[NOTE: This article first appeared in the Summer 2013 Edition of Hyatt & Stubblefield, P.C.'s "Community Developments"]
Now that sales of homes and condominium units are picking back up, developers are once again looking for development opportunities. Sometimes a better deal can be made by buying a partially completed development rather than starting from scratch and assembling raw land. However, buying into an existing development can bring risks and obligations as well. A prudent buyer always conducts research and analysis of a proposed real estate acquisition, but purchasing unsold inventory in a planned community or condominium project may require additional research beyond what is normally done when acquiring raw land for future development. This is particularly true where the seller is a lender who acquired the property through foreclosure. This article outlines a few of the issues to be examined.
Examine Land Records. A title examination should be conducted to determine whether any declaration of covenants, conditions and restrictions ("declaration") burdens the property being acquired. The analysis, however, can not end there. When a declaration exists for a planned community, many people assume that the declaration covers the entire community. That is not always the case. Some developments may have left off a portion of the community on purpose for flexibility or other purposes. Even when a portion of the property was subsequently subjected to the declaration, there are a number of ways in which such submission of land to a declaration can be defective. One of the more common problems is that the party submitting the land does not actually own the land. A thorough examination should include an analysis as to which lots or tracts of land were submitted to the declaration and whether the party submitting such land owned the land or had the written consent of the land owner to do so.
Identify any Community Association. Where the declaration provides for an association, the actual existence of the association should be confirmed. Was the association incorporated? Is the corporate registration still valid, or has the association been dissolved by the state for failure to file annual registrations?
Identify Community Governing Documents. All documents that purportedly apply to the community should be identified. A title report should identify all documents recorded in the land records which affect the property, but there may be other documents which are not part of the public record that could bind a purchaser, such as association bylaws, articles of incorporation, design guidelines, and rules and regulations. The seller should be asked to identify and provide copies of all known community documents.
Evaluate Effect of Any Foreclosure. Often, the seller of the remaining lots in a planned community is a lender who acquired the property through foreclosure of the original developer. It is important to understand whether the lender's interest was subordinated to the declaration or had priority over the declaration. If the lender's interest has priority over the declaration, the lender could take title to the property through foreclosure of the mortgage without being subject to the declaration. If some lots had already been sold before the foreclosure, the community could be left with some lots being subject to the declaration and some not if the lender does nothing to consent to or otherwise adopt the declaration.
Examine Status of Declarant Rights. If the buyer desires to have any control over the community or special rights or status beyond that of a general property owner, the buyer must acquire the rights reserved to the original developer or "declarant" in the declaration or other governing documents. Declarant rights do not automatically stay with the land, so the buyer will need to obtain an assignment of any declarant rights. The purchase contract should grant the buyer the option of obtaining an assignment of some or all declarant rights from the seller at closing.
Before determining whether to acquire declarant rights, the actual rights should be examined along with any obligations of the declarant. Many of the rights may have expired and the declarant obligations may outweigh the benefits of being the declarant. A developer buying the remaining inventory in a planned community cannot assume that it will be able to wield total control over the community. The governing documents will need to be examined to determine what control a new declarant may hold over the land and the association.
In addition, declarant rights may only be acquired from one who currently holds those rights. It is important to determine whether the seller obtained a valid assignment from the original declarant. A lender who acquired the property through foreclosure may not have acquired the declarant rights from the original declarant. If the seller does not hold the declarant rights, is the original declarant still in existence? Can the seller cause the original declarant to make an assignment to the buyer?
Examine Rights Under Governing Documents. There are a number of actions that a developer typically wants to take or wants to protect against. A thorough examination of all of the community governing documents is necessary to fully understand the scope of control that the developer will hold, whether as a special declarant right or by virtue of holding a certain number of units in the community.
• Does the homeowners association sell memberships to persons who are not lot owners within the community?
• If the buyer acquires land that has not yet been submitted to the declaration, will the declarant have the power and option to submit such land to the declaration?
• Is there any land that should be withdrawn from the declaration, and will the declarant hold the power to do so?
• Does the declarant hold architectural review/control rights? Does the declarant have the power to amend or adopt any design standards?
• Does the declarant have the power to unilaterally amend the governing documents?
• Does the declarant have the power to block other unit owners from amending the governing documents?
• Does declarant control the composition of the association's board of directors or will declarant hold at least a majority of the seats on the board?
Evaluate Obligations Under Governing Documents. In addition to rights that will accrue to the buyer, the community documents need to be examined to determine the obligations on the property being acquired and when any future obligations will become due. What is the nature of the land being acquired?
• Do the units being acquired presently owe assessments to the association? When will the assessment obligation be triggered?
• Is there an obligation to construct a home within a certain period of time?
• Will the buyer be acquiring land that is designated as common area? If so, should the property be transferred to the association by the seller prior to closing?
Investigate Association Funding. Regardless of whether the developer will take over control of the association, the association's financial state should be reviewed since it could impact sales. Have owners been assessed? What is the delinquency rate? If the declarant owes assessments on its property, have those assessments been paid? Have reserves been adequately funded or could future assessment increases be needed to fund repairs?
Thorough community association due diligence can be beyond the scope of experience of some acquisition teams and what they are prepared to conduct. We are happy to help analyze a community prior to acquisition and can efficiently synthesize the issues based on our over 40 years of experience in the development of planned communities.