Make Hay While the Sun Shines
The sun is certainly shining on the vacation rental business. Real estate agents, owners, potential buyers, and investors have great incentive to cash-in on the opportunities in the current market. As with any business opportunity, pitfalls exist for the unwary.
In this real-world example, a lack of clear rules and regulations led multiple parties in a real estate transaction to assume permissible uses for purchased property without determining zoning and covenant restrictions prior to the sale.
SITUATION
The listing agent for a sale property included language in the MLS description indicating the home was a great vacation rental opportunity. The listing agent lived in the same subdivision and knew that at least one home had been used as a vacation rental for years. The listing agent assumed there no restrictions. The buyer, who planned to retire in 3–5 years, purchased the property with the intent of listing it on an online rental platform to offset carrying costs.
PROBLEM
After closing, the buyer posted the home for rent and a group of neighbors threatened a lawsuit, claiming rentals were prohibited by the subdivision as commercial activity. The seller’s disclosure indicated no such restrictions and no active Home Owners Association (HOA). In fact, there had never been an active HOA in the 30–40-year history of the subdivision.
In this ongoing situation, the main complaint by the unhappy neighbors is the noise and disruption caused by short-term renters. The buyer is now holding the listing agent and his own agent accountable for marketing the property as a vacation rental opportunity when, in fact, there may be subdivision restrictions in place that prevent short-term rentals.
MISTAKE
In this particular transaction, the language was not clear on short-term rental restrictions, and there was no issue until the neighbors complained. It is essential for a buyer entering the short-term rental market to determine whether applicable governmental land use regulations (zoning), or Declarations of Covenants, Conditions, and Restrictions (CC&Rs) specific to a subdivision, will allow a residence to be used for short-term, vacation, or homestay rentals. Since the business model is relatively new, governing law has not been fully developed.
It is not reliable to assume that a property currently in use as a short-term rental property in a subdivision is an indication the use is allowed under existing rules. Moreover, non-conforming use is not automatically “grandfathered in.” Certainly, enforcement of use restrictions is likely to become more active over time as governmental units and home owners associations react to the perceived negative effect short-term rentals may have on neighborhoods and communities. Prior to making an offer to purchase, especially within a planned community, a potential buyer should be referred to his or her independent attorney to obtain a complete copy of current CC&Rs for that particular community. The buyer’s attorney should provide a written opinion on whether short-term or vacation-type rentals are a permissive use for the property. For a number of reasons, real estate agents should avoid downloading copies of CC&Rs from the public records and furnishing to a potential buyer. It is not unusual for original CC&Rs to have been amended many times over the years. In searching the public records, there is also a potential risk of an error or omission resulting from an agent’s failure to discover a particular recorded amendment that may affect property use. Another potential downside for an agent is a buyer’s request to interpret the meaning of the materials furnished. The agent’s response to such questions may be taken and construed as a professional opinion. Why take the unnecessary risk? Explanations and interpretation of legal documents should be referred to the buyer’s attorney.
RESULT
Where monetary opportunity presents itself, conflicts will inevitably arise between owners who want to take advantage of the opportunity, and owners who perceive the peace, tranquility, and security of the neighborhood may be disrupted by streams of strangers coming and going. In many jurisdictions, the issue of short-term rental use conforming to existing regulations has become something for the courts to decide.
In such litigation, the meaning and import of certain well-recognized words and terms have come into question. It is common for CC&Rs to declare a subdivision as “limited to single-family residences.” The issue in question is the meaning of “single-family residence.” Does that term apply to the layout of the structure, i.e., the number of bedrooms, bathrooms, or kitchens; or does the restriction apply to the use of the property? Does such designation restrict occupancy to the owner only? Does the term “single family” limit occupancy only to persons related by blood or marriage to the owner? What is a “residence?” At what point does the actual use of a “single-family residence” fall within the definition of a commercial enterprise, such as a hotel?
While all of these questions are beguiling to attorneys, few people (other than attorneys) want to get dragged into litigation. Agents and buyers are generally reluctant to get an attorney involved early in pre-contract discussions due to a common perception: lawyers may increase the time, cost, and complexity of getting to contract. In the absence of attorney participation, agents should unequivocally decline to make even casual statements, which the prospective buyer may claim to have relied upon in making the decision to purchase. The cost of early involvement of a buyer’s attorney in determining land use will be far less expensive and less time consuming than litigation, and may insulate the agent from an errors or omissions claim.
In this particular transaction, all parties are currently trying to work together to avoid litigation with the neighbors, and working to develop subdivision rules about rentals that will be a win-win for all owners.
PREVENTION
Unfortunately, we live in a litigious society. If, after purchase, the buyer is denied income or suffers a diminishment in value because their property does not qualify for an intended use such as short-term rentals, he or she may seek to recover such monetary losses from the real estate agent. While not always successful, such claims have been made. Defending a claim, however flimsy, is always time consuming and expensive. Agents should encourage potential buyers to negotiate a due diligence provision in the offer to provide their attorney with adequate time for a legal opinion based on legal research. Another good practice for agents is to incorporate a simple statement in written communications advising clients to seek land use advice from a lawyer early in the discussions, and definitely prior to closing.
So, make hay while the sun shines; but be aware that even good hay may have some thorns mixed in the bale.
For more information about E&O coverage and other risk management topics, visit pearlinsurance.com.The purpose of this article is to inform and insulate real estate professionals from potential monetary claims and professional grievances. The fact patterns are from actual claims against real estate agents. While the author is an experienced claims representative, the opinions expressed herein are general in nature, not fact nor state specific; and therefore, should not be taken as a substitute for legal advice from an attorney licensed in your state. This article was produced in conjunction with AXA XL and is not to be taken as legal advice.