Within the last several months, community association attorneys in North Carolina have begun to see a new scenario with their clients: the ground lease. Usually, when someone purchases a lot, they own the lot and any structures on that lot, such as a home, outbuildings, or landscaping installations. However, we are now seeing situations where someone purchases a lot, but only leases the home and other structures on the lot (the “Improvements”) for some long period with an option to buy at the end. The duration of these leases is variable, but often extends to periods as long as 99 years. The ability to buy the lease out early varies from agreement to agreement. Some would-be homeowners are attracted to this scenario because, by not having to purchase the Improvements up front, they can minimize housing costs and still get into a desirable neighborhood. This type of arrangement is fairly common in low income housing communities, but is a new trend in traditional residential communities.
The ground lease situation creates new challenges for community associations. Now, instead of one “lot” owner, the association may need to deal with two separate parties, the lot owner, and the Improvements owner. This leads to a number of issues which I will briefly touch on here. Each situation is slightly different, and I encourage any association with questions about such a scenario to contact their attorney for further, specific counsel.
Who Is the Member?
Most covenants define association members as the owners of lots, and impose rights and obligations on those association members. In the ground lease situation, this allocation of obligations may be less than clear, and sometimes ground leases will require certain notices be sent not only to the lot owner, but also the Improvements owner. Associations owe certain duties of confidentiality to their members, and are prohibited under State and federal laws from sharing debt collection information with third parties. Associations and their management companies need to make sure that they are not agreeing to include third parties in collection or other enforcement communications without specific authority to do so, either in a recorded deed or lease, or some other official legal document. In most situations, a simple letter from the Improvements asking for notice is not going to be sufficient. Boards and management companies change, and records are lost- particularly when the duration of a lease is 99 years. In almost all situations, associations are going to need to push for something to be recorded in the chain of title to specifically address who is to be considered the association member and responsible party.
Enforcement and Collection
Enforcement and collection issues are also significantly complicated by ground leases. What happens if a lot owner fails to pay assessments, and the association needs to foreclose? Can they foreclose on the lot but not the Improvements on that lot? How does that work? Further, issues can come up related to what a lot may be used for, versus what a structure may be used for. If there is a prohibition against using a lot for a rental, does that automatically prohibit the use of the home on that lot for such purposes? Probably, but enforcement and foreclosure rights will need to be carefully considered in the context of the particular ground lease and its terms.
Insurance
Insurance can be significantly complicated by ground leases in townhome communities, or any community with a master policy covering structures on lots. In a ground lease scenario, who is the intended beneficiary of proceeds in a casualty event? If the lot owner does not own the Improvements, then the association may need to work through the lessor for any repairs, even though the resident may wish to be actively involved in the reconstruction process.
Ground leases are complicated legal agreements and can create confusion for associations trying to identify their members and their members’ obligations. However, with increasing mortgage rates, rising home prices and low home inventory, we can expect to see increasing use of this arrangement in communities across the country. Associations that take the time to understand this arrangement, and the particulars of any such arrangement in their communities, will avoid confusion and possible liability as they incorporate these new members into their constituency.