Lease Restrictions: A Noble Idea That Can Backfire On Owners

Lease Restrictions: A Noble Idea That Can Backfire On Owners

Lease restrictions are typically birthed with noble intent – to foster owner-occupancy and ensure that buyers can get loans for properties within the community.

When new lease restrictions are forcibly applied to limit rental activity in buildings and neighborhoods, it is a taking of property rights which can set off litigation from disgruntled owners.

This issue has impacted me as a property owner, and I’m familiar with the emotions and frustrations felt by advocates and antagonists to lease restrictions.  A recent situation with a buyer was frustrating enough that I want to share my experience (which is not unique) about how lease restrictions can adversely impact current owners, sellers, and buyers.

Lease restrictions will do two things, guaranteed:

1) limit the number of renters in a community
2) limit the number of buyers for properties within a community

Experience > Theory

Amber and I own two condos: one we live in (Shore), and one we lease out (Sabine).  In 2008, we moved into a beautiful 1bd/1ba at Sabine.  Later, we desired more space and we found it at the Shore.  Just as we were closing on our new home, the HOA at Sabine decided to install lease restrictions which could have forced us carry the costs of a vacant property.  Even worse, the resulting litigation also impeded most owners’ ability to sell (lenders don’t like litigation).  The entire situation was bad for owners.

I was able to get our condo leased before the rules went into effect by lowering the rent to below market rate in order to quickly get a tenant.  We didn’t set out to be investors, we’ve had good fortune to be what economists call “upwardly mobile”.  Austin being a young city, we aren’t unique: we are par for the course.

Real World Consequences

Here’s a scenario from this past weekend.  I’m representing an investor/buyer.  They are an out-of-state empty-nester couple excited about investing in Austin.  Perhaps they’ll retire here, but not for a few years.  We previewed a condo that they really, really liked.  They could pay cash or leverage historically low mortgage interest rates to buy the property.

But, they won’t be buying this property, and it’s not for lack of interest or money.  It’s because they can’t lease it out per a new rule installed by the building’s HOA to cap the number of leases at 25% of the total.

A Tough Market Made Tougher

The seller of this property is collateral damage from the HOA’s new rule.  This seller lost a buyer.

Lease caps will alienate investors and upwardly mobile buyers.  The expected result will be longer days on market and reduced market value.

Furthermore, if an HOA installs lease restrictions improperly then they can face lengthy litigation, like what happened at Sabine where the litigation combined with the lease cap froze sales for over a year.  Ouch.

I suppose there is a positive here: all things being equal, communities without lease restrictions are postured to receive a relative windfall of alienated buyers.

Misconceptions

1) If more than 25% of a condominium is leased then buyers cannot get mortgages.

This is patently false.  According to local mortgage broker Pete Fajkowski, for established condominium complexes, 90% of the units must be sold, all phases of construction must be complete, the Homeowner’s Association must have been under the control of the homeowners for one year, and Owner Occupied and Second Home units must make up at least 51% of the units sold.  (link to Freddie Mac rules)

2) Renters won’t care for their homes and neighbors like owner-occupants do.

Make all the judgements you want about owner occupants being more desirable than renters.  I’ve lived as both, and have been a neighbor to both.  Most likely you have, too.  I do prefer to be around other people vested in my community.  But, guess what?  Owners can be jerks, while our tenant at Sabine has actually improved the place.

I’m sympathetic to both sides of this issue.  And, I do think there’s a tipping point beyond 50%.  Otherwise, from a real estate perspective, lease caps can be damaging to market value.  As a resident/neighbor, the renters vs. owners debate isn’t sufficient to warrant a lease cap which will restrict the use of the property.

Lease caps may have been a good idea back in 2008… in Florida… or wherever an entire community was at risk of becoming apartments.  In today’s market, lease restricting is an over-kill solution to a debatable problem, and is more likely to hurt property owners.

This is my experience. What do you think? Are lease restrictions needed in Austin, Texas?

About Jude Galligan

Jude Galligan, REALTOR, Principal of REATX Realty and publisher of Downtown Austin Blog (aka. "DAB"), spends his time matching remarkable people with remarkable properties in Austin’s urban core. A resident owner in downtown Austin, Jude serves on the Board of the Downtown Austin Alliance (DAA) and the City of Austin Downtown Commission. Contact Jude.

Comments

  1. avatar Bill Stadler says:

    I bet the residents of that community were relieved that the seller couldn’t dump another renter on them. Wish I lived there!

  2. Having dealt with condos long enough, both as an owner of few rental properties and a downtown resident, I strongly feel that a restriction is required. A high rental ratio is in general not a good thing for a variety of reasons. It will have a big impact on the resale value of the units as well.

    If it becomes non-warrantable(>50% renters) then it’s a totally different story, you will be lucky if you can even sell it, forget about a good resale value! I have seen condos depreciating by more than 40% as they became non-warrantable, right here in Austin. There are greater chances of this happening when a property goes into auction. Usually there will be an investor ride at the auctions and the majority of the units will be purchased by them. This is where HOA has to be proactive and safeguard the interests of the property.

    This is typically not an issue with high end condos. These condos are typically so expensive that the income/expense ratio will not work out for investors. I can’t imagine a lot of investors buying in ‘Austonian’ just to use them as rental properties.

  3. It is an interesting dilemma! My wife and I are targeting Austin for our eventual retirement. If the economy does not cooperate, that could be an endless dream. We have a 2nd home and a rental property in downtown Austin.

    I do not agree with the mandatory caps due to the reasons you state in your article. I do believe the HOA has considerable discretion in managing potential problems with renters and/or homeowners with current or potential revised by-laws.

    I serve on the HOA board in my Northern Virginia community and it is a thankless job helping manage the community. Our community is about 40% renters. Other than a few problems from some of the houses with “group” occupants (non related occupants), I cannot tell much difference from homeowners vs. renters.

    I do not know a homeowner or an investor that likes to rent to a poor tenant. The focus should be on the review of a tenant and HOA/landlord action to evict a poor tenant. The HOA has the power to impose fines and force collection of fines per most HOA by-laws. This is a double edged sword and requires “reasonableness” in board member elections and participation.

    We have lived through a difficult HOA board. We were even challenged by an “unreasonable” board to get a 2/3 homeowner response on enforcing a by-law provision for a homeowner. With a little effort by the community as a whole, the 2/3 was achieved and the board resigned. We now have a reasonable board that enhances the value of the property for ALL homeowners.

  4. Interesting perspective. I agree with Lance Hunter. I am actually one of his undesirables (not part of community) in that my wife and I own a 2BR/2BA downtown condo in Austin but live in another state to the north (we lived in Texas before moving north with job transfers). But, we have no interest in renting out the place since we enjoy far too much the freedom to come and go at will. We also have seen first hand the downside of too many renters in the building we purchased in and appreciate the 25% cap that was recently put into place by the HOA. In the long term, the 25% cap is a far better investment in increasing the building’s value than worrying about a couple of soon-to-be retired folks who might not be able to afford to cover the costs of an investment right at this moment in time. I think your perspective (both as owner of two condos and as a Realtor) is being swayed towards your occupation’s interests rather than that of the condo community as a whole due to the ‘lost sale’. I am certain there will be buyers in the near future for whom the restrictions become a strong selling point for those units in a restricted community over another.

    Owners make much better neighbors (on average) than renters. Of course, there are plenty of exceptions.

  5. avatar Lance Hunter says:

    I’m in favor of rental restrictions because the last thing Austin needs more of are absentee landlords. Sorry you lost that empty-nester sale, but out-of-state buyers looking to Austin as an investment are not the type of buyers we want downtown. (There are more than enough of them in the suburbs now.) They don’t care about the community, because they aren’t part of the community. It’s better to let the property sit empty a while longer until a local buyer comes along.

    I’m more sympathetic to people living in Austin and owning more than one property. (Especially as I’ll likely find myself in the same spot in a couple of years.) If there were a way to make it so that rental caps only applied to out-of-state owners that would be ideal.

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