Transferring Control in Association Developments Power Plays

Once the first home in a new community development is sold, its homeowner association is activated. And from that moment on, the association has to fulfill its obligations to the community and its residents.

At the start of the process, the developer has a controlling interest in the community and gradually transfers power to the homeowners. How this is done can be key to starting off a new community with a well informed, prepared board of directors and happy residents.

Building a Board in Three Phases

When a community is built, the developer establishes the association and controls it as well. As units are purchased, the homeowners are added to the association. New Jersey's Planned Real Estate Development Full Disclosure Act (PREDFDA) dictates that, once formed, an association must be turned over to the homeowners in gradual steps. All of the state's residential real estate developments are governed by PREDFDA, which mandates that certain information about a development must be made available to a potential purchaser so that an informed purchase is made. For example, PREDFDA requires a developer to register their planned community with the Department of Community Affairs (DCA), provide a public offering statement with specific details about the project, and spell out how the association will eventually be governed and managed after the transition period.

First, sixty days after the first 25 percent of the homes have been sold, no fewer than 25 percent of the board members must be elected by the owners.

"If you have a five-member board and you have 100 homes in the community, once 25 percent of them have been sold from the developer to homeowners, you have to have an election," says Dan Murphy of Greenbaum, Rowe, Smith & Davis, PC, a law firm based in Woodbridge. "If you have a five-member board, they elect two homeowner representatives to the board." At this stage, the developer holds the other three seats.

The next stage comes after 50 percent of the homes have been purchased. At that point, the statute requires that no fewer than 40 percent of the board be controlled by homeowners.

How many members the board will consist of is determined by the developer, with the help of an attorney.

"When I create the governing documents in the public offering plan for these communities, if I have a relatively small community [fewer than 50 homes] then I may create a board that has three members," Murphy says. "In a larger community, I would create a board with five members. Once you start creating boards with more than 300 or 400 homes, that's when you have to decide whether or not to create a seven-member board."

Murphy says one of the main reasons for this is that in smaller communities, it can be difficult to find enough people to fill out the board. This can be especially true in communities that aren't specifically planned for retirees or older adults.

"If you're creating an age-restricted community, typically those homeowners have more time to devote to activities—like participating in the governance of the community association. If it's not an age-restricted community, with families who have children, they have a lot of things to attend to: Going to work, shuttling kids to activities, and so forth, and are usually less likely to want to join a board."

The last step comes after 75 percent of the homes have been sold.

"The developer must call a meeting in order to elect the remaining seats on the board," Murphy says. "However, as long as the developer owns one lot, interest unit or home in the community, he has the right to retain one seat on the board."

In theory, the developer can set up the board in a way that turns more seats over the homeowners than the statute requires (for example, having 40 percent of the board be elected by the owners after 25 percent of the homes have been sold). This, however, doesn't happen very often.

"It's not in the best interest of the developer to do that," says Murphy, "because in the early stages of developing a community, the developer wants to have control of governing the actions of the association."

Toward the end of the transition process, there will also be a turnover of the physical components of the community, like the common areas, or a swimming pool, clubhouse, and so forth. The last phase includes the developer turning over the financial assets of the community—the bank accounts and reserve funds that were contributed to by each purchaser.

Avoiding Conflicts

According to R. Bruce Freeman, a partner with Woehling & Freeman in Westfield, an inherent problem with the developer controlling the board in its earliest stages is that developers often aren't too concerned with the long-term goings on of the development.

"A developer's intent is to build, sell, and get out," Freeman says. "So one of the initial conflicts is that the individual or entity that establishes the long-term governing structure of the community has no interest in the long-term governing structure of the community. As the developer, he will generally sell and get out."

Developers rely on establishing documents provided by their lawyers.

"Most developers will rely on their attorney to prepare the documents, and most attorneys will work off of an existing set of documents that are then tailored for the specific community," says E.J. Miranda, a spokesperson for the New Jersey DCA.

"As a general rule, developers try to make the project as cookie-cutter as possible because it reduces the cost," Freeman says. "Are some developers better than others? Sure. Some developers are more attuned to getting the association set up in a way that it can run properly in the long term."

Murphy says there's a way to get the homeowner more involved in the community in addition to assigning board seats. Committees can be formed—and Murphy suggests establishing one for rules and regulations.

"There is no one better than the people who are living there to understand what the unique aspects of their community are and therefore, what appropriate rules and regulations may be required." Murphy says. "So a smart developer, as the controlling member of the board, authorizes the creation of unit-owner or homeowner committees. What they're doing is getting the people involved and getting the people to adopt rules and regulations that they think are appropriate for their community, rather than the developer trying to determine what rules and regulations are appropriate for the community.

"Committee involvement gets the homeowners involved, and it creates a working relationship between the developer and the homeowners," Murphy continues. "And that's important, because if a developer excludes the homeowners from the decision-making process in their community and thinks it's all going to go away when he sells the homes, it leaves the homeowners saying, 'The developer just sold his homes and left, and now we're here trying to run an association by ourselves without guidance or education.'"

Murphy says that he sees the committee-forming approach being adopted by what he calls the "smart" developers out there, but says that some still are concerned with just unloading the homes as quickly as possible and moving on.

Contracts

An association exists after just one home is bought. At that point, the community has to start carrying out certain functions like maintenance and operations. Since the developer controls the board early on, he or she will hire a management company, a landscaper, a cleaning service for common areas and other contractor and vendors.

However, these initial contracts cannot be any longer than a year so that the association board—which will eventually be made completely of homeowners - can make the choices it feels are best for the community.

"[The one-year limitation clause] prevents a developer from entering long-term contracts that the homeowner-controlled association decides aren't in the best interest of the association," Murphy says.

Buyers' Responsibilities

People buying the units in a new development tend not to concern themselves with the administrative state of the association they're buying into. A homebuyer has so much to worry about—getting a mortgage, determining if the home and area is right for them, looking into the school, moving—that asking about the governing of the property can be overlooked.

"An assumption I'm making is that buyers, as a general rule, really don't focus on their membership in the association and how that association is going to run," Freeman says. "They're focusing on their units, the basics, and the association—which will be very important in their lives—really isn't foremost in their minds."

So what's the problem if a developer sets up the guidelines and regulations in a boilerplate or "cookie-cutter" matter? Couldn't the homeowners just change anything they don't like?

"The fundamental problem is that it is difficult to change," Freeman says. "First, it requires a substantial community-wide vote. Secondly, people have expectations about how the place is going to work that may not be realistic or appropriate. And thirdly, developers sometimes cut special deals with individual buyers in order to get the sale—like allowing an owner to have a pet when pets otherwise aren't allowed, or allowing an owner to put something in his backyard when there's a restriction against it—and then the association is left to clean up the mess when the rest of the community tries to enforce the restrictions uniformly."

Freeman uses the issue of pets as an example. From the developer's perspective, it may be advantageous to have liberal rules regarding pets because that opens up the pool of potential buyers. But after the developer is gone, the majority of owners may not want pets roaming the HOA's property, or may want to limit what size and kind of pet an association member can have.

"There are also a multitude of examples in terms of yard areas," Freeman says. "What owners can do, what they can't do, where they can put satellite dishes. The are a host of issues that come up in each situation."

It can certainly be difficult for new homeowners to become an association, especially since there's a good chance that most buyers are first-time owners. But Freeman says they will eventually adopt the role.

"They will become the association, and they will take control of the association and become board members and committee members, and they'll run it. It's a matter of getting into that role, and the role is thrust upon them when 75 percent of the units are sold. They don't have a choice, they have to take over at that point and time. And all of a sudden they realize what they have to step up and take control."

Anthony Stoeckert is a freelance writer and frequent contributor to The New Jersey Cooperator.

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