DEALING WITH RENTERS

With increasing frequency, condominium and homeowner associations are examining the legality – and the consequences – of modifying their governing documents to restrict members from renting their units. Usually they have a number of concerns about renters that can be loosely classified as five fears; fear of losing access to resale financing; fear of decreased owner pride and involvement in the association; fear of a loss of “community” feeling due to greater transiency of residents; fear of having insurance underwritten at higher apartment rates rather than lower condominium rates; and fear of problems with maintaining standards of behavior. It is not surprising that many associations are voicing these concerns – the number of owner-occupied housing units has been declining nationally since 1980. According to U.S. Census data for the Puget Sound, Washington area, 41 percent of the housing units in King County, Washington (the site of Seattle), and 34 percent of the housing units in the county just North are nonowner occupied. In Boston, a 1991 study by the Boston Redevelopment Authority found that only 37 percent of the city’s ondominium units are owner-occupied. These changes are due to several factors. When the real estate market is soft, there are large numbers of foreclosures, both against owners and against developers. Many of those foreclosed units have been unloaded by financial institutions to investors who have chosen to rent them rather than remarket them in a soft market. Investors have also been “purchasers of last resort” for sellers
trapped in depressed market conditions. Many owners who have moved for economic, personal, or geographic reasons have retained their units. Owners have found themselves faced with the decision of whether to sell their unit or hold on to it, either for investment purposes or because they are waiting for the market to strengthen. In many cases, it is the rental practices of these small, unsophisticated, and sometimes
unwilling investors that have wreaked the most havoc on neighbors.

The Parties involved

At a recent workshop on renters, I used a graphic demonstration to allow participants to examine the validity of the perception that renters are problems. I asked those people who were currently renters to stand and remain standing. A couple of property managers stood up. I then asked those people who had ever been renters to join the first group in standing. About two-thirds of the group stood up. Next, I asked everybody who had ever rented a property for an office or a vacation to stand. Everybody except two people stood. I got the final holdouts to concede that they had rented cars. Now I submit that any group that gives up its Saturday to attend a CAI program can’t be all bad. I also submit that the problem is more often a communication problem than a renter problem. A number of different parties are involved when someone rents a unit – and that can mean a variety of different interests. The association has an interest first and foremost in maintaining and enhancing the value of the property. In doing so, the board and management attempt to maintain and enforce standards of conduct and use – rules and covenants – in an efficient and inexpensive manner. The association wants to ensure owner access to affordable, competitive resale financing, and it also has a stake in maintaining owner involvement. Finally, the association and all owners have an interest in maintaining access to property insurance at the lower condominium rate rather than at the higher apartment rate. The investor owner shares the association’s interest in maintaining and enhancing the value of the investment in the unit. The investor owner
also has an interest in maximizing net income and minimizing inconvenience. If the investor sees maximizing income as a short-term goal, however, that could create a conflict. The tenant is generally interested in maximizing the personal utility and enjoyment of their home while minimizing the inconvenience connected with it. Lenders have an interest as well. The lenders generally want to minimize the risk of defaults and preserve the value of their collateral. How lenders believe they can best achieve this is reflected in the underwriting standards they apply when deciding whether or not to make a particular loan. While each individual bank, mortgage company, or savings and loan may have different criteria, there are generally accepted sets of criteria promulgated by the secondary mortgage market. This secondary market is primarily made up of the Federal National Mortgage Association (Fannie Mae), the Federal Home Loan Mortgage Corporation (Freddie Mac), the Government National Mortgage Association (Ginnie Mae), the Federal Housing Authority of the United States Department of Housing and Urban Development (FHA), and the Veterans Administration (VA). Each of these organizations has promulgated its own loan underwriting standards – and these standards have great significance for an association considering options for dealing with renters.

Lenders and Rental Restrictions

If an association wishes to pursue a limit on the number of rentals, I strongly suggest that it work with its attorney to obtain advance approval for the amendment from FHA, Fannie Mae, and Freddie Mac. At first glance, these institutions appear to apply a double standard. On the one hand, they find projects with large numbers of renters unacceptable for underwriting purposes. On the other hand, some lenders are also unwilling to accept certain mechanisms in a project’s declaration that restrict an owner’s right to rent a unit. All of Fannie Mae’s Project Standards have owner-occupancy requirements. Fannie Mae Type A project acceptance for principal residence projects is generally the most desirable classification of eligibility. Type A acceptance is available for “established” condominium projects where the lender is providing
financing on a spot-loan basis. Established condominium projects are ones where construction is completed, at least 90 percent of the units are sold, and the owners have controlled the association for at least one year.
To qualify as a Type A principal residence project, at least 70 percent of the total units must be conveyed to purchasers who are occupying the units as their principal residences. Also, no single entity may own
more than 10 percent of the total units in the project. There are many other requirements not related to ownership and occupancy that also must be met. If the project meets all of the eligibility requirements except the 70 percent owner occupancy requirement, it may qualify as a Type A investor/second home project. Under these standards, lenders may sell loans secured by owner-occupied principal residences
and second homes that meet a number of additional requirements, including that at least 50 percent of the units are occupied by owners as principal or secondary residences.
The underwriting requirements for Type B acceptance have occupancy requirements as well. They are applicable only to new projects or conversions with a 70 percent pre-sale to owners who intend to occupy their units as principal residences or second homes. Type C acceptance is considerably more rigorous in its project requirements and has a 60 percent owner-occupancy requirement. In addition to owner-occupancy standards, an association’s governing documents must meet Fannie Mae’s legal requirements. One of these legal requirements deals with leasing and states: “Any lease or rental agreement must be in writing and must be subject to the requirements of the project documents and the owners, association. No unit may be leased or rented for less than 30 days-the project documents may require a minimum initial term of at least six months. There should be no other restrictions relating to the term of any lease or rental agreement.” Fannie Mae interprets this as prohibiting a total restriction on renting. Notwithstanding this, it did grant a limited waiver to one association to allow a 30 percent ceiling on the number of units that could be rented at any one time. While VA does not have a limit on the percentage of
units that ma be occupied by renters, they do have a strong regulatory bias against restrictions on an owner’s right to rent. Acceptable restrictions include a requirement that leases have a minimum initial term of up to one year, age restrictions, or restrictions imposed by state or local housing authorities. Recently one Washington condominium project amended its documents and the VA gave notice that the condo
would no longer qualify for VA financing. The documents were amended to do three things: to provide for mandatory tenant screening by owners, to make leases subject to the association’s governing documents, and to allow the association to review and approve such leases. After attempts to negotiate with the local VA staff proved ineffective, the matter was appealed to the head of the VA’s Loan Guaranty Section in Washington, D.C. VA eventually approved the language in question; however, sellers must disclose the restrictions in writing to potential purchasers. FHA will not make loans in projects that are not 51 percent owner-occupied.
While FHA’s legal guidelines do not seem to prohibit rental restrictions, this author has received inconsistent reactions from FHA’s local and national staffs. Officials in Seattle have verbally expressed reservations with most of the available mechanisms for restricting renters. They are concerned that a person who owns a unit might be transferred out of town and would not be able to meet their mortgage obligation if they were unable to rent the unit. At the CAI Research Foundation Symposium on Multiple Ownership Acts in November 1991, Harwood “Woody” Martin of the FHA national office offered the opinion that FHA would welcome any restrictions in an association’s documents that limited the number of nonowner occupants. FHA, however, does not perform a legal review of the project documents. Instead they rely on an opinion letter from their attorney which states that the governing documents must comply with FHA regulations.

Types of Restrictions

If the lenders approve restrictions, will the courts approve them as well? Most courts that have considered rental restrictions have upheld them. Typically these restrictions have been found not to constitute
unreasonable restraints on alienation, since an owner could always sell the unit to a person who intended to occupy it. Judicial decisions have supported approaches such as@ * A total prohibition against
leasing * A prohibition against leasing without the consent of the board * The power to impose a minimum one-month rental period, a maximum of six rentals per year, a limitation on the number of persons who may occupy a unit, a restriction on tenants having pets without board approval, and a $25 processing fee * The prohibition and leasing of units “as a regular practice for business, speculative, investment or other similar practices” * A right of first refusal to rent a unit granted to the association or its assignee * A limitation on the number of times an owner may rent a unit * A limit on the number of units that an owner may purchase To ensure enforceability, an association should include any leasing restrictions in the declaration or master deed. Rules passed by the board may not be strong enough to curtail a right of ownership as fundamental as the right to lease one’s property. Restrictions should be uniform in their application, both on their face and in their enforcement. A restriction that only applies to purchasers of units after a certain date would most likely be struck down as discriminatory. A Florida court struck down a regulation that allowed older members to rent their apartments once a year, but restricted newer owners to renting once every two years. Short of an outright ban on leasing, there are a couple of approaches to restricting rental units. One approach prohibits owners from renting their unit until they have lived in it for a minimum period. This approach, with a two-year minimum owner residency, was recently adopted by a Seattle association. In New Jersey, a one-year minimum residency requirement is being challenged in a lawsuit.
A second approach limits the number of units that one person may own in a condominium. It is possible to restrict ownership, for example, to one, two, or three units per owner. A variant on this approach is to say that a person can only own one nonowner occupied unit in the condominium. This would allow a person who lives in the condominium to own a second unit, but would restrict nonoccupant owners to ownership of only one unit. I do not recommend these approaches. Although they are likely to be enforceable, their only effectiveness will be to discourage investors from acquiring blocks of units. Such a restriction does not deter an owner who moves out and converts his or her only unit to rental, nor does it stop the acquisition by the small investor of one unit – or more, depending upon the limit selected – for rental purposes. Perhaps the best approach is to allow owners to rent as long as the number of nonowner-occupied units is less than 30 percent. Once the percentage of rental units reaches 30 percent, an owner who wants to rent goes on a waiting list. When an existing tenant moves out, that unit cannot be re-rented until everyone on the waiting list has had a chance to rent his or her unit. This scheme provides
an equitable sharing of the opportunity to rent while limiting the number of rentals. This approach has been conditionally approved by Fannie Mae in one Seattle case. The risk is that at some point an owner may have to go on a waiting list before he or she is able to re-rent a unit, which can discourage investor owners from buying into the project. If the project is not at the 30 percent renter level, there is a good chance it will never reach that level based on the decreased attractiveness of the project to investor owners.

Try Communication

Rather than restrict an owner’s right to rent, associations may want to address some of the concerns about renters instead. One such alternative is a strong communication program designed to keep absentee owners aware of and involved in the affairs of the association. It should also make sure prospective tenants know the rules and expectations before they sign a lease. If a tenant knows in advance that there is a high standard of courtesy, respect, and responsibility expected of all residents – and a rigorous program to enforce that standard – it is likely to deter renters who are unwilling to live up to that norm. This is consistent with the tenant’s desire to minimize inconvenience. As part of ensuring that this communication process takes place, I recommend amending an association’s declaration to require owners to give their tenants a copy of a tenant handbook. The handbook should contain all pertinent provisions of the declaration, by-laws, and rules as well as an explanation of association living. This should occur before they sign a lease for the unit. A lease addendum, signed and submitted to the association by the landlord, should be included to acknowledge that the tenant received the information, read it, and agreed to be bound by it. If the landlord fails to provide this information, the association should have the power to provide it – and assess the owner for the cost. Communication should not stop at this point. Getting tenants involved in the association and the life of the common interest community is a key to successful relationships between resident owners and renters. If associations make welcome wagon visits to new owners, they should make that same visit to new renters. Tenants should be advised of what issues they address to their landlords and what issues they address to the association. They should also know who the proper contacts are for the association, and they should receive copies of the association’s newsletters and notices of association board and membership meetings. Tenants should be encouraged to attend those meetings, to voice their concerns, and to volunteer for service on association committees. They should also be welcomed into the community social life. A tenant who is treated as a responsible member of the community is more likely to act like one. I also suggest an amendment to the association’s declaration requiring professional screening of all prospective renters. This will maximize the likelihood that owners will make rational decisions about who to entrust their investments to. Most commercial apartment operators screen their tenants to weed out undesirables as a matter of course. As a result, the less desirable
tenants have looked to other sources of housing. One of the easiest rentals for a tenant with a poor rental history is a single-family home or a condominium owned by a small investor who does not have access to or knowledge of screening services. The best way to ensure tenant screening is by having the association or its manager become a member in a reputable tenant screening service. However, the evaluation of information received from the screening service an the selection of an appropriate tenant should be made solely by the unit owner. I also suggest amending the declaration to give the association stronger enforcement tools against tenants. This includes the right to deal directly with a tenant who is violating a rule or covenant rather than having to go through the unit owner. If your state condominium law allows associations to levy fines for violation of the covenants or rules after notice and an opportunity for a hearing, I recommend that the language in the declaration contain specific authorization for the association to levy such fines against tenants. Finally, I recommend that the association, after notice and a hearing, be given the power to require an owner to evict a tenant who will not comply with the association’s regulations. If the owner fails to do so, then the association should be authorized to do so and to assess the costs to the owner. The eviction powers should also extend to a tenant who has gained occupancy of a unit without an owner going through the required screening process. In many declarations that comply with the legal requirements of the secondary mortgage market, an amendment that restricts leasing requires approval not only by 67 percent of the unit owners, but also by 51 percent of the eligible mortgagees holding mortgages on units in the condominium. Eligible mortgagees are those holders of a first mortgage on a unit who have requested in writing that the association notify them of any proposed action or amendment that requires the consent of a specified percentage of mortgage holders. Adopting the declaration amendments recommended in this article may require educating mortgage holders about the problems renters can present to an association. It is a problem that is not going to go away.