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Is Your Condo Development a Candidate for Sale as a Single Parcel?

         The future of many common interest developments resembles the present-day reality of condominium conversions that are often born with serious maintenance issues and a cash deficit. If the association cannot pay for essential maintenance, the value of the units will drop, similar to the recession-caused loss of value today, but they will fail to sell notwithstanding lower asking prices, and the owners, many now under water, will stop paying their assessments. When the association gets to the point where it cannot pay for essential services or do critical maintenance, then the local municipality will have to decide if the units remain habitable. If the answer is “no,” condemnation may be next step.

            But the owners may not have to wait for the local municipality to act. The O’Toole case which was discussed in a previous post (November 17, 2008) decided that a board of directors of a community association not only has the responsibility to pay the debts of the association, it also has a duty to specially assess the members sufficiently to pay those debts, and not only that, a court may put a receiver in place to insure that the obligations are carried out. So then the question arises--what if an owner decides to sue the association for failing to adequately maintain the project and the owners cannot afford the special assessment levied to pay the resulting judgment, for say, failing to make roof repairs when needed? If a court can order the owners to pay an assessment that they cannot afford, the next logical step would be for the court-appointed receiver to initiate foreclosure of the properties to collect the unaffordable assessment.

            Whether this is a likely scenario or not is irrelevant--it is the only likely scenario if the court-ordered assessment is big enough. With no way for the homeowners to protect their property, foreclosures would no doubt ensue. If the assessment were big enough such that most owners could not afford it, or the assessment exceeded their equity, again not surprising, especially in the seriously depressed market that exists today, the receiver would have to be prepared to empty out the development, substituting banks or other lenders in place of homeowners and most likely turning the property into a rental apartment that will have to be maintained by the foreclosing lenders. The court in O’Toole ignored an essential truth--while it may ultimately be up to the owners to pay for maintenance and repairs--if the existing owners lack the cash to do that, the project will likely default to lender ownership.

            But there may be another alternative. In California there is a statutory remedy for an obsolete common interest development, and it allows an entire project to be ordered sold in one of three instances: (1) A material damage or destruction occurring more than three years prior to the partition request and repairs have not been made; (2) At least three-quarters of the project has been damaged or destroyed, and 50% or more of the separate interest owners oppose re-construction; and (3) The project is 50 or more years old, is obsolete and uneconomic, and more than 50% of the owners oppose restoration. Many associations are approaching the 50-year mark. But even before that, could a seriously deteriorated infrastructure qualify as “material damage” to the point where it would qualify under the statute above? Would a court, looking at a project that has deteriorated to the point of becoming uninhabitable, order it sold? In that instance, could a majority of owners force the project to be sold in its entirety, and if they did would they realize more value than trying to sell their individual unit in this badly deteriorated project?

            The answer is--that in the right circumstance with the right facts--yes. What are those facts? If the special assessment necessary to achieve basic habitability exceeds the ability of the present owners to pay, you may not need anything else. These scenarios, played out over time, await many common interest developments today. They are under-funded for critical maintenance, values have fallen, and owners have no incentive to contribute additional capital. But rather than wait for a judgment creditor or lenders to foreclose, the association should look critically at the possibility of selling the entire project and thus realizing greater value from a sale as a single parcel than as multiple individual interests that cannot continue to exist in their present form.

            This may seem like a draconian reaction to an inability to raise sufficient funds to maintain the project, but if the owners wait long enough without taking any action, their individual interests may become worthless. So rather than watch the project deteriorate to the point of obsolescence or lender takeover, owners of severely distressed common interest developments might want to consider an outright sale of the entire project. If you believe your project may have a similar future, talk to an attorney with experience in this area about the steps you can take to maximize the value of your project and avoid handing it over to the banks. Or call us--we'll advise you or refer you to someone who can.