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Unbundled Property Rights Condominium Leashold Restrictions

There are only two kinds of unit owners in any given condominium: those who live there and those who do not. Resident owners often take measures to tax absentee owners with additional fees, or establish policies to diminish landlord owners’ expectations of use and enjoyment in the property. And each time a conflict escalates, the litigants end up in court, only to hear the same message: We cannot, in the context of a common interest scheme, tolerate separate classes of ownership that would benefit the resident owner off the back of the absentee owner.

Resident owners believe that their biases against landlord owners are justified. After all, living in a common interest community often requires a subordination of one’s self-interest to that of the larger association. Owners who live on the property are more interdependently vested than the average Joe living just outside the gate. Resident owners clearly care how policies pertaining to trash and pets affect them and want to ensure that their association board is fiscally responsible. Investor owners, on the other hand, do not typically contribute ideas or resources for the betterment of the community, and they do not vote for trustees or capital improvements. What’s more, the higher percentage of the rentals that exist in any one community may affect individual lender financing.

When a community is dominated by investor ownership, the worry is that property values hang precariously in the balance—and resident owners are more sensitive to this issue now more than ever, when home values are depressed.

The issue then becomes primarily one of reconciling the individual owner’s legitimate expectation of property rights (economic and otherwise) with the association’s interest in shutting out the investor owners for the overall preservation of the property itself. Dozens of communities are struggling with this question in the recessed economy. Even though some communities recognize that rentals may be a viable alternative when overall condo sales are stalled, it seem more communities prefer to devise restrictive policies that would discourage or ban renting altogether.

This provokes all kinds of questions. Did the master deed originally permit leases, and if so, on what authority does the association now restrict them? Just because a purchaser was originally on notice that the governing documents could one day be amended, is this enough to slash an owner’s substantial property rights? What about those owners who are currently in contractual agreements with tenants—will they be made to phase them out? Or, do we extend certain privileges to those already renting, which may create the problematic special classes of owners? And what about public policy concerns? If multitudes of communities shun renters, will there be enough housing in New Jersey for those who cannot afford to buy?

Legal Authority

Whether or not an owner is entitled to the entire bundle of property rights in a condominium scheme depends on state law—and even then, the answer is frequently elusive. Some courts find that owners, in fact, have no kind of vested rights in a statutorily-created condominium. Other states reason that upon purchase of a condominium unit, owners voluntarily give up a few property rights to adhere to a common scheme.

In New Jersey, the Condominium Act at N.J.S.A. 46:8B-4 establishes that each unit “shall constitute a separate parcel of real property, which may be dealt with by the owner thereof in the same manner as is otherwise permitted by law for any other parcel of real property.” By definition, at least, it would seem that a condominium owner in New Jersey has no lesser property interest than that of full power over a fee simple estate.

Prohibitions on rentals are not necessarily a restraint on alienation. While New Jersey has not yet addressed some of these issues head-on, others courts across the country have done so. In a condominium, use and leasing restrictions are generally only found unreasonable if they are arbitrary, violate a public policy or impose a burden on the use of land. While courts across the country differ in their considerations of the validity of those restrictions, they generally hold that a restriction on alienation is invalid only if it is “unlimited, absolute and unreasonable.” Typically, courts will uphold a restriction that frustrates any one owner’s purpose when weighed against the benefit conferred to the collective homeowners.

The Condominium Act, at N.J.S.A. 46:8B-9(m), requires that “restrictions or limitations on the use, occupancy, transfer, leasing or other disposition of any unit…and limitations upon the use of common elements” be set forth in the recorded master deed. If the use and occupancy restrictions are not originally addressed in the master deed or an amendment to the master deed, the restrictions will not be held to be enforceable against unit owners, even where individual deeds contain certain restrictive covenants.

Accordingly, many master deeds provide under a section entitled “Restrictions” that unit owners may lease units so long as the rental is (i) of the entire Unit, (ii) for a period of at least six months…and so long as the leases are in writing and expressly subject to all provisions of the condominium documents. The section also describes that failure of the lessee to fully comply with the condominium documents shall constitute a material default under the lease and be grounds for termination and eviction.

Notwithstanding that most master deeds do address leasing to some degree, frequently boards fail to understand that an owner’s option to lease the unit may rise to that of a property right. In Thanasoulis v. Winston Towers 200 Association, the New Jersey Supreme Court explored this very issue, holding that the association exceeded its authority when it promulgated rules that charged non-resident owners higher parking fees than resident owners.

In this case, the parking facilities were part of the common elements, and pursuant to the master deed, the plaintiff’s ownership interest included his unit, an undivided proportionate interest in the common elements, and the right to rent a parking space. The court concluded that the association’s actions had the effect of “expropriating the economic value of the plaintiff’s parking space for its own use” and of “changing the unit” contrary to the act. The court directed that “a unit owner should retain essentially the same property rights originally deeded to him for as long as he owns his unit, unless he affirmatively consents to their being altered.”

Similarly, in 560 Ocean Club v. Ocean Club Condominium Association, the court found that the association exceeded its authority when it restricted, by rule, leaseholds to intervals of 30 or 90 days. Even though the master deed authorized the association to approve or disapprove of leases, the master deed did not specifically empower the association to restrict lease terms. The court concluded that the association’s action effectively “confiscated part of the property interest acquired by the unit owner.” Had the rule been instead adopted as an amendment to the master deed, it is uncertain whether the outcome would have been the same.

For the last ten years, the Appellate Court is sounding the same theme: In Chin v. Coventry Square Condominium Association, the Appellate Court refused to allow the imposition of “revenue-raising fees” on landlord-owners. The court reasoned that associations enjoy wide latitude to inspect units upon change of tenancies, as well as to review lease agreements to ensure compliance with the governing documents. The associations may even charge a nominal rental fee to cover administrative costs related to the rental, but those reasonable fees must be directly related to the associated administrative cost.

Drawing support from Thanasoulis, the Chin court warned that it would not allow “invidious classifications or unfairly diminish the rights of some unit owners for the benefit of others.” As recently as 2005, in Micheve v. Wyndham Place at Freehold Condominium Association, the Appellate Division foreclosed the association from assessing new purchasers with a capital contribution fee, declaring that “such an imposition upon one class of condominium unit owners violates N.J.S.A. 46:8B-17.”

Practical Considerations

The only way to further restrict an owner’s right to lease his unit is to pass an amendment to the master deed and even then, the action may cause trouble. Foremost, N.J.S.A. 46:8B-11 establishes that even where there is an amendment, the amendment may not “change a unit” unless the owner of record consents. There is a credible argument that where a unit is defined as property that may be acquired, held, leased, mortgaged and conveyed as any other real property, such an outright restriction on leasing is untenable.

Where boards are nonetheless drafting amendments, they are advised to try to craft amendments that are not so rigid in application. It is best that these amendments do not interfere with owners’ existing tenancies, making the association potentially liable for interference of contractual relationship or prospective business advantage.

In consideration of existing leaseholds, while not foolproof, the association might be well-advised to incorporate a phase-out process extending beyond a year to give any current owners reasonable time to make other arrangements beyond those leases already in place. Some boards make the mistake of “grandfathering” those units currently renting with the right to lease indefinitely irrespective of the ban on all other units. Consistent with case law in New Jersey, this would only serve to cause, yet again, a special class of owners who are treated differently from the rest. Boards should try to avoid creating lease restrictions that can be characterized as invalid restraints on alienation.

Boards also frequently try to be flexible by drafting amendments that allow exceptions to the rental ban for such things as “hardship,” “inability to sell a unit” or “service in the armed forces.” All too often, boards also take the liberty to then advantageously redefine the definitions of “occupancy” and “single-family ownership.” This is risky business, because even where the board’s intentions are good, ultimately those who will be permitted to rent their units and those who are precluded will be determined in the board’s discretion.

The danger is that where the board has discretion to choose among owners who may become landlords and who will not, there is great potential for a board to be wrong or misguided and subject the association to claims arising under the Fair Housing Act (FHA) or the Law Against Discrimination (LAD). In Berner v. the Enclave Condominium Association, although the landlord-owner himself was not of a protected class, the court found that the owner had standing to pursue LAD and FHA actions against the association for its interference in the lease agreement between him and an African-American tenant. The court found that the board ultimately deprived the owner of his tenant, and in addition to the owner’s suit, the association settled the claim of discrimination with the would-be tenant for more than $140,000.

Similarly, in United States v. Branella, prospective tenants sued an association claiming that it violated the FHA by discriminating against them based on familial status. While the court found against the tenants on the facts here, it articulated that under the FHA, as amended, one must only show either intentional disparate treatment with regard to housing or disparate impact alone, without proof of discriminatory intent.

The Appellate Division in United Property Owners Association of Belmar v. Borough of Belmar deliberated on a zoning matter, overturning parts of a township ordinance that sought to “purge transients.” The court found that by restricting rental terms and occupancy the ordinance was “impermissibly arbitrary and constituting an unreasonable restraint on the use of property.”

Maybe the best amendment—if there is one—is one that caps rentals at a set percentage in the community overall. This way, no particular unit is favored and no one unit is benefitted indefinitely. Upon the expiration of a given leasehold, an owner next on the association’s “waitlist” has the opportunity to rent the unit.

Public Policy Considerations

In Mulligan v. Panther Valley Property Owners Association, the Appellate Court applied a “Reasonableness Standard” to uphold an amendment that prohibited sale of home to a Tier 3 registered sexual offender. The court reasoned that the amendment did not unlawfully restrict sale or lease of a home where there were only “80 Tier 3 registered sexual offenders in New Jersey’s population of approximately 8.4 million.” Clearly, an owner attempting to sell would suffer no smaller population of buyers. Even more persuasive to the court, no owner in Panther Valley was disadvantaged from his or her neighbor regarding the potential pool of purchasers.

The court also took pause to consider the matter from a public policy standpoint. Even though it stopped short of drawing conclusions that Tier 3 offenders would be deprived of housing choices if too many associations banned “their kind,” the court nonetheless left open such a possibility, finding the result of a “large segment of the housing market [being] unavailable to one category of individual” repugnant to public policy.

Interestingly, if one considers this reasoning in the context of wide-spread community association prohibition of renters, first, one more easily finds that owners are likely faced with a much smaller population with whom they may economically bargain by way of a lease. Secondly, various owners in any one community would be affected differently depending on whether the owner traditionally leased the unit or not and on whether the board’s discretion to allow or forbid leasing resulted in disparate result for some homeowners over others. And finally, there does exist the very real possibility that where more than a million people alone in New Jersey call a community association home, the result is in fact that a large segment of the housing market would become unavailable to one category of individual—the renter.

Conclusion

Traditionally, the courts in New Jersey have balanced the scales, reasonably upholding associations’ lease restrictions while carefully preserving each unit owner’s bundle of property rights. These use restrictions did not manifest as invalid restraints on alienation so long as everyone played fairly. The court justified the concept that no association could create a discrete class of non-resident owners for the purposes of taxing them separately and depriving them of the “full value of the unit and its appurtenances.”

Today’s picture is much different, and the lines may not be as clear. Now the balance is one of unbundling individual property rights, not for the ancillary financial benefit of the association, but for the association’s perceived long-term protection and viability. While most homeowners give up some freedoms when entering into the condominium form of ownership, homeowners still buy into the condominium scheme with an expectation that all inherent rights of fee simple ownership were intact. There is no question that this kind of full fee simple ownership is, to an extent, a right, not merely a contractual privilege. But most compelling is how the court, in light of its precedential holdings, will evaluate these rental restrictions in the context of recasting property rights. Will the court find it permissible, maybe even laudable, to diminish individual property rights and expectations for the advancement and protection of the larger collective?

Jennifer A. Loheac, Esq. is an associate in the Real Estate Department and a member of the Community Association Practice Group of the Woodbridge-based law firm of Greenbaum, Rowe, Smith & Davis LLP.

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