any people ask me for information about the pros and cons of limiting the number of rentals in any given California HOA development, or imposing restrictions like requiring purchasers to reside in the property (or at least refraining from renting it to another) for a year or more before they have a right to lease it to another. A Board may be interested in looking a lease limiting provision because through attending seminars or reading industry articles, it sees how such an amendment can benefit the owners in the Association. 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 attempting to enforce governing documents may read about such a provision and believe it is important to restrict rentals, because of common problems associated with rentals. There are those on the other side that believe these amendments are not legal. The courts have determined otherwise.

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 and to alleviate problems 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 type 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 (including the secondary mortgage market providers like FNMA and FHLMC). Percentages like this adversely affect some financing options, and certainly if your association reaches 50%+ rentals, you are likely to encounter more limited financing options. That† kind of rental percentage most likely eliminates the option of loans that are generally sold to the secondary mortgage market (which is a substantial percentage of home loans). This high rental percentage requires potential buyers and owners who want to refinance to look for private financing because most banks and savings and loans sell to the secondary market.

Most 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 but there are no reasonable means available to evict 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. Studies done by the Department of Real Estate in California actually show 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. 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.

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 concerned about rentals and will be supportive of a limiting amendment. My experience is that owners do not always see things from the Board's perspective.

Is California different than other states in any way?

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". 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, without having any background information as to what the courts in California or any other state have done with such provisions. Legal advice without the educated backup information or knowledge is worth little.

The Courts of California Are Open to Lease Limiting Amendments

The appellate courts of California have spoken now twice on the issue of leasing limitations, and a third and/or fourth case may be forthcoming as at least two Superior Courts have approved HOA lease limiting amendments.

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.)"

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.

The validity of lease limitation provisions have been upheld in other states' courts as well.

Pending California Superior Court Cases: There are two cases I am following in California where an owner has challenged a restriction. They are both in Southern California. In the Superior Court both HOAs that were challenged won. In both cases, the owners have vowed to seek redress in the Appeals courts. I will be publishing more information on these as I get it on my website, either in the blog answers or in the form of an article or primer. You can sign up for the free E-news as well and there will be articles in that publication over time.

Possibilities for 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 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 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 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. However, I have been to such meetings scheduled by the Board to see that only one or two people are interested in the subject enough to attend the meeting.

What are the advantages to a lease limitation provision?

They deter purchase by investment owners.

They tend to lessen problems relating to rentals.

They may protect the "finance-ability" of units by avoiding some of the constraints of the mortgage markets (like FHLMC and FNMA) that have restrictions on lending in high percentage rental developments.

They tend to attract purchasers who are looking for protections of 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.
• 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.

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 FHLMC and FNMA are major "players".

In proposing any lease limitation amendment, I will offer clients practical advice based upon my own experiences and this includes:

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 doing this. The Association can use the support of the community and needs approval - every vote counts. This means persons currently leasing will not be subject to the limitation (they will be counted in the percentage but not prohibited by it from continuing to lease). 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); others grandfather all current owners. The provisions which grandfather in everybody who currently owns in the development are commonly used when it 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.

Lender Issues: Some documents require lender approval for changes in the leasing rights. The provision may bring mixed responses from lenders. The secondary mortgage market may not wish to see any restrictions on leasing properties because that will make it unable to ease out a foreclosed property until it sells, but on the other hand, it may have difficulty marketing a product in a development with a high percentage of lenders. Because of lender concerns, I often recommend an exception to the quota limitation to give lenders that foreclose time to reasonably market the property. Otherwise, if they hold back on their own foreclosure process because they cannot lease the property, 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, 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. 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.

Pending Legislation: A bill introduced (AB2259) and was presented to the Governor this year that would affect enforcement of lease limitation amendments making them unenforceable as to owners that do not consent to them in writing. The bill was vetoed; however, there will probably be more attention paid to these restrictions in the future as it raised awareness of the issues. There is more information on this and other aspects available in Lease Limitation Primers now available on my website in the Webstore.

Voting on These Amendments. Voting on these amendments must be done per Civil Code Section 1363.03 (the double envelope secret voting process). It is critical if you want an effective amendment to enforce that it be well written, must†amend the CC&Rs (not the Bylaws or Rules),†and that the approval of members required to pass it is achieved. Be sure to check not only the amendment provisions of the CC&Rs for members, but also the section that provides lender protection (mortgagee provisions). You will commonly find higher percentages of owner approval required for making material changes such as leasing and rental restrictions that affect an owner's right to lease or rent their property.† 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. You may want to seek an analysis of that question before proceeding to have the amendment written. This one thing may affect your decision to put such an amendment to the owners.

I hope this information is helpful. You can send me an email if you wish to receive†a poll/survey that I recommend be sent to owners, to provide the Board with important feedback, and a form for the Board to provide feedback to me if you want me to draft the ballot and measure for a vote of the members.† 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 a charge of course, for writing an amendment, but the survey is free.

A legal opinion on the actual approval of owners and/or lenders, information on voting requirements, ballot presentation, etc., and estimate for writing the amendments can be obtained by sending an email request to: Califcondoguru@aol.com.

Beth Grimm, California HOA Attorney Beth Grimm, California HOA Attorney