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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 was a new law added to the books as of January 1, 2012, found at Civil Code Section 1360.2, which became Civil Code Section 4740 in 2014 when the Davis Stirling Act was reorganized. Through legislative language, rental restrictions are addressed in a way that exempts all current owners from a restriction prohibiting leasing of a home in a common interest development that is effective after 1/1/2012. The restrictions already recorded before that date by HOAs and Condo Associations is not affected by this exemption language. The lawmakers recognized that HOAs may want to protect the residential characteristics, but did not want owners being blindsided by a prohibition or cap approved after their purchase. The new law essentially requires boards, if the members pass a new amendment that prohibits leasing or renting, to treat all current owners, as well as certain others such as heirs or who take the property, as being "grandfathered" meaning that the cap cannot be enforced against them. The board can send out consent forms and ask members to voluntarily consent to the new amendment - but many think this would be an exercise in futility. This is not a drastic change for many associations that found they had to "grandfather" all current owners anyway, before the law even passed, in order to get the measure approved. But the heirs have not commonly been grandfathered.
To be enforceable, I believe that a rental cap, based on some guiding principles gleaned from cases in California and other states, should be in or in an amendment to the Declaration of Covenants, Conditions, and Restrictions which are called CC&Rs, or the equivalent recorded agreements, rather than the Bylaws or rules. Some legal practitioners say otherwise. I do not agree with them. I believe Owners need to be allowed to vote on these and they should be in a recorded Declaration or Amendment to be enforceable. They need to show up on a title report and also need to be called out with a letter or notice supplied with an HOA's governing documents when they exist in the documents and an escrow demand is made.
The goal of a lease or rental limitation is to get and keep the percentage of rentals reasonably low so as to minimize the problems that can arise as to financing and enforcement-related issues commonly associated with high percentage rental developments. The following information speaks to the practical and legal ramifications (and pros and cons) of a lease/rental limiting provision. Many people believe and many Boards experience that there are fewer rules enforcement problems communities where there are more onsite owners. As far back as 1985 the California Department of Real Estate commissioned a survey of 1000 homeowner associations confirmed that developments with more rentals have more problems.
Many associations want to look at proposing these types of regulations to the members. It is good to have some education about what issues can arise and how to minimize the risk of a challenge to such a clause.
FINANCING AND INSURANCE QUESTIONS: It is common knowledge that a high percentage of rentals can adversely affect financing options for properties in condominiums and townhomes. Although FHA recently relaxed its standards and will now consider loans in developments that are at least 35% owner occupied (the percentage was until recently 51%) and is urging HOAs to consider higher rental caps, lenders are not all on board with this. FNMA and FHLMC (more commonly known as Fannie Mae and Freddie Mac) have reportedly dropped rental caps altogether but other criterial can be a factor when there is a large percentage of rental properties. And I have been informed by different realtors and bankers that some lenders shy away from HOAs that have a high percentage of rentals. All lender questionnaires requested in a sale transaction request the number of owner occupied properties. The question is there for a reason.
I have also been informed by some HOA insurance brokers that some insurors have stopped providing quotes to HOAs that have a high number of rentals. And I've been informed by managers who are dealing with a high percentage if rental properties are finding themselves spending more time resolving violations than communities that have a low percentage of rentals. So, if an association gets up over 30-40% rentals, and especially if it hits the 50% rentals mark, it will pose problems that HOAs with high owner-occupancy ratios are not likely to experience, such as overtaxing the HOA management or getting complaints from owners that they cannot sell their property because a loan fell through because of the high rental ratios.
It is easy to understand why there tends to be a difference between renters and resident owners. Renters are generally more transient than residents. The more transient part of society tends to have less interest in taking care of the real estate they occupy for temporary purposes than the buyer who has crossed the line into property ownership and has pride in his or her home. And management must deal with off site people when there is a violation. †And 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 and the owners try to shift responsibility to the HOA. Some tenants simply thumb their noses at the Board. Of course this can also happen with owners, but tenants have less of a stake in the HOA than owners. Some see the negative aspects attached to an "apartment mentality" that comes with some renters who disregard the neighbors and property.
Some boards want to amend the documents to prohibit 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 will discourage investors from buying in the development if it sets a rental cap. Requiring a residency period before a new owner can rent their property is not a very good idea these days because FHA has ruled that is an unacceptable prohibition. In the same published document though, the rental caps were determined to be acceptable.
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:
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.
- (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.)
- (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
GENERAL CONSIDERATIONS - INVOLVING OWNERS
A Survey Is A Good Way To Find Out Where Owners Stand.
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.
The Economic Downturn Created a Difficult Dichotomy, and Another is not Inconceivable.
I have attended 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 generally have 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 having to move in with parents (or parents having to move in with their adult children) and rent out the unit to make the assessment payments can be a concern. A lot of this fear is alleviated after 1/1/2012 since 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 or accept that.
PROS AND CONS
What are the advantages and disadvantages to a lease limitation provision?
Advantages: They can alleviate some of the problems relating to a high percentage of rentals. They can help protect the "finance-ability" of HOA lots and units by not eliminating lenders that have restrictions on lending in high percentage rental developments. They should attract resident owner purchasers interested in community, and help protect the residential quality of the development.
Mixed Bag ≠ Advantages and Disadvantages: The rental caps deter purchase by investment owners. But that can also limit the purchase pool. †And while certain lenders would prefer lower rental percentages, the same lenders might be averse to approving a rental cap, fearing the inability to rent the property if they can't sell it†
And, a rental cap can push an owner - who is really trying to save his or her property from bank foreclosure or who is unable to pay assessments but could do so by moving elsewhere and renting out the unit - over the edge, and into foreclosure. This can hurt the owner and the HOA both.
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. However, managers in high rental developments will likely say that they would rather do this than be dealing with a high number of rules violations with absentee owners.
Obtaining Enough Votes for Passage: Boards should inform and involve the community enough to believe a super majority of owners are "on board" (generally favorable) to such an amendment before going to the expense to have one prepared and circulated because most amendments to CC&Rs in California require a super majority to approve. Voting on the amendment must be done by the double envelope secret voting process. You can count on opposition from a at least a small (or 1) contingent of the community who call any limit on leasing "un-American". The bottom line is that an HOA 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. Financial hardship is hard to define but the more objectively it can be described, or at least requiring some evidence, can help a board avoid claims of inconsistent treatment. The HOA may want to include lenders who are actively trying to sell a foreclosed property, 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.
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 rental cap, 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" (which I would definitely say is somewhere between 40-50% rentals) if the cap is set too high, especially when all owners are "grandfathered" when the amendment is recorded, 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 may 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.
(** Note that Beth Grimm is a retired attorney as of December 31, 2018. All of the statements in this article are made for guidance only. An attorney should be retained to advise on the benefits, pros and cons of a lease limitation amendment for any individual association, and should be retained for any drafting or such an amendment! This is not a job for a layperson.)