique problems of condominium living and the resulting need for more control over--and limitations upon--the rights of the individual owner than in more traditional forms of property ownership. " '[I]nherent in the condominium concept is the principle that to promote the health, happiness, and peace of mind of the majority of the unit owners since they are living in such close proximity and using facilities in common, each unit owner must give up a certain degree of freedom of choice which he might otherwise enjoy in separate, privately owned property.' " (Laguna Royale Owners Assn. v. Darger (1981) 119 Cal.App.3d 670, 681-682, 174 Cal.Rptr. 136, quoting Hidden Harbour Estates, Inc. v. Norman (Fla.App.1975) 309 So.2d 180, 181-182.) "Thus, it is essential to successful condominium living and the maintenance of the value of these increasingly significant property interests that the owners as a group have the authority to regulate reasonably the use and alienation of the condominiums." (Laguna Royale, supra, 119 Cal.App.3d at p. 682, 174 Cal.Rptr. 136.)"
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:
Possibilities for a Lease/Rental Limiting Amendment: These are some of the types of limiting amendments that have been approved in California HOAs:
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 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.
Board members who educate themselves bring to the table good information about the benefits of the provisions; however, in their zest to do good work, they sometimes forget to equally express the downside of the amendments. Members who are concerned with their specific issues focus on either the upside (the value of attempting to limit rentals) or the downside (the limitations on financing options with the clause namely either discouraging or preventing 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 "massaging" to convince all parties that the bearer of news and information, whether the Board or the attorney is not that 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 your home if you have to move in with your parents (or children) and rent it out to make the payments is a prevailing fear in today's climate. One way to work with this? "Grandfather" all current owners. Another way? Write in a generous "hardship" clause. Of course, there are those (including some attorneys) that will respond negatively to this because it does not protect the original goal of getting rentals under control. And they would be right too. A loose provision or setting aside enforcement to deal with the real economic concerns does not instigate tight control over rentals. It is a difficult dichotomy, to be sure. It is hard to begin with 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?
What are the disadvantages of a lease limitation provision?
There are no statistics I know of 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 those persons already leasing properties in the development, unless there is a "grandfather" clause which allows those people to keep leasing the property if they were when the amendment was proposed. I always recommend grandfathering those currently leasing as I believe it could be a problem to retract a right that has been established by action over time (some of the cases actually discuss "vested" rights as being important). The Association can use the support of the community and needs approval - every vote counts. And in this economy, it often seems that anything less than "grandfathering" all owners dooms an amendment. See more on "grandfathering" below.
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. It seems that it would give people special rules just for them, and it does. However, it is a concept that is necessary in some circumstances to reach a goal, and in some cases to circumvent legal challenges. Some associations limit the "grandfathering" to expire as leases terminate, or as those leasing or renting properties at a certain point in time (usually the date the limiting amendment is approved or becomes effective). Most I have written allow at least the owners currently renting their properties to others to continue doing so until the property transfers to another party. Today, more and more associations are looking at grandfathering all current owners so that all owners will be on the same footing. The provisions which grandfather in everybody who currently owns in the development are commonly used when the measure might otherwise lack sufficient support to pass. Naturally, the more owners or Lots/Units that are "grandfathered" (exempt from the new restrictions), the longer it takes for an actual limitation to become effective practically. Most Boards want to look at percentage limitations that are at or near the current percentage of rentals to keep that percentage from getting higher and some allowance needs to be made for hardship exemptions. Some need to look at percentages that are lower. Some need to "work their way backwards" to a lower percentage of rentals. These considerations factor into discussions about what it will take to get member approval of such an amendment. In today's tough economy, many HOAs are finding it hard to get approval for these amendments without grandfathering all owners.
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.
I hope this information is helpful - if you wish, you may read on to access a poll/survey that I recommend asking owners to return to provide the Board with important feedback and a list of items that I need to prepare the amendment (and the cost). If you have questions, feel free to send me an email to califcondoguru@aol.com.
Please read the information included with this poll. It was prepared by an attorney knowledgeable about HOA law.
Would you be in favor of limiting leasing (renting out properties) in the development?
Yes, No, or Comment:
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Would you like the Board to schedule an informational meeting about this?
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Would you like to have an attorney come to an Association meeting to answer questions?
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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.
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Do you think all owners currently leasing should be "grandfathered" (exempt from the limitation)? _________________________________________________________________________________________
Do you think all owners should be "grandfathered" whether currently leasing or not (this would take longer to have a beneficial effect as it would affect only purchasers of units after the amendment becomes effective).
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Do you have any other comments? We are interested in your opinions and thoughts.
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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.
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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.
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 WISH TO HAVE A LEASE LIMITATION AMENDMENT AND BALLOT DRAFTED
_____ WE WANT FEEDBACK ON THE AMENDMENT REQUIREMENTS PRIOR TO AUTHORIZING DRAFTING OF THE AMENDMENT.
_____ (Y or N) 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] subsequent to their purchase.
_____ We would like a percentage limitation based on the following numbers:
______ limit for # OF LEASED UNITS _____ # OF TOTAL UNITS in complex
WHAT 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?
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I recommend at least grandfathering (exempting) those currently leasing because obviously they will not vote for an amendment that prohibits them from leasing and they have already established that is what they intend to do with the property. Your preference if more? If blank, the restriction will be written only to include those that are already leasing. If there are none, grandfathering is not necessary.
Comments?______________________________________________________________________
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 a mail voting campaign, is for approximately 3 hours at your hourly rate ($290/hr.), and that an additional hour may be needed if we seek feedback on the amendment requirements prior to going forward with the amendment.
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Date____________________
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Return to : BETH A. GRIMM. P.L.C., 3478 Buskirk Ave., Ste. 1000  |
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 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. There are those lay people and even legal practitioners that believe these amendments are not legal. The courts have determined otherwise.