guest blog by Deborah Goonan
One of the most controversial battles in residential HOAs and Condos centers on rental restrictions. This blog analyzes the arguments for and against rental restrictions in HOAs, and why the ratio of tenants to owners in Associations has become a hot button issue.
The argument against rental restrictions
Like many Americans, I have owned homes in HOA-free neighborhoods, and I lived in these homes as my primary residence. However, when employment opportunities took my family to another state in the midst of the recent real estate bust, we found ourselves unable to sell our home of 14 years. Fortunately, we were able to lease the home to another family for about a year and half, until the market improved, when we were able to sell. I don’t know what we would have done if we had been forced to keep the house vacant due to rental restrictions that are often imposed by HOAs.
A vacant house or condominium presents financial challenges – hiring someone to maintain the yard and periodically check on the property; winterizing in cold climates; keeping the house cool and mold-free in warm, humid climates; prevention of vandalism and squatting; and increased property insurance rates. Renting the home covers most if not all of the carrying costs, allows owners to deduct some of their expenses from income taxes, and, if the tenant is properly vetted, keeps the property relatively well maintained.
But what if your HOA restricts rentals in your community to just 5% of homes? One woman in a Pennsylvania HOA is now challenging her Board because, as explained in the story linked below, the Board of Freedom Woods HOA, a community of 275 homes, has enacted that rather draconian rental restriction without a vote of its membership. The Association attorney claims the Board has the authority to enact these restrictions under the “business judgment rule,” however now that the HOA has been challenged, he is also recommending an amendment of the Declaration. (CC&Rs)
Aside from the issue that the Board may have overstepped its boundaries by unilaterally creating rental restrictions, when a formal amendment is most likely required, there are larger considerations.
What about the property rights of individuals to rent their homes? In HOAs, that right is simply not guaranteed. It is very common for HOA and condo associations to cap the percentage of units rented to 20-30%, but, as this example illustrates, the restrictions can lead to enforcement of any arbitrary ratio decided by the Association, including an outright ban.
Why would owners want to discourage rentals in HOAs?
The flip side of the argument in favor of restricting rentals is that when the number of rentals exceeds a certain ratio (currently not more than 50% for FHA), many buyers cannot qualify for financing, thereby reducing the marketability of homes. And then there are the somewhat debatable arguments that too many rental properties result in a less stable neighborhood with a transient population, and that properties tend to be less well maintained by renters than owners. All of these factors are believe to drive property values lower.
Additionally, let’s consider why HOA and especially Condo and Townhouse communities tend to evolve toward a relatively high percentage of rentals, when compared to HOA-free neighborhoods.
During the recent economic downturn, many owners became reluctant landlords. But very few non-HOA neighborhoods changed from primarily resident-owners to tenants with absentee investor-landlords. For the most part, people who rented their single-family homes were those that had no other viable economic alternative.
On the other hand, a significant number of HOA buyers never intend to live in their units. It is common for investors to purchase multiple properties within the same community, particularly in locations that are in high demand, gaining voting rights for each unit. In short, they acquire a significant share of the corporate HOA, in order to obtain greater control over the community. The more they can affect the direction of the Board (often serving on the Board) the more control they have over variables that affect their profit potential.
Typically, investors buy units at low prices, hoping to sell later at a profit, and generating rental income during the holding period. Sometimes they buy early in the process to take advantage of price incentives. Often they will purchase in a depressed market, or in transitional communities – where owners are moving to newer homes or more desirable locations. HOAs or Condos that occupy valuable land are particularly attractive to investors or developers. Once they purchase several units, investors can entice or pressure existing owners to sell to them, sometimes at a low price. Over time, a few investors can acquire a majority of units, perhaps even enough to stage a hostile takeover by voting to dissolve the Association. After dissolution, investors are free to redevelop and convert to different, more profitable residential or commercial uses.
Of course, that is exactly what we see happening in HOAs, and especially condominiums. Notably, in the state of Florida, investors can vote for dissolution with an 80% voting interest. So it is little wonder that HOA owners fear the increased presence of tenants in their communities.
A new kind of block busting?
Investor influx and takeovers are rarely seen in HOA-free neighborhoods, where owners cannot accumulate multiple votes within the voting jurisdiction. There is no corporate Board, and votes at the municipal and county level are allocated one per resident rather than based upon shares of property owned. In other words, there is no inherent advantage to acquiring and holding onto multiple homes within a defined geographic neighborhood.
A review of history prior to passage of the Fair Housing Act in 1968 calls to mind the once-profitable practice of block busting. Although economic circumstances and owner fears are somewhat different nowadays, it certainly appears that real estate investors and developers have seized upon a similarly profitable but onerous process in HOAs.
The controversial decision in your HOA
No matter which side of the issue you favor, if you are part of the voting minority, you must abide by whatever the majority decides. If most of the owners are full-time residents, the Board may easily convince them to restrict rentals, with the consequence of limiting owner rights in the future.
But keep in mind that sometimes a minority of individual owners is the voting “majority.” If a few individuals just so happen to own multiple properties, they control the vote. And if most of the properties they own happen to be rentals, then they will most likely favor lax restrictions that could lead owners to migrating out of the HOA, and making the community vulnerable to decline and investor takeover.
Definitely a quandary.
It’s been my understanding that when the HOA hits the 30/70 mark the lenders dry up. I would assume the mortgage companies have some sort of calculation that they use to determine more the 30% rentals indicates higher risks. That makes sense.
Investors as opposed to an owner who rents a unit also makes a difference. For example, if a parent or grandparent passes away leaving an HOA controlled unit to their heir they have limited options if they live out of town. If there is a mortgage that exceeds what the unit will sell for then they lose all that has been paid in the downpayment and monthly payments on the unit. If it’s ripe for rental than it can be a good way to pay down the mortgage until it will sell at a break even point. Of course, the risk of increased dues, special assessments, and fines created by renters does exist. Or, perhaps the heirs think they will occupy the property when they retire so they wish to keep it. Or having a rental will help on their personal income taxes. When the owner handles the rental they then to be more selective about who occupies their property in hopes of not having to deal with damages, non-payment, and evictions. It becomes a “Catch 22” what to do.
Investors grab up the foreclosures often times with the assistance of a board member providing them with insider information. Board members can “tip-off” the investor that an owner is struggling and the investor can check to see what is owed and buy the unit by paying off the mortgage and taking the unit. Most investors that I know also hold a real estate license so they handle the transaction without real estate commissions and often times pay cash so to acquire the unit the investment is mostly for the unit not the closing costs, filing fees, transfer fees, etc. Board members seem to like this arrangement because it keeps units from being listed for sale and therefore the real estate industry isn’t advertising how many units have been on the market, how long they stayed on the market, and what the selling price was. It keeps the image of a “fire sale” under wraps. Investors tend not to maintain the interior of the property as well nor be as selective about who they rent to. This can result in people with criminal backgrounds, drug dealers, or any number of other risky behaviors. (Thus, Dave Russell in fighting to keep the Crime Free Program intact in Arizona.)
Board members will complain about rentals and even discuss changing the declarations so less rentals can exist at the same time they do everything possible to encourage rentals by having pools, tennis courts, playgrounds, and basketball courts. Do a survey in many HOAs and you’ll find the only people using these amenities are the renters. Again, a “Catch 22” situation.
The other risk with investors owning multiple units is if there is a special assessment for say, a new roof, will they be able to pay those assessments in one lump sum for fifteen units? And if not, will the board move to foreclose on those units? Unlikely, but the absence of those payments affects the cash flow of the HOA even if the investor makes payments with interest.
Perhaps a solution would be to charge a higher rate of dues on rental units just like the insurance industry does? The HOA dues are tax deductible for the rental units where it is not for the owner-occupied unit. On that note, I understand legal bills are also tax deductible on a rental unit if the owner has a legal battle with the HOA. Again, legal expenses are not tax deductible for an owner-occupied. We had one unit where the owner was sued over a fence and had a daycare in the home. She wrote the legal expenses off as a business expense for the daycare. (Check with an accountant on whether that would be legal because I have no idea, I just know what she told me she did.)
These are all just more reasons not to buy in an HOA. I’ve been in one for nine years and still cannot find one good thing about HOA living. It’s been all pain and no pleasure which makes for a very bad real estate investment.
I know several HOA homeowners who have been “reluctant” landlords. They have had to rent their home because they aren’t able to sell it for even close to what they paid for it. They have had to move because of a new job, new school district, or they are able to rent a smaller home for less money than the cost of mortgage and utilities in the home they own. They don’t want to walk away and ruin their credit. Deborah was “lucky” she could sell the house after a year and a half. The people I know, after 5 and 6 years, are still not close to having the market improved enough to sell. They tell me that are impatiently waiting.