Homeowners Associations (HOAs) are established in numerous communities throughout the United States.
If you live in or own a property in the Indianapolis suburbs, there’s a good chance that an HOA is in place.
And with that comes Covenants, Conditions and Restrictions (CC&Rs) that you, and your Tenants by extension, must follow.
Some of these requirements can be somewhat straightforward and trivial. For example:
- Trash cans cannot be left at the curb for more than 12 hours.
- Residents and guests cannot park on any grass areas.
- Grass cannot exceed 4″ in height.
These are basic, “Be a good neighbor” requirements that most people already comply with and have no real problems doing so.
Although HOAs may not, in some cases, have the best reputations, they are put in place to protect the value of the properties and provide safety for Residents and Homeowners.
However, one regulation, in particular, has raised some concern with rental property owners: rental caps.
As a property management company, we’ve received numerous questions about rental caps established by HOAs and the impact they have on investors.
T&H Realty recently met with attorney Matthew Griffith of Griffith Xidias Law Group to discuss why there has been an increase in rental restrictions and what investors should look for when it comes to their current and future rental properties.
What Are Rental Caps?
When an HOA sets up a restriction like a rental cap, the neighborhood is capping the number of homes that can be rentals in the community. A common cap we see here in Central Indiana is 10%.
So, once 10% of the properties in the neighborhood become rental properties, no additional rental properties are allowed. The only way for another home to become a rental home is if an existing rental property is sold to an owner-occupant.
Why Are HOAs Implementing Caps?
The simple answer is that investors love the suburbs, they are buying there en masse and, in some cases, changing the dynamic of neighborhoods.
The suburbs are appealing to investors for many reasons: The Resident pool is huge, home values typically rise and Resident retention, because of the quality school systems and community amenities, is generally strong.
But, HOAs don’t love investors.
The traditional thinking is that Residents will not maintain the property like an owner-occupant, which hurts the overall appearance, desirability, and possibly, the value, of the neighborhood.
Wall Street Is Now On Main Street
Over the past few years, Wall Street and other large businesses have become investors.
Big corporations have arrived in suburban communities, many in Central Indiana for example, and are gobbling up available homes.
Those corporations make cash offers and oftentimes waive inspections. This makes it very difficult for owner-occupants to compete.
Sellers simply want the best terms and, in almost all cases, don’t care who they are selling their home to.
As a result, Wall street often wins.
“Wall Street decided to become landlords and these investment firms – large companies – have invested billions with a “B” in single-family homes,” said Griffith. “They have sucked up the inventory to the point where first-time homebuyers and second-time homebuyers have had a hard time. The inventory is pulled off the market before the homebuyer can even get to it.”
The increased number of investors set off alarms for communities with an HOA because they want to maintain the quality of the neighborhoods. In the minds of the HOAs, this translates into allowing fewer tenants.
“The number of (rental) homes in those PUDs (planned urban developments) with HOAs has increased pretty significantly,” noted Griffith. “There are just more tenants living in those homes. The HOAs have responded by putting restrictions on them. That’s what’s happening.”
Advice Before Buying A Property In An HOA
If you are looking to purchase a property in an HOA, it’s critical that you thoroughly read your Covenants & Restrictions BEFORE closing the transaction.
Even in the Purchase Agreement, you should be clear that you intend to purchase the property as a rental home and the offer is contingent on being able to do that.
Imagine buying a rental property without the ability to even rent it.
Obviously, that doesn’t make sense and is a terrible position to find yourself in.
“That’s like opening a donut shop and not buying sugar or maybe worse, that’s like buying a donut shop, but it doesn’t have a front door for the customers to walk through,” said Griffith. “How are you going to sell donuts if you can’t even get into the place?”
While we realize that CC&Rs can be very long with lots of legalese, it’s still critical that investors thoroughly understand the HOAs position on rental properties.
“This really starts with the purchase agreement,” noted Griffith. “The purchase agreement requires the seller to provide basic documents and those include the HOA documents. You’ve got to read them.
“They’re not fun to read, but you have to understand that if you are going to buy a house in a neighborhood where there are covenants, you are agreeing to that contract – the covenants. And if you don’t read the contract, how do you know what’s in the contract?”
What Happens If a Cap Is Instituted During A Tenancy?
Let’s assume that you buy a property and no rental cap exists.
However, a year or two later, you receive a letter from the HOA that a rental cap could be coming.
In almost every scenario, such a change can only occur when the majority (sometimes as high as 75%) of homeowners agree to a rental cap. HOAs can’t just unilaterally institute a cap without going though the proper channels.
So, as the old saying goes, “Get out and vote.”
If the cap is instituted, this is where things can become sticky.
In MOST cases, if you have a rental property, your property is grandfathered in.
“If you already have a tenant in place, you are essentially grandfathered in”, said Griffith. “There’s sometimes a battle, depending on how the covenants are written, as to whether once that lease expires, (if) the landlord can rent again, or they (and the property) are grandfathered in as a rental.”
Again, this goes back to how the rental cap amendment is written.
In most cases, the PROPERTY is grandfathered.
In some cases, the TENANT is grandfathered.
If only your Tenant is grandfathered. you may be forced to sell the property once the Tenant vacates.
In some extreme cases, an investor could be required to receive HOA permission to renew or extend the lease of an existing Tenant.
Again, read the contract and be sure you understand it thoroughly.
Is There Anything You Can Do If You Purchase A Property With Rental Restrictions?
There are cases where investors have purchased a rental property where they are unable to rent out the home due to HOA regulations.
When someone gets into this situation, there are two basic things you can do to prevent losing too much on your assets.
Perhaps the easiest is to simply sell it.
Although you might suffer a financial loss, it won’t be as significant as keeping a home that is contractually incapable of earning income.
If you haven’t yet leased the property, you can begin the process of selling right away. However, if your home is already rented out, then you will need to come to an agreement with the Tenant in order for them to move out.
According to Griffith, another option, which can be a little more difficult to put together and isn’t a perfect solution, is to set up a land contract.
A land contract can be written up if your current Tenant agrees to become a buyer, and no longer a renter, of the property. Once the contract is in place, the tenant (now the buyer) would make “mortgage” and not “lease” payments to you. As a result, the home is no longer – technically – a rental home and you should be clear of any rental cap issues.
Even though land contracts or rent-to-own agreements aren’t the preferred method for getting out of the issue caused by the rental restriction, it might be the best option for you depending on your circumstances.
Before entering into one of these contracts, we highly encourage you to seek the advise of an Attorney.
At the end of the day, everything comes down to your contract – the CC&Rs. In every legal situation, it’s best to be well-informed of what you are getting into before you sign.
Same goes for purchasing a property you would like to turn into a rental home.
There are plenty of communities that don’t have an HOA if you would like to avoid any of those regulations. Or, if you are unsure about what is in your property contract, you can talk with an attorney to ensure the neighborhood’s HOA doesn’t have any rental restrictions that would prevent you from renting.
Our brokerage team at T&H, is also highly qualified to advise you and walk you through your property options and inform you about various neighborhoods that could fit your investment goals best.