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RENTAL LIMITATIONS AMENDMENTS - ARE THEY LEGAL IN CALIFORNIA?
(AND WHAT YOU NEED TO KNOW IF YOU WANT TO CONSIDER ONE)
©Beth A. Grimm, Attorney
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 treat all current owners, and their heirs, as being "grandfathered" 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, and most practitioners think sending out a request to sign "consents" to be subject to the amendments is likely to be an exercise in futility. 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. But the "heirs" have not commonly been grandfathered.
A limiting amendment passed after January 1, 2012, will apply to subsequent purchasers 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 before that date. To be enforceable, the provision, based on some guiding principles gleaned from cased in California and other states, should be in the Declaration of Covenants, Conditions, and Restrictions which are called CC&Rs, or the equivalent recorded agreements, rather than the Bylaws or rules.
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 and think lease limitations are a way to prevent tenants. They are, to a degree, but they are not the only way to deal with tenant issues. It is true that 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, but Boards often focus on tenants as the problem. Associations all over California have experienced the phenomenon - 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. The last study on the topic commissioned by the Department of Real Estate in California back in 1985 actually showed that developments with a high percentage of rentals tend to have more problems than those with lower numbers so this thinking is not far-fetched or unsubstantiated. Logic suggests 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 block sales to "investors". I don't believe this is the way to go. I think such a provision is a tougher sell to the courts, given the legal questions discussed below. Adopting a lease limitation provision should discourage investors from buying in the development if it limits the number of rentals or requires owner occupancy for a certain period of time before the right to lease is established.
THE LEGAL QUESTION: Many typical questions arise about the legality of lease limitation provisions in California and elsewhere. Board and owner education before proposing any amendment that would limit rentals in the development is important. 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. Owners are concerned about their individual situation and seldom see the big picture which is imminent if the percentage of rentals rises to a certain level, that level being 40-50% rentals, and they certainly do not see all the problems with rentals that the board sees.
Is California different than other states?
There is a statute in California which prohibits unreasonable restraints on alienation of property (Civil Code Section 711). 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 very important as well. They, too, speak to the reasonableness of the amendment. This is why I believe that a prohibition on purchase by investors would meet tougher opposition in court. Some of the state court justices have discussed the importance of hardship exceptions as making the provision reasonable and therefore acceptable.
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. There is actually a more specific statute dealing with restrictions for homeowner associations (CC&Rs/Declarations) and I discuss this in more detail below.
Still, some people question the legality of the lease and rental limitations in California without any knowledge-based foundation or any understanding of the ramifications of unbridled rentals. People simply don't want to be told what they can do with their property." But that is not the reality in a homeowners association. Generally, the collective group can decide things for all individuals. The fear, anger and distrust is an understandable emotion, especially given the 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 having performed any research as to what the courts in California or any other state have done with such provisions. Legal advice from these providers can get an owner into trouble it is hard to get out of.
THE COURTS OF CALIFORNIA HAVE APPROVED LEASE LIMITING AMENDMENTS
The appellate courts of California have spoken now twice on the reasonableness of leasing limitations 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:
- (1) The amendment that was approved via a valid election of the members to restrict leasing to a minimum of 30 days (to prevent vacation rental leasing) was found to be reasonable; and
- (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 in 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].) " The case was never certified/published so it cannot be cited as binding authority but it is indicative of of the way the judges analyzed the Davis Stirling Act to the Civil Code on restraints on alienation as they apply to these amendments in California.
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:
- (1) Limiting rentals to a percentage of the total Units/Lots. (The most common limits seem to range from 20-30% but I have seen 0-10% and 40% as well.)
- (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 Telling.
A survey is included with this article that is designed specifically so that homeowners can provide input to the board. Boards can expand on it if they wish. But owners need valid information like that in this article to fully
understand the ramifications, so that they can answer from an educated viewpoint. Simply answering the questionnaire without understanding the perceived need or the potential issues, can lead to skewed results. Some 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 in my own experience more than half of the disputes Associations bring to me with nuisance issues or rules violations involve tenants.
I usually suggest a two-three week turnaround time to return the survey and have it considered before any amendment is circulated to the membership. Some Boards want to have a town hall meeting to discuss the prospects. I think that is wise, if the Board is prepared to meet the "Doubting Thomases" in a civil way, countering arguments with information instead of disgust or dismay. 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 are open to receiving more information, and the board can get feedback from the membership. Sometimes the discussion can get quite heated, uncovering strong opinions which were not divulged in the survey. Sometimes only one or two people show up. I would say based on experience that the meetings on lease limitation amendments are better 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, may avoid honest discussion of the cons of the amendments. That leaves it to objectors to bring up the concerns, and that can make the board look biased or 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 can take some effort to owners that neither the Board nor the attorney is the "enemy". Boards tend to have had good intentions when proposing that limitations. 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 real concern in today's climate. This argument can be diluted today since after 1/1/2012 everyone that owns at the time the amendment passes is effectively "grandfathered" and won't be restricted by the amendment unless a written consent is signed, but owners do not automatically know that.
PROS AND CONS
What are the advantages to a lease limitation provision?
- They deter purchase by investment owners.
- They can alleviate some of the problems relating to a high percentage of rentals.
- They usually help 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.
- 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?
- The "pool" of possible purchasers is more limited because the properties are not appealing to investors.
- They can lead to legal challenges by unhappy owners who want to lease and cannot although these can often be resolved through the assistance of an attorney who has worked with these provisions and can recite the laws accurately.
- They can push an owner who is trying to save his or her property from bank foreclosure or who is unable to pay assessments but could do these things if they moved elsewhere and rented out the unit over the edge.
- 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". In the current climate, investors may also be major "players" as home prices drop. But this also tends to concern Boards and owners because when the investor "pool" in any association exceeds 10% of the properties, it hinders if not prevents FHA loans and FNMA financing of units in the complex.
Obtaining Enough Votes for Passage: Boards should inform and involve the community enough to believe the majority of owners are "on board" (generally favorable) to such an amendment before going to the expense to have one prepared and circulated. Voting on the amendment must be done by the double envelope secret voting process. Generally, you can count on opposition from a contingent of the community who call any limit on leasing "un-American". I always used to recommend grandfathering those currently leasing at least and in some associations all owners if it appeared that is the only way the community would embrace the amendment. Now all owners are automatically grandfathered if the limitations are adopted after 1/1/2012. "Grandfathering" owners means that none of those who owned at the time the amendment passes are limited by the amendment, but new purchasers are. The bottom line is that an association needs the support of the community to get sufficient votes for approval - every vote counts.
Hardship Clauses: I believe all proposed amendments should have some mechanism to provide relief for exceptions to the limitations such as military service, a temporary job transfer, or a family illness that forces one to move for a limited period of time. The HOA may want to exclude lenders from the requirements, especially if lender approval is needed to pass the measure (see below). I believe the "waiver/hardship" exception period should be not more than one year, with the possibility of one or two requests for extension, depending on the circumstances leading to the request.
Grandfather Clauses: "Grandfathering" means exempting from limitations. As of 1/1/2012 law already effectively provides exempts all current owners unless an owner signs an informed consent. Boards would have to keep a list of owners at the time the amendment passes. Including the provision in the future amendments would remind members and the board who is exempt. It would prompt boards to document the ownership list at the time the measure becomes effective in order to enforce it properly.
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 or rehabilitation periods 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 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.
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 $900-$1100 (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.
Beth Grimm, California HOA/Condo Attorney
PS THE ESTIMATE FOR SERVICES IS GOOD UNTIL DECEMBER 31, 2012 Letter information subject to full rights: ©Beth A. Grimm, P.L.C.