A new home or condo may seem like a great deal. But your client had better scrutinize the rules impacting a community association before buying into it.
Stiff new rules, many enacted to curtail renters and investors amid the foreclosure crisis of the past few years, could impact a property’s value. In fact, an investor client may wish to gauge the sentiment of a homeowners’ association or condo association to rentals before buying. Otherwise, there could be headaches.

“Associations were really burned by all those investors who speculated and they’re angry!” declares Harry A. Heist, a landlord-tenant law attorney in Fort Myers Beach, Fla. “They’ll have long application processes. Often, they will not give a reason why they didn’t approve it.”

Rules generally are contained in an association’s governing documents. If they’re too restrictive, they risk damaging resale values by cutting into the pool of prospective buyers.

Rental restrictions have already been cited in the sale of some 100-150 homes last year by American Homes 4 Rent, an Agoura Hills, Calif., real estate investment trust. Jack Corrigan, the company’s chief operating officer, has said in published reports that it’s cheaper to buy the homes while prices are low or at auction. If a neighborhood restricts rental properties, the company will simply sell the homes and won’t buy there again.

This might be an attractive strategy in a real estate market that had prices spiraling upward. It could prove costly, though, if real estate values plummet.
Hedge funds and private equity funds have accounted for 30% to 40% of sales over the last 18 months, explains Jack McCabe, a real estate analyst in Deerfield Beach, Fla. In community associations, corporate and investor owners are slowly replacing Mr. and Mrs. Smith. Unit owners are suddenly finding that a majority of the homes in their neighborhood communities are rentals.

Residents in single-family communities or condos fear renters are transients. Renters, many believe, tend not to take care of a property as well as owners residing in the property.

Making matters worse: Those hired by hedge funds or private equity firms often are out-of-staters with the objective of collecting rent and/or selling at a higher price. Unit owners fear these owners will neglect property, make the cheapest repairs and sell to the highest bidder.

McCabe says the problem of associations getting overrun by investors is particularly prevalent in Southeast Florida, Orlando and Sarasota; in Phoenix; in Las Vegas; and in San Francisco and Orange County, Calif.

Here are just a few rules that community associations have invoked more often since the real estate foreclosure crisis hit:

• Associations are increasingly employing their right to approve or deny the sale of a unit. They are also exercising rights to approve or deny tenants.

• As maintenance fees go unpaid, associations are invoking their rights to collect rent from tenants.

• At least in Florida, an association has the right to restrict the ability of a unit owner and the tenant to use certain amenities, like a clubhouse, if dues go unpaid. But gate locks can’t be changed and an association can’t turn off utilities.

• Associations are weeding out investors by prohibiting a new owner from renting a property for, say, one year to as many as five years after purchase.

• Rentals—especially vacation rentals—are required to be at least for a specific term. Restrictions are being set on the number of rental leases an owner can have in, say, a six-month or one-year period. And communities are restricting the percentage of their units allowed as rentals.

Banning rentals entirely, however, has serious consequences, says Nancy Polomis, a community association attorney in Edina, Minn. A condo association risks losing a “certification,” permitting buyers into that community to qualify for attractive Federal Housing Administration financing.

Under the FHA’s certification rules, an administration spokesman confirms, an association cannot exclude all rentals, though it can establish a maximum number. Also, it can’t require a rental lease to be subject to the condominium board for approval.

There’s a catch-22. If an association allows too many rentals, Polomis says, a buyer could run into a roadblock qualifying for a loan the lender plans to sell to Fannie Mae or Freddie Mac. Qualification guidelines for these loans generally require that no more than 49% of units in an association be rentals.

There’s a difference between condo associations and homeowner associations. Members of a condo association own individual units and a percentage of buildings, common areas and amenities. Members of homeowners’ associations own both their homes and the lots upon which they sit. They also own an individual interest in common areas, which may include not only recreational areas but also streets.

Florida and California lead the nation in the number of community associations, with 46,000 and 42,500, respectively, according to a 2012 statistical report by the Foundation for Community Association Research in Falls Church, Va. Next in line: Texas, Illinois, North Carolina, New York and Massachusetts.

There’s a lot to consider when buying a property managed by a community association. The majority hire property managers to run the day-to-day community operations. But 40% don’t. Boards of directors are often made up of volunteers, and services may be farmed out. 
The issue of how to deal with rentals affects more than you’d think. Nationally, there are 323,600 community associations. They include nearly one of four U.S. homes. There are slightly more homeowners’ associations than condo associations. Fewer than 5% are cooperatives.

The problem of too many rentals haunts not only community associations. Municipalities are also cracking down—particularly on short-term rentals promoted by such vacation Web sites as AirBnB. Madison, Wis., for example, last fall began classifying homeowners who rent out their property for short terms as “tourist rooming houses,” subject to a $595 licensing fee and another $220 annual fee upon renewal. New York City bans rentals of less than 30 days. The Arlington, Va.-based Institute for Justice seeks to strike down a ban by the city of Winona, Minn., against rentals that make up more than 30% of any city block. That case is in a state appeals court in St. Paul.

Apart from community association and municipal rules, there also may be state and federal rules to consider. For example, in Florida, state rules governing the limiting of rentals by an association have been in a state of flux, notes Yeline Goin, attorney for Becker & Poliakoff in Fort Lauderdale.

As of this writing, a condo owner who tries to rent out a unit after an association imposes a rental restriction has more rights than a homeowner. That’s because a condo association restriction may only take effect after the unit is sold.

However, a homeowner association’s new rental restriction can immediately affect all homeowners—including existing homeowners.

In addition, federal issues threaten increases to unit owners’ association maintenance fees and/or assessments, suggests David Ramsey, chair of the Government and Public Affairs Committee of the Community Associations Institute in Falls Church. Among those:

• New Fannie Mae “lien priority” rules, effective January 14, could restrict the ability of community associations to recover more than six months’ worth of delinquent association fees on a foreclosure. Exceptions apply to certain grandfathered states, like Connecticut and Florida.

• The Federal Emergency Management Agency excludes condominium associations from emergency relief, though this issue is currently under study.
• The remapping of federal flood zones threatens to raise flood insurance rates for some community associations in low-lying areas.

• The Federal Trade Commission is reviewing the prospect of broadening the Fair Debt Collection Practices Act. This could hurt community association efforts to collect on delinquent accounts.

• Proposed interagency rules, governing the type of mortgages that federal government-sponsored enterprises may buy, could negatively impact borrowers in community associations.

Despite community association restrictions, investors are still buying properties with the intention of renting them out. “I’ve had associations where they’ve discovered that people are renting without reporting it,” says Minnesota attorney Polomis. “When they find out, there’s some explaining to do and fines are imposed. The landlord isn’t happy being fined. The tenant is caught in the middle.”

Polomis advises that your clients read the governing documents they typically get within the stipulated time frame they have to review them and ask many questions. “If you have a specific use in mind, ask if it’s allowed. Most associations won’t deal with prospective purchasers because they don’t owe them anything. If a [unit] owner asks, however, they have to answer questions.”

Analyst McCabe warns that a lot of professional investors planned to make a killing buying real estate on the cheap and selling at a much higher price. In 2013, though, many deviated from that plan by paying full retail value or above.

Meanwhile, costs have risen. Windstorm and flood insurance rates are rising dramatically. Property taxes are going up. So are interest rates. The costs of maintenance and repairs are increasing.

“I don’t think the hedge funds understood all the things that can cost more money with home ownership,” McCabe says. “These are bright financial-balance-sheet guys. The costs to make them habitable are more than what they had budgeted.”

What surprises McCabe is that companies like Blackstone Group (in New York), set rents for different properties, but don’t seem willing to negotiate. “If they’re asking $2,500 [monthly] for a property and you offer $2,200, they tell you no and let the place sit empty,” he says.

Now these properties are starting to be securitized. But those purchased at an attractive price are mixed in with those that weren’t.

“They take a handful from Florida and Arizona and a handful from five or six locations and put them in the same package,” McCabe warns. “It’s hard to tell when they acquired them, if they overpaid or if they’re asking too much for rent. Quite a few of them are going to end up losing money.”