THE LEASING ROUND AROUND

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THE LEASING ROUND AROUND

BY MIYE JOHNSON YI

The effects of a difficult economy driven by a substantial downturn in the housing market and the rise of investor owned properties are making it challenging for many community associations to effectively enforce covenants prohibiting and/or restricting the leasing of property.These real estate investors include private individuals who wish to rent their property as well as investment companies that are purchasing large numbers of distressed properties looking to lease them until the real estate market recovers to the point where they can be sold for a substantial profit.

Obviously, the goals of these real estate investors are in direct conflict with the goals of many associations to maintain predominantly owner-occupied communities.As such, it has become more challenging than ever for associations to enforce their leasing restrictions.While leasing challenges vary, issues commonly faced by associations include entity owner occupancy, transfers of nominal interests in property to tenants and a substantial rise in the number of undue hardship leasing requests.

Typically, “Leasing “is defined as “the regular, exclusive occupancy of a Unit by any persons other than the Owner.”However, questions arise as to how this definition applies to property owned by a corporation or other legal entity such as a trust that cannot itself occupy the property.These questions come into play not only due to the rise of properties owned by investment companies but also as more private investors form corporations, limited liability companies, trusts, and other legal entities for their specific properties, often in an effort to circumvent leasing restrictions.In a typical scenario, a tenant is named as an officer in the entity or given a small ownership interest in the entity in order to create a legal basis for the position that they are legitimately occupying the property on behalf of the entity.The question then becomes whether or not the arrangement is in substance a lease.

Additionally, investor owners are also transferring nominal interests in their properties (typically 1%) to their tenants to circumvent leasing restrictions.In many governing documents, “Owner” is defined as “the record owner of fee simple title to any Unit or Lot.”As such, by transferring nominal interests in properties to tenants, owners are circumventing leasing restrictions by making their tenants effectively “Owner(s)” as defined in the governing documents.While such an arrangement may present an enforcement challenge to the association, it also exposes both the owner and the tenant to substantial risk.Among other things, the owner runs the risk that the tenant might convey or encumber the 1% interest, complicating any future ability on the part of the owner to sell or mortgage the property.From the tenant’s standpoint, the arrangement imposes upon the tenant all of the obligations of property ownership, including the obligation to pay taxes and assessments.

While these types of situations make enforcement more difficult for associations, there are still actions which may be taken to regulate and control them. First, when dealing with such owners, associations should require certain information to be provided in regards to the owner and the occupant including copies of the organizational documents of the entity, the name and contact information for the owner and occupant, documentation showing the relationship between the owner and the occupant as well as copies of any agreements between the owner and the occupant in regards to the property.

Second, in addition to requesting such documentation, an association should engage in its own separate investigation as well.A few things to look for include property advertisements for lease prior to occupancy, prior leasing requests as well as information about the owner’s scope of business and occupant information.Associations can also put together questionnaires for owners to complete and return that may include additional questions regarding such matters.All such documentation and information obtained should be carefully considered by the association in determining if such an arrangement is effectively a lease.

If, after careful consideration, the association determines that the arrangement is a lease, then the association should treat such owners as it would any other owner in violation of a leasing restriction. The key thing that boards of directors must remember is to treat all owners fairly and equally. The best way to ensure that is to have leasing provisions in place to deal with such situations and to be consistent in the enforcement of such provisions.

That being the case, it is imperative for associations to have provisions in their governing documents specifically addressing such ownership and occupancy. Many associations have amended their governing documents or adopted regulations to include such provisions. With such leasing provisions in place, associations can more easily and effectively enforce leasing restrictions and minimize challenges from owners.

Such leasing provisions and evidence of consistent adherence to and enforcement of those provisions will provide a greater basis of support should legal action become necessary.Accordingly, the third option available to associations is court action against an owner to enforce compliance.While court action is an option, associations must carefully consider the information obtained, the circumstances of the case, and the costs involved to determine if court action is the best remedy available.

In addition to these leasing issues, associations are dealing with more undue hardship leasing requests than ever before.Undue hardship leasing permits are intended to allow an owner to lease when an association’s leasing capacity is met and the owner must lease to avoid an undue hardship.While many associations with leasing provisions in their governing documents have examples of circumstances that constitute undue hardship, determining what qualifies as an undue hardship with regard to other requests can be more challenging.

While some owners provide an overwhelming amount of information to try and convince boards of directors to find undue hardship, a good rule of thumb in determining what constitutes an undue hardship, outside of any mentioned in the association’s leasing provisions, is to ask if the situation is created by or is within the control of the owner.If the answer is yes, then it is more likely that the situation does not constitute an undue hardship.However, with all enforcement action, the association should be consistent and treat all owners fairly and equally.So for instance, if the board of directors determines that an owner whose company is requiring an out of state assignment for a year constitutes an undue hardship, then otherrequests with the same reasoning should be treated the same.

While associations are dealing with more challenging leasing issues than ever before, options are available to minimize the leasing round around caused by such owners. Armed with sound leasing provisions in their governing documents and by adhering to consistent and uniform procedures for enforcement, associations can effectively deal with these issues.