The Shelf Condominium Conundrum

By David Van Atta, Hanna & Van Atta © all rights reserved

When a real estate developer is planning a multifamily residential project, or mixed use
project with residential units, the developer may want to consider having the project
approved as condominiums even though the developer may not want to sell condominium
units to the public. The developer may want to go this route in order to maintain
flexibility as to its future prospects; with the idea of starting the project out as a rental
project, but reserving, so to speak, the right to sell condominium units in the future, or to
allow a future owner of the complex to sell condominium units in the future. In addition,
having the condominium approvals for the project may enhance the inherent value of the
property, even if no units are initially sold. Informally, we refer to a project as a “shelf
condominium project” where a property that is approved by the local government as a
condominium project, but where no units are sold to the public, but, instead, rented out to
tenants. In addressing the prospects of a shelf condominium, there are several issues that
need to be considered.

  • Why do a shelf condo and how?
  • How to retain rights to the condominium project after initial approvals: the West
    Hollywood issue.
  • The Property tax issue:
  • DRE issues – at the beginning and later on.
  • Tenant disclosure requirements in leases and rights of refusal

Why do a shelf condo and how?
Creation of a condominium project entails satisfying local land use requirements, the
approval and recordation of a final subdivision map, or parcel map, for condominium
purposes, the recordation of a condominium plan and the recordation of a condominium
enabling declaration of covenants, conditions and restrictions in the local records. In
addition, for the sale of units in a residential condominium project to the public, an
application must be made with the State of California Department of Real Estate
(“DRE”) for a Final Subdivision Public Report. For this application to be approved and
the Final Public Report to be issued, the condominium owners association must be
formed, by filing articles of incorporation with the Secretary of State, if the association is
to be incorporated, and adoption of association bylaws. For a shelf condominium, as we
will discuss, the developer may want to undertake some, but, perhaps, not all of these

Condominium Subdivision Map. To establish a shelf condominium project the
developer must obtain local government approvals. Such local government approval
generally entails obtaining the approval of a final subdivision map for condominium
purposes.** (See California Subdivision Map Act (Gov. Code §§66410 et seq.)
[Condominium projects, community apartment projects, and the conversion of an existing
apartment building into such a project, regardless of the number of units, are subdivisions
under the Map Act (with certain exceptions as provided in Gov. Code §66426). (Gov.
Code §66424)] [**In some jurisdictions, but not most, a condominium development may
entail satisfying certain local zoning or land use requirements; however, from a zoning
and land use perspective, most multifamily rental developments have the same zoning as
a residential condominium project. However, some cities do require special zoning for
condominiums.] The approval of a condominium subdivision involves what is described as a “one lot
subdivision map for condominium purposes”. Under the Map Act, a condominium
subdivision map need not show the details of the separate units or the common areas; this
is handled under the condominium plans that are prepared for a project pursuant to Civil
Code section 1351, after the subdivision map is approved by the local government. (See
Map Act (Gov. Code §66424 and §66427.) [The tentative map for a condominium project should only describe the boundaries of the real property on which the project is located, and need not show the buildings or the
manner in which the buildings or the airspace above the property shown on the map are
to be divided. (Government Code §66427(a).) A map for a condominium project need not
include a condominium plan or plans, as defined in Civil Code §4285, and the City or
County governing body may not refuse approval of a parcel, tentative, or final map of the
project on account of the absence of a condominium plan. (Gov. Code §66427(a).))

Condominium Plan. The condominium plan is a document that is separate and distinct
from the subdivision map. It is defined and described in Civil Code section 4285. The
condominium plan is either a separately recorded document or can be attached as an
exhibit to the condominium project’s declaration of covenants, conditions and restrictions
(“CC&R’s). Usually the condominium plan is attached to the CC&R’s for smaller
projects, and is recorded as a separate document for larger or more complex projects. The
recordation of a condominium plan is required for a condominium project under the
Davis Stirling Common Interest Development Act. (Civ. Code §4200(b).)

Condominium CC&R’s. Ultimately CC&R’s must be prepared and recorded for the
creation of a condominium project. In California, condominium projects are “common
interest developments” under the Davis-Stirling Common Interest Development Act.
(Civil Code §§4000 et seq.) One of the requirements for formation of a condominium
project is the recordation of a “declaration”. (Civ. Code §4200(a).) The “Declaration”
means the document, however denominated, which contains the information required by
Civil Code Section 4135. (See Civ. Code §§4250 and 4255).) This document is often
referred to as the CC&R’s.

The Public Report and Association Formation.
For the sale of residential condominiums to the public in California, the developer must
obtain a Final Public Report from the Department of Real Estate pursuant to the
California Subdivided Lands Act. (Bus. & Prof. Code §§11000 et seq.) A developer can
also obtain a Conditional Public Report under certain circumstances, that would allow the
developer to offer units for sale, but not close such sales unless certain conditions were
met. (Bus. & Prof. Code §11018.12.) To obtain a Final Public Report, the developer
must satisfy a variety of requirements with the Department of Real Estate, including
obtaining a final map, recording the condominium plan, recording the CC&R’s, as well
as filing the articles of incorporation for the condominium owners association, if the
association is to be incorporated. The developer can go through all of these various steps
and obtain the Final Public Report [or Conditional Public Report] and then elect not to
sell units to the public. The Final Public Report once issued is valid for 5 years.
However, by doing so, the developer may have to address certain concerns, such as the
issue of property taxation that we will later discuss.

The Conversion Issue:
If the developer is not going to sell the condominium units in the immediate future, why
should the developer go through this process, which can be somewhat time consuming
and costly? The primary concern pertains to the issue of condominium conversion
risks. As well, by obtaining the public report, the project would be positioned to go to
sale more readily, if the market changed, and made unit sales advantageous. If the
developer does not obtain condominium project approval at the front end, if, later, the
developer, or its successor project owner, desires to sell the residences in the project as
condominiums, the developer or successor will have to effectuate what is commonly
called a “condominium conversion”. Note that there is not legal or statutory definition of
the term “condominium conversion” in California; however, a residential condominium
conversion is generally understood to be the effectuation of a condominium project for a
project that was initially developed as a rental apartment project, and where apartment
units have been rented to tenants. A condominium conversion in California is subject to
statutory requirement under the Subdivision Map Act, and, often, local governmental
requirements and limitations. These requirements make the process very complicated,
expensive and, at times, almost impossible to accomplish. By obtaining all of the
approvals required for a condominium project before tenants sign leases or move into the
project, the general wisdom is that the subsequent sales of the condominium units are not
a conversion and not subject to the State laws or local ordinances that limit or restrict
condominium conversions.

The West Hollywood Issue:
Should the developer obtain a Public Report? By obtaining a final subdivision public
report, it is arguable that the approved condominium project is not to be subject to further
local government constraints or enactments regarding the future sales of condominiums.
This approach is based on a California Supreme Court case generally referred to as the
“West Hollywood” case. (City of West Hollywood v. Beverly Towers, Inc., 52 Cal. 3d
1184, 278 Cal. Rptr. 375, 805 P.2d 329 (1991).) Once the developer obtains the basic
condominium subdivision map approval, there is a concern as to whether, without doing
more, the local jurisdiction, the city or county that has land use jurisdiction over the
property, can adopt future laws or ordinances that would limit or preclude the sale of the
units in the condominium project subject to the approved map. Under West Hollywood,
pertaining to an approved condominium conversion, where no units were sold, but a final
public report was obtained, the California Supreme Court ruled that a city may not
impose further restrictions or conditions on a conversion subsequent to the developer
securing all of the necessary discretionary approvals and satisfying all the requirements
established by state law in order to be able to offer the units for sale. Although this case
actually applied to an approved conversion project, the case can be used for the premises
that if a final public report has been obtained for any condominium project, whether or
not a conversion, the city cannot impose further restrictions or conditions on the
condominium project. There may be other legal arguments that a newly constructed condominium project
should not be subject to any such future laws enacted by a city restricting the sale of
condominiums in the future, based on what is known as the “vested rights” case law.
However, these arguments would be strengthened if a Final Public Report was obtained,
as the West Hollywood cases doctrine could then be applied as well.

Marketing Delays:
Obtaining the Final Public Report bolsters the protection against the municipality
attempting to apply new restrictions on the sale of the condominium units and provides
the developer or its successor in ownership with the avenue of being able to sell units
without delay if the market warrants it. If the public report is not obtained until later,
then there will be a time delay in going to market; it currently takes at least 9 months to
obtain a public report from the DRE. Therefore, if the paper work is done at the outset,
this time delay can be avoided. However, as discussed below, if there is a long delay
from when the public report was obtained and the date of going to market, the developer
or its successor may have to file an amendment to cover any material changes that may
have occurred in the interim.

The Property tax issue:
When the property is developed as an apartment complex without a condominium
subdivision, the property will, upon completion, be assessed by the county tax assessor as
a new residential apartment complex, with one tax bill. When both the subdivision map
and the condominium plan are recorded, the county tax assessor may reassess the
property and segregate the taxes on the property, issuing individual tax bills for each of
the condominium units. This could result in a higher aggregate tax bill than if the
building was assessed as an apartment complex. In addition, there is added administrative
complexity to handle the multiplicity of tax bill payments. However, the California law
appears to allow the property owner to request an exemption from separate assessment of
the condominium units at the time the Condominium Plan is recorded, and the units will
not be separately assessed until a unit is conveyed separately. Therefore the property
taxation issue can be overcome if the exemption request is filed. Revenue and Taxation
Code Section 2188.6(d). Revenue and Taxation Code Section 2188.6. Separate assessment of condominium units.
(a) Unless a request for exemption has been recorded pursuant to subdivision (d), prior to
the creation of a condominium as defined in Section 783 of the Civil Code, the county assessor
may separately assess each individual unit which is shown on the condominium plan of a
proposed condominium project when all of the following documents have been recorded as
required by law:
(1) A subdivision final map or parcel map, as described in Sections 66434 and 66445,
respectively, of the Government Code.
(2) A condominium plan, as defined in Section 4120 or 6540 of the Civil Code.
(3) A declaration, as defined in Section 4135 or 6546 of the Civil Code.
(b) The tax due on each individual unit shall constitute a lien solely on that unit.
(c) The lien created pursuant to this section shall be a lien on an undivided interest in a portion of
real property coupled with a separate interest in space called a unit as described in Section 4125
or 6542 of the Civil Code.
(d) The record owner of the real property may record with the condominium plan a
request that the real property be exempt from separate assessment pursuant to this section.
If a request for exemption is recorded, separate assessment of a condominium unit shall be
made only in accordance with Section 2188.3.
Revenue and Taxation Code Section 2188.3. Condominium; separate assessment. Whenever real
property has been divided into condominiums, as defined in Section 783 of the Civil Code, (a) each condominium owned in fee shall be separately assessed to the owner thereof, and the tax on each such condominium shall constitute a lien solely thereon; (b) each condominium not owned in fee shall be separately assessed, as if it were owned in fee, to the owner of the condominium or the owner of the fee or both (and the tax on each such condominium shall be a lien solely on the interest of the owner of the fee in the real property included in such condominium and on such condominium), if so agreed by the assessor in a writing of record; such an agreement shall be binding upon such assessor and his successors in office with respect to such project so long as it continues to be divided into condominiums in the same manner as that in effect when the agreement was made. When a property owner obtains approval for a condominium project from the local governments, such as approval of a condominium subdivision map, but instead of selling units immediately intends to hold the units for rental for a period of time, the property owner should consider and evaluate the potential property tax ramifications. If no units are sold, the assessment of valuation should be as a rental apartment project, and not based on valuation as a condominium project. To avoid having each unit separately assessed, the owner should file a request for exemption from separate assessment under Revenue and Taxation Code §2188.6. This request must be made at the time of recordation of the condominium plan.

DRE issues – at the beginning and later on.
After a property has been built as a condominium project, but no units are sold, if a
public report was obtained, before the developer, or its successors, goes to sell the units
to the public, the DRE will have to be notified as to any material changes that had
occurred since the issuance. If the building is more than a few years old, the DRE
budgets of the owner’s association operations will have to be brought current. If reserve
funds had not been collected for long term capital items, this will have to either be made
up on sales, or some adjustment in the association budgeting will have to be made. In
addition, if a great deal of time has gone by, the legal documents for the project may need
to be updated for new laws that were enacted. In addition, the DRE will require
information as to the condition of the building and its systems if the building is more than
five years old and a public report is then sought. This could include inspection reports by
qualified experts, such a engineers as to the condition of elements of the building.
Tenant disclosure requirements in leases and rights of refusal:
When a condominium subdivision has occurred and units are rented, the landlord of the
condominium units is required to provide certain disclosures to the tenants that the
property is a condominium project, and that the apartment units can be sold as
condominiums, and that the tenant, if the unit is sold during his or her lease term, will be
provided a right to purchaser the unit. See Government Code §66459.

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