Why this matters: Learn the use restrictions and operating conditions placed on conduct in HOA communities, the obligations and assessments imposed on an owner of a unit in a CID and how a seller agent requests CID documents concerning use restrictions and HOA finances from the HOA for delivery to prospective buyers when marketing a CID unit for sale.
Follow along with an audio reading of this article adapted as a chapter from our upcoming Real Estate Practice course update.
Housing managed by your neighbors
A buyer seeking to acquire a unit in a condominium project, or in any other residential common interest development (CID), is bargaining for living restrictions and ownership operating costs unlike those experienced in the ownership of a self-managed single family residence (SFR).
Ownership of a unit in a condominium project includes compulsory membership in the homeowners’ association (HOA). The HOA is charged with managing and operating the entire project.
As a common owner of the project and an HOA member, use and operating restrictions are placed on most types of conduct, including:
- parking;
- pets;
- guests;
- signs;
- use of the pool, recreational and other like-type common facilities;
- patio balconies;
- care and maintenance of the unit;
- structural alterations; and
- leasing of the premises.
The implicit bargain in becoming an owner-member is the consent to conform your conduct to meet extensive use restrictions in exchange for every other owner-member doing the same. The standards for the conduct are found in the use restriction documents created for the project, such as association bylaws, Covenants, Conditions and Restrictions (CC&Rs) and operating policies.
Related video:
Read more about CC&Rs.
HOA governance by committees
The HOA has a board of directors and committees, both consisting of owner-members appointed to oversee the conduct of all owner-members and their guests. When a member violates a restriction, a committee may recommend the HOA take steps to enforce compliance, usually by a notice of violation to the offending owner-member.
A fair comparison to the member’s occupancy in a multiple-unit housing project, such as a condominium development, is a tenant’s occupancy in an apartment complex of equal quality in construction, appearance and location. The landlord also controls the behavior of a tenant in an apartment with:
- use restrictions;
- operating rules; and
- landlord-established policies for a more responsive competitive environment.
As a competitor, a landlord is subject to market conditions when establishing guidelines for tenant conduct. Unlike an HOA, a landlord does not rule by majority vote, committees or directors.
Yet the conduct of tenants is regulated and policed in very much the same way as the conduct of a member of a condominium project. Security arrangements implemented and maintained for condominium projects and apartment complexes are the same. That is, the owner (HOA) needs to maintain the property so its intended use is safe and secure from dangerous defects and preventable criminal activity.
Both a landlord and an HOA board of directors are responsible for the safety of the users of their respective multiple-housing projects. Both are managed housing.
Related article:
Classification of member obligations
The prospective buyer needs to understand that ownership of a unit in a CID includes a highly intertwined socio-economic relationship with all other members of the HOA unlike an apartment tenant.
A commonality of interest arising out of CID ownership creates a relationship amongst the members built not only on use restrictions and operating rules, but also on mutual financial commitments to one another, a sort of pooling arrangement for operating costs.
Financially, all members collectively provide all the revenue the HOA needs to pay its expenses. These costs include present and future repairs, restorations, replacements and maintenance of all components of the structures owned by the HOA or in common by all members.
Thus, the HOA obligations undertaken by a prospective buyer on acquiring a unit in a CID are classified as either:
- use restrictions contained in the association’s articles of incorporation, by-laws, recorded CC&Rs, age restriction statements and operating policies; and
- financial obligations to pay assessments as documented in annual reports, including:
- pro forma operating budgets;
- a Certified Public Accountant’s (CPA’s) financial review;
- an assessment of collections and enforcement policy;
- an insurance policy summary;
- a list of construction defects; and
- any notice of changes made in assessments not yet due and payable.
Related FARM letter:
Assessments generate revenue
Two types of assessment charges exist to fund the expenditures of HOAs:
- regular assessments, which fund the operating budget to pay for the cost of maintaining the common areas; and
- special assessments, which are levied to pay for the cost of repairs and replacements which exceed the amount anticipated for reserves and funded by the regular assessments.
Annual increases in the dollar amount levied as regular assessments are limited to a 20% increase in the regular assessment over the prior year. Any increase in special assessments is limited to 5% of the prior year’s budgeted expenses. [Calif. Civil Code §5605(b)]
An extraordinary expense brought about by an emergency lifts the limits placed on the amount of an increase in regular and special assessments. Extraordinary expenses include amounts necessitated:
- by a court order;
- to repair life-threatening conditions; and
- to make unforeseen repairs. [CC §5610]
The schedule for payment of assessments by a CID’s members is based on two types of assessment:
- Regular assessments set annually, due and payable in monthly installments; and
- Special assessments due and payable in a lump sum on a date set by the HOA when making the assessment.
Related article:
The buyer’s expectations about assessments
To better understand the extent of the personal financial burden of assessment obligations, a prospective buyer of a unit needs to analyze an HOA’s current assessments based on:
- present and future annual operating costs the HOA might incur; and
- the amounts set aside annually as reserves for future restoration or replacement of major components of the improvements.
When the association’s cash reserves are insufficient to pay for foreseeable major repairs to components of the structure, the association uses a special assessment. Special assessments immediately call for additional funds from members to provide revenue to cover these extraordinary or inadequately reserved expenditures.
Arguably, repairs and replacements for which the HOA needs assessment revenues to cover costs are expenses any owner of an SFR may incur.
However, the difference in a CID is the individual member may not substitute their time, effort and personal judgment for:
- how much will be paid;
- when the repairs will take place;
- how repairs may be financed; or
- exactly what repairs or quality of repairs are appropriate.
The individual members leave these decisions to HOA committees who ideally vote based on the same concerns and ability to pay as the prospective buyer of a unit.
Related Client Q&A:
Checking for order in the HOA’s financial house
To determine whether an HOA has its finances in order, a prospective buyer and their buyer agent look to the financial reports held by the owner and readily available from the HOA on the owner’s request.
The HOA’s current pro forma operating budget is the starting point for the prospective buyer’s analysis of the financial impact the purchase of a unit in the CID will have on their income. Again, it is the regular assessments which the HOA can increase to build up otherwise inadequate reserves or levy a special assessment to cover an immediate expenditure when cash reserves are insufficient.
The pro forma operating budget makes several mandatory disclosures about the state of the HOA’s finances at the end of the fiscal year, including:
- The current estimate of the future cash reserves necessary to repair, replace, restore and maintain the HOA’s major components.
- The current balance of accumulated cash reserves set aside to repair, replace, restore or maintain the HOA’s major components.
- Money losses or settlement amounts awarded to the HOA for injuries to property due to construction or design defects. [CC 5565(b)]
Related article:
Before setting a price, consider deferred assessments
On review of the HOA’s pro forma operating budget, the prospective buyer quickly determines whether a cash reserve shortage exists. When a shortage exists, the HOA obtains funds for adequate reserves or to pay for current repairs or replacements by increasing the annual assessments (paid monthly by members) or call for a special assessment (a lump sum amount paid by members).
Thus, when setting the purchase price of a unit, the buyer considers (the present value of) the amount of deferred assessments not levied but are due in the future from owners when eventually levied.
Some HOAs initially supply only a summary of the pro forma operating budget. In this case, the buyer requests the full budget which the HOA delivers without further charge.
Further, the prospective buyer needs to review the other HOA documents to properly evaluate (price) the unit considered for acquisition, and the financial impact of assessments on the buyer’s disposable income.
For example, another financial disclosure issued by the HOA, unless the HOA’s annual revenues are $75,000 or less, is a CPA’s review of the HOA’s financial statement, a separate statement from the pro forma operating budget. Look in the CPA’s review for comments about deficiencies in reserves, delinquent assessments or unusual accounting procedures. [CC §5305]
Related article:
The HOA’s assessment enforcement policy
Also available from the HOA is a statement on the HOA’s policies for enforcing collection of delinquent payments of assessments. [CC §5310(a)(7)]
A critical issue for a prospective buyer of a unit is the method used by the HOA to enforce collection of assessments, for example:
- does the HOA record a Notice of Default and proceed with a trustee’s foreclosure on the owner’s unit for the delinquent assessments, a default which the owner may cure by payment of delinquencies and statutorily limited foreclosure costs; or
- does the HOA hire an attorney and file a lawsuit requiring a response and a trial which results in a personal money judgment against the owner, which has no limit on the dollar amount of costs and attorney fees to defend or prosecute; and when not paid, becomes an abstract of judgment which is a foreclosable lien on all property owned by the owner and collectible by attaching the owner’s wages or salary? Meanwhile, the owner remains on title, and further assessments are owed until the judgment is satisfied by the owner’s wages and property. [CC §5675]
Further, prior to initiating foreclosure on an owner’s interest in a unit, the HOA gives the owner the option to participate in an alternative dispute resolution to structure the repayment of delinquent assessments. [CC §5705]
The buyer agent representing a prospective buyer of a unit in a CID reviews with their buyer all readily available HOA information and provides advice before making an offer. With this review, the buyer and the buyer agent best determine the price the buyer might offer for the unit and whether they have the ability (and desire) to carry the cost of ownership after acquisition.
Further, when the prospective buyer is using mortgage funds to purchase the unit, lenders require the HOA to:
- possess properly maintained reserves;
- limit delinquent assessments; and
- limit investor ownership of multiple units in the CID.
These financial requirements are strictest for FHA-insured and VA-guaranteed mortgages. Here, a CID is required to meet minimum financial, occupancy and legal guidelines to qualify as approved projects for FHA and VA mortgages. Frequently, CIDs are mismanaged by the board and financing requirements designed to protect mortgage lenders and insurers from losses end up protecting the prospective buyer using mortgage funding.
Related video:
Read more about the Notice of Default.
HOA delivery of its documentation
An association’s participation with a seller agent to induce a prospective buyer to enter a purchase agreement and close escrow and acquire a unit located within the CID is limited to:
- providing the seller agent, on written request from the owner of the unit marketed for sale, documents regarding the permissible use of the unit and the financial condition of the HOA. [CC §4525; See RPI Form 135]
- providing escrow, on written request from the owner of the unit marketed for sale, with documents which include notices, statements, lists and disclosures regarding the status of the owner’s membership in the HOA; and
- changing HOA administrative records to reflect the identification of the new owner when the prospective buyer purchases the unit.
The HOA may charge a service fee equal to their reasonable cost to prepare and deliver the documents the owner requests. Separately, a change of ownership charge is permitted, limited to the amount necessary to reimburse the association for its actual out-of-pocket cost incurred to change its internal records to reflect the new ownership of the unit. [CC §5600(b)]
Within ten days after the postmark on the mailing or hand delivery to the HOA of a written request from the owner itemizing the documents sought from the HOA, the association is obligated to provide them to the owner. A willful failure to timely deliver the requested documents subjects the HOA to a penalty of up to $500. [CC §4530]
The seller agent delivers the association documents regarding use restrictions and financial data to a prospective buyer prior to entering into a purchase agreement. By delivering disclosures to a prospective buyer before the seller and the buyer enter into a purchase agreement, the buyer may not later use CID or HOA information to terminate the purchase agreement.
Related article:
Form-of-the-Week: Request for Homeowner Association Documents and HOA Addendum — Forms 135 and 309
HOA documents provided to escrow
Status documents are also available from the HOA on request (usually by escrow) prior to closing. Using these documents, the buyer and the buyer agent confirm the owner’s representations in the purchase agreement about the status of occupancy and the assessments imposed on the unit being sold.
Escrow’s only concern with HOA documents is the receipt of information for the purpose of prorations made necessary by prepaid or delinquent assessments.
The closing documents needed by escrow and the buyer regarding the owner’s status with the HOA include:
- the CID’s statement of condition of assessments for escrow to calculate prorates and adjustments on closing; and
- any HOA notices to the owner of CC&R violations, a list of construction defects and any assessment charges not yet due and payable for the buyer to confirm the representations the owner made in the purchase agreement.
Related Client Q&A:
Client Q&A: What documents do I need to request from my HOA when selling my unit?
CC&R cover page or stamp
When a seller agent provides a buyer (or tenant) with a copy of the HOA’s use restriction documents, a cover page or stamp on the first page of the CC&Rs is included. The cover page or stamp states, in at least 14-point boldface type, the following:
“If this document contains any restriction based on race, color, religion, sex, sexual orientation, familial status, marital status, disability, national origin, source of income as defined in subdivision (p) of Section 12955, or ancestry, that restriction violates state and federal fair housing laws and is void, and may be removed pursuant to Section 12956.2 of the Government Code. Lawful restrictions under state and federal law on the age of occupants in senior housing or housing for older persons shall not be construed as restrictions based on familial status.”
Related video:
Read more about fair housing.
The role of the seller agent
A seller agent is occasionally remiss, or simply ignorant without training on their general duties owed to prospective condo buyers. However, the informed seller agent knows exactly what CID information and documents are made available to prospective buyers to properly market and disclose material facts about a condominium unit the agent markets for sale.
Accordingly, on entering into a seller representation agreement, the seller agent prepares the owner’s request to the HOA to deliver the CID documents concerning use restrictions and HOA finances. The documents are delivered by the HOA within ten days of the posted or hand delivered request. [CC §4525; See RPI Form 135]
The seller, and thus the seller agent, is obligated by statute to ensure the disclosures are handed to prospective buyers as soon as practicable (ASAP). The gathering of HOA documents takes around 15 days after the seller agent prepares and presents the request of documents for the seller’s signature and delivery to the HOA.
Thus, the ready availability of the documents allows the seller agent to make disclosures available to a prospective buyer on a prospective buyer’s or buyer agent’s request for information, and always before the owner accepts an offer. [CC 1368(a)]
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