A Condo Ownership Concern
A Condo Ownership Concern
Many residential properties are governed by a Home Owner Association (HOA). This can vary from an association that only maintains a small greenbelt area to an association that is responsible for every detail of a development including even the exterior walls and roofs of the individual units.
While we will use the term “condo” (short for condominium) in this article, the discussion also applies to any other community which has CC&Rs or other legal documentation which might be used to restrict rental of a unit. In addition to true condos, this will include subdivisions of any other names, whether within multi-unit buildings or separate buildings (e.g., townhouses and planned unit developments) or even single-family homes.
Investors who might consider buying condos for rentals, current owners of rental condos, and even owner-occupants all need to be concerned about current and future restrictions, even associations’ prohibitions, against renting units.
These restrictions are not limited to the current housing market. For many years now, newer condo developments have been providing for rental restrictions, even prohibitions. Developers have created more restrictive CC&Rs regarding rentals and other issues in an attempt to provide homeowners with more protection of property values. The rental issue can also impact the financing for a property within a development.
In addition to investors who originally purchased condos for rentals, owners who had purchased condos for personal residences are now renting their properties, or at least trying to do so because some reason required them to move from the area and they were unable to sell their properties in today’s bad housing market.
Increasing numbers of rental units, or the potential therefore, and changing financing requirements are motivating HOAs of developments which did not originally restrict rentals to consider limiting or reducing the number of units that are not owner-occupied in order to maintain or improve property values for owners, at least as perceived by the Directors and by the necessary majority of owners.
If CC&Rs or Bylaws don’t already limit rentals, they would have to be amended, typically a lengthy process. Changes to CC&Rs and Bylaws will require approval of owners of a certain percentage of units in the development as specified in the association documents and/or state law, often two-thirds and always at least one-half of unit owners.
Restrictions and even outright prohibition of leasing arise for two different reasons. First, there is a perception that tenants do not maintain a property or otherwise follows the rules and regulations as well as do owner-occupants. It is also assumed that unit owners who lease units are less concerned about maintaining their properties and less likely to pay association fees in a timely manner. Both issues, if and when true, potentially result in lower property values. Second, there is the fact that for developments having a large percentage of tenant occupied units, loans may be more costly or may be available from significantly fewer sources. The second reason is based on the fact that lenders are concerned about the first reason.
Investors can, of course, determine before purchasing a unit whether a particular development prohibits or otherwise restricts rental use. Even when there is no outright prohibition against rentals, there can be restrictions that critically impact rental. For example, some communities that allow leasing involve the association in the tenant approval process. If prospective tenants must be approved by the association, investors need to be concerned about two issues. First, the rental applicant needs to be informed of the matter and the fact that it might result in delay. Second, it is not unknown for associations to violate fair housing laws in their approval criteria and this can create liability for the owner.
However, even when there are no current restrictions on leasing, investors should consider certain factors that might affect rental use in the future, particularly the percentage of owners required to change CC&Rs. Owners who already rent their condos should remain alert for potential changes that will restrict rentals.
Owner Associations usually have considerable control over (1) the physical condition in which a property must be maintained (2) uses of a property, and (3) how a property can be modified. Even though many condo owners may think that rules and regulations are overly dictatorial, Courts have, in general, upheld them because the CC&Rs and Bylaws were agreed to when the unit was purchased. Disallowing rental of units within a community would not in itself violate fair housing laws and such restrictions have been upheld by courts in some states.
In addition to rental restrictions, borrowers may find it more difficult to obtain government backed financing. Two issues for discussion are (1) percentage of units that are owner-occupied and (2) percentage of units for which association fees and assessments are delinquent.
The Federal Housing Administration, Fannie Mae, and Freddie Mac for a long time had rules setting limits on the number of units in an association that can be leased. For example, with an FHA-insured mortgage the property had to be at least 50% owner-occupied.
The Federal Housing Administration recently changed its policy and will no longer approve mortgages on a loan-by-loan basis on condominium units. Now, the entire project must be cleared by the agency before it will insure a mortgage on a unit in that community. Part of the approval process is making sure the percentage of non-owner-occupied units doesn’t violate the rules. Similarly government run Fannie Mae and Freddie Mac have changed their requirements for condo financing.
New condo financing policies of Fannie and Freddie require the evaluation of the condo association and operations. This is in addition to the usual evaluation of the credit qualifications of the borrower. The federal agencies now have requirements pertaining to the association’s financial statements, status of dues and assessments receivable from residents, insurance, and even the ownership breakdown of the units in the development.
Lenders are also less likely to approve a purchase or refinance loan for a condo if a significant number of owners in the development are past due on their dues or assessments. In particular, if dues or assessments are 30 or more days delinquent for more than 15% of the units in a condo development, the entire development earns a “non-warrantable designation” and loans insured by the above government entities are unavailable.
Even loans that are not government insured may be less available and/or more costly because of similar rules.
These requirements have an impact on obtaining purchase loans by prospective buyers and refinancing by existing owners, because loans that can’t be purchased or guaranteed by Fannie or Freddie are both more costly and harder to get.
There are a number of ways associations may try to encourage owner-occupancy and reduce rentals including the following:
- Require that no person or entity can own more than two units,
- Require that in order to own a second unit or lot require that the buyer must live in the first one,
- Limit the number of times a unit or lot may be leased or the length of time that it may be leased during each calendar year,
- Have a cap on the percentage of units or lots that can be rented. If the cap has been met, the homeowner goes on a waiting list.
- Charge the owner a fee each time a tenant moves in or out.
In order to win the approval for increasing restrictions on leasing from the necessary number of owners, the association board will usually have to show some flexibility to both those who already rent their units and to those who can think of reasons why they may wish to or even need to rent their units in the future. Ways to reduce the impact of restrictions for certain classes of owners including the following exemptions:
- Allow limited periods of rental for military or other transfers in which the owner intends to return, with maximum flexibility being given to military owners who have the least control over their destinies.
- Allow owners to rent their units for a limited period during difficult economic times, with determination of what constitutes hardship and who interprets the rules being well defined.
- Grandfather those who were owners when the rules were changed.
Parties on opposite sides of the issue – owners who wish to increase restrictions and those who want to oppose restrictions – should speak with an attorney who specializes in homeowner association law. Those for restrictions will need to ensure that the association doesn’t violate state law and those against restrictions will want to protect their rights.
Those who are renting units or who consider that they may want to do so in the future should probably consider the fact that long-term values of their units may actually be enhanced by reasonable restrictions.
Additional Information
For additional discussions regarding Associations and many other subjects see our “Buying Income Property” and “Managing Income Property eCourses.