Some believe that developments deteriorate because of all those renters. Perhaps, the thinking goes, investors, those non-resident owners don't care about the community and never support dues increases to keep common areas safe, well maintained and looking good.
The simplest solution to these problems? Easy, the reasoning goes: Let's just kick the renters out and limit how many units can be leased in the future.
While the theory is not totally conclusive that high numbers of rentals are the cause of actual or potential property decline, the trend towards limiting rentals has definitely increased in the last five years. In part, this drive has been fueled by regulations promulgated by the federal Department of Housing and Urban Development (HUD), which in the past has restricted insured loans to properties in developments where at least a majority of the lots or units are owner-occupied. While the percentage of owner-occupied properties always fluctuates, the point is that obtaining financing in developments with large numbers of rentals can be difficult, loans cost more in projects with low owner-occupancy ratios and, sometimes, mortgage money is even impossible to acquire.
This article assumes that the Association wishes to consider rules limiting the total number of lots or units (hereafter for ease, simply referred to as units) which can be rented at any one time and explores the legal, practical and political issues our firm has encountered in the process of helping our clients consider and vote upon rental limitation amendments to the CC&Rs.
Our clients are sometimes surprised to hear the rental limits issue phrased as I've done above. Yet, the practical effect of a rental restriction amendment to the CC&Rs is exactly that: by limiting the number of rentals in a community, the Association in effect says existing owners may not sell their property to a huge category of potential buyers, i.e., investors who do not, at the time of sale, intend to personally live in the development. Can it be done? While no case or law specifically says so, I believe limitations, properly drafted and applied, will be upheld upon legal challenge.
Although it might be hard to tell, the legality of rental limitation CC&R amendments is addressed in the few terse words contained in Civil Code section 711: Conditions restraining alienation, when repugnant to the interest created, are void. (No wonder people say lawyers drive them crazy!)
Basically, this phrase means that limitations on the use of property sold to another which are unreasonable cannot be enforced against the buyer; in other words, the sale of the property would be valid, but the limitations (i.e., the restraint) would be void. Courts have struck down a variety of restraints, including those that prohibit the seller from later conveying the property to another or making her promise not to do so; or from promising not to convey property for a specific period of time or to specific classes of people based on their racial identity. A good example of a law prohibiting a restraint on alienation found in certain CC&Rs is contained in Section 1368 of the Davis-Stirling Common Interest Development Act which requires an Association to disclose that a CC&R restriction limiting occupancy on the basis of age contrary to the Unruh Civil Rights Act will not be enforced.
On the other hand, certain types of restraints on alienation have been upheld upon challenge. These include the fairly standard right of first refusal; a due on sale clause which accelerates a loan balance upon sale; and even a provision limiting sales to buyers who met low income qualifications of the National Housing Act. Beyond these types of restraints on alienation, we have the more familiar: CC&R provisions that prohibit use of property in hundreds of ways (no business operation, no lot changes without permission, etc.) also act in some respects as a limitation on the free use of property and thus the free sale of it.
In California, only two cases have dealt with the lease rental limitation issue in the context of community associations. In the first, the court upheld a bylaw amendment that prohibited condominium occupancy to adults. If the case were brought today, it would be stricken as violative of various anti-discrimination laws. Still, the case does reflect that Associations have certain, albeit limited, abilities to limit occupancy. In the other case, City of Oceanside v McKenna, the court upheld CC&R provisions which prohibited leasing of units and sales to those outside certain low income qualifications. While upholding rental limitations, the focus of the case reflected the public policy inherent in supporting government subsidized low income housing and, while unsaid, the fact that the lease limitations existed from the outset of the development and not added after the original CC&Rs were recorded.
Still, the trend in the law generally speaking has been to uphold reasonable restraints on alienation. We believe that reasonable limitations on leasing, coupled with procedural safeguards, proper grandfathering rights and exceptions for good cause approved by the membership and contained in the CC&Rs will be upheld if and when they are challenged.
The basic rental limitation amendment to the CC&Rs will state that not more than a certain percentage (typically 20-30%) of the units may be rented at any particular time, subject to grandfathering rights or hardship exceptions. The amendment should also include procedures for owners to apply for the right to lease units, maintenance by the board of a rental list, a process by which lease applications are reviewed and prioritized, a specification of written lease requirements and other aspects of the lease process. The amendment may also refer to the specific enforcement rights available to the Association in the event owners violate the lease restrictive covenants contained in the amendment to the CC&Rs.
A lease restriction will appeal to some and be strongly opposed by others. The benefits of a lease restriction include maximizing financing opportunities for first time buyers, perceived ease and reduced costs of maintenance, increase in property values and greater control of the community by the community. Perceived disadvantages of a lease restriction include an artificial limitation on potential buyers (investors and those who might wish to keep their first unit before moving to a more expensive home), reduction in property values (flowing from the reduced buyer pool), difficulties of maintaining and enforcing the lease limitations and possible owner disputes.
Can these contrasting viewpoints be mediated or harmonized? To some extent, they can, by submitting to the membership an appropriate grandfather clause that minimizes the impact of the lease restrictions on existing owners and by permitting hardship exceptions. Most importantly, a good educational campaign is needed.
The Amendment Process
Fundamentally, it is important to recognize that limitations on the lease of units must be set forth in the CC&Rs. Limitations contained in Bylaws, Articles of Incorporation, or Rules would most likely not be enforceable for a number of reasons, including most obviously the fact that Rules do not require membership approval and are not recorded against and therefore binding upon property.
Since the limitations need be contained in the CC&Rs, they require membership approval. The Association, working with excellent management assistance, should plan on spending a few months publicizing the issues before a vote. Newsletters, separate mailings and neighborhood town hall meetings should be part of the process. Q and A formats, the introduction of experts, such as lenders, realtors and appraisers, should also be part of the educational process. The Association's community association attorney should also participate in reviewing all written materials and attending meetings intended to shed light on the issues. It is essential that the attorney be capable of addressing the many questions and concerns that arise in a manner which is non-threatening, informing, careful and firm.
The Proposed CC&R amendment must be distributed to the members prior to the conduct of a vote. A vote may be conducted at a meeting (that is, by proxy) or by mail (by ballot). The necessary percentage of approval (which varies with each set of CC&Rs) will be the same regardless of how the vote is conducted, although there are some advantages to conducting the vote by ballot. The strategy of doing so should be discussed with counsel.
Many CC&Rs will require the approval of lenders--either all lenders of funds to association members or only those lenders who have requested notice of important voting matters. Securing lender consent can be quite difficult for two reasons: a lender may resist any limitation on the sale of property and, in any event, it may be difficult to find a lender representative willing to take the responsibility to cast a vote at all!
A grandfather clause validates an existing violation or a condition that will become a violation as a result in a change of rules, policies or governing documents. There are numerous types of grandfather clauses in the lease restriction context. These include provisions which state that owners who at the time the lease restriction amendment is recorded:
There are many variations on the type of lease limitation provisions which can be adopted by the membership. The greater the protection afforded to existing owners, the longer it will take for the development to achieve its goal of reducing the number of units being rented at any one time. These are some of the factors the board and membership must consider in ultimately deciding on a type of rental restriction amendment that is best suited to their community.
In addition to affording grandfather rights, a rental-limitation amendment should also include clauses dealing with unusual hardships which allow the board to make exceptions and allow units to be rented that otherwise would be prohibited by the lease limitations. Clauses we draft typically allow but do not require the board to waive some or all of the provisions of the lease-limitation provisions for a limited term in a variety of circumstances. These circumstances can include personal, economic or employment hardships and are always subject to terms and conditions deemed proper by the board.
The board of directors has fiduciary duty to enforce the governing documents where doing so is in the best interest of the community. This is particularly true when it comes to enforcing lease restrictions which, to be effective and to achieve the goal of rental reduction, must be defended if challenged.
Usually, a challenge to the enforceability of a lease restriction will be raised not by an existing owner but by a new purchaser who wishes to lease their unit (and who is likely an investor owner). While the board may avail itself of the traditional remedies for violations of the governing documents--including imposition of fines, suspension of the right to use common area facilities or amenities or to vote-the bottom line will be whether the board wishes to file suit against the new owner to compel compliance with the lease limitations. The stakes will be high for both parties: for the Association, the question will be whether it is willing to fight for the lease limitation; for the new owner, the inability to lease may well render the purchase of the unit irrelevant and unprofitable (if the owner is not or will not move in).
So long as the Association has properly approved the rental limitations, and the procedures and limitations themselves are not unreasonable, there is a strong likelihood that the Association will prevail in arbitrations or lawsuits arising out of the lease limits. The key is prudent long-term planning, developing and implementing amendments that secure the consent of the membership, fairly applying the limitations and working with experienced management and counsel to assure the best possible amendment for the community.