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3 Ways to Overcome Restrictive Leasing Covenants

by Ken Corsini on August 22, 2012 · 5 comments

  

I have been buying and selling houses for over 7 years now and never really had any problems with my Homeowners Associations …. until this year.  Interestingly, I’ve run into problems on three different properties in different neighborhoods just in the last few months.  What I’ve encountered are HOA’s with restrictive covenants limiting an owners ability to rent properties in the neighborhood.

It’s understandable why an HOA would want to limit either the percentage of properties in the neighborhood that can be rented or the ability to rent at all. They want to protect home values and prevent the neighborhood from declining due to a high percentage of rental properties.  I suppose if I lived in a traditional subdivision, I would probably want the same provision in my HOA to protect my own home values. However, as a real estate investor, dealing with these types of restrictive covenants can be frustrating (especially if you are not informed until after the purchase).

If you’ve purchased an investment property with the intention of leasing it, only to find out the HOA will not allow you to rent the property – don’t fret!

Here are three ways you can deal with a leasing restriction:

1.)    Owner Finance the Property – Rather than leasing a property, you list your property as an owner finance. There are a number of individuals out there right now that cannot obtain conventional financing that are looking for this type of opportunity.  BiggerPockets has a number of different articles with good information on how to do this.

2.)    Put the Property in a Trust – Interestingly, one of the HOA’s I am dealing with right now has a specific provision in their covenants that states something like this, “if the person(s) residing in the property has a beneficial interest in a Trust that owns the property, this shall not be prohibited under the leasing restriction.”  Simply put, you can create a Trust to hold title to the property and then assign some marginal interest in the trust to your tenant.

3.)    Put the Property in an LLC – I have actually done this on another one of my properties in the last month. Similar to the Trust strategy (above), you can create an LLC for the specific property and give your tenant a marginal interest in the LLC. Thus, the tenant actually becomes an owner, not just a renter.  You can outline the terms in the operating agreement and even create an exclusive option to buy the interest back from the tenant at some point in the future.

One of the things I love about real estate is the constant need for creativity and problem solving. With changing market dynamics, regulations, etc., there is a never ending need to adjust and evolve as a real estate investor. Who would have thought the market would crash and neighborhood HOA’s would be forced to implement leasing restrictions? Luckily, with some consultation from other real estate professionals and some creativity, we are able to continue investing in neighborhoods with these restrictions.

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{ 5 comments… read them below or add one }

Jason August 22, 2012 at 9:53 am

Ken,

What do your state laws say about the HOA restrictions? I know some HOA’s will try and be more restrictive then they are legally allowed to.

Jason

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Greg August 22, 2012 at 10:51 am

I sometimes wonder how much granting a tenant “marginal” ownership of an LLC or a trust is honoring the spirit of the HOA. I guess I’m apprehensive about being too “lawyerly”. Just my $0.02.

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Kimberly Jones August 22, 2012 at 11:13 am

Personally, I cannot think of anything that could turn hellish easier than granting a tenant partial ownership rights. Wind up in court and your intentions will be pretty plain to see.
Owner financing, yes, good stuff. Playing with tenants, never a good idea.

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Jeff Brown August 22, 2012 at 11:46 am

As I read this, it occurred to me how fortunate I’ve been lately. Most of the HOAs in control of the investments I like, have been controlled from Day 1 by experienced investors. This has proven to be helpful, to say the least. :)

Good stuff, Ken, and on an emerging issue. HOAs are gonna be put under the gun more as time passes.

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Kevin Yeats August 27, 2012 at 9:45 am

Ken, my first thought on your second and third strategies is the same as others have mentioned.

I’m no lawyer but I would want a lawyer to bless the strategy and assure me that if the client gets sued or thrown in jail that the other party could NOT reach MY interest in the property with the lawsuit.

I guess a real strong case in point is if the tenant is dealing drugs or growing drugs on the property.

I’d be more comfortable with your first strategy

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