 Think Tech Away, Civil Engagement Lives Here. Aloha, welcome to Condo Insider. I'm Richard Emory, your host for today's session. I would like to share with everybody that next Tuesday, February 27th at 9 a.m. at Honolulu Halley, will be the day the city council determines whether the older buildings will be required to retrofit their fire sprinklers systems. Don't know what the Vegas odds are on that, but I can tell you that hundreds have testified against it because of the cost burden it may put on homeowners. That being said, we're all concerned about fire safety, and we encourage every building to look at fire safety issues and take necessary steps to protect their residents. Today, we're going to talk about an issue that has surfaced that there's a lot of misunderstandings on. And that is that when an association forecloses on an apartment owned by an owner and gets possession and want to rent it out, what's the best way to do it? What are the risk and rewards? And I've asked a very good friend of mine and very knowledgeable guy on this topic, Peter Wargo, to join me today and talk about the do or not to do with regard to association rentals of condos, of units owned by condo boards. Anyway, Peter Wargo, welcome to the show, and I've known you for decades. Tell us a little bit about you so everybody knows who you are. Well, thanks for having me on the show, Richard. And yeah, I've known Richard for a long time. I came over to Hawaii over 40 years ago in the military. And like a lot of people at that time, retired and decided to stay in this beautiful land and got into real estate, started my own company. And I've been a real estate broker and involved in property management and rentals for 35 years. And if I remember correctly, you were actually in the Special Forces and went to Vietnam, among other places. That is correct. Well, let me thank you for your service and they do all the military because certainly if we didn't have people willing to stand up for our country and our values, we would be maybe not in the place we are today. So thank you for your service. Thank you, and thank you for acknowledging that. Anyway, let's talk about something that's dear to my heart is when you look at the condo association, and you look at, I'll make it up, a hundred unit project, and they do a budget every year. They depend on all hundred people paying their maintenance fees. It's not like a profit making enterprise. They basically look at the cost of operation and they look at dividing it by the percentage of common interest or whatever the documents say by a hundred people. And so if one person or more doesn't pay, it leaves a puka in the budget. You don't have the money. And so we see where associations regularly will foreclose on an owner. And sometimes banks are not paying their mortgage. Can you just briefly share with us, we hear the terms judicial foreclosure, non-judicial foreclosure, in real layman's terms, what the difference is? Yeah, I can do it in layman's term because I'm not an attorney, and I know you've covered the subject many times. But if you think of it in layman's terms, as I would, judicial is a long process, and that's usually where you're trying to procure the title. It takes a long time. It's very expensive. It takes a lot of legal help. The non-judicial route was really kind of a fast track of less money. You don't get the title, but you can get possession of the unit and the right to at least try to rent the unit. So that was my understanding of the difference between the two. So time and money. I think that's pretty accurate. My experience has been because of all the changes in the foreclosure law, it could take a lender three or four years to foreclose and clean up the title for lack of a better word, so you have clear title. That's correct. Where a non-judicial foreclosure can be done in a matter of months and give you possession. So if someone foreclosed around the mortgage, for example, or a second mortgage, whatever it may be, giving you possession and the benefits, well, first of all, which way do the associations usually go and why? Well, most of them are going to go with non-judicial because you want to get someone in there to generate income, as you said. You're never going to have 100% of the people paying. But if you know you're going to lose some, but if you can get some people in there renting and get some of those maintenance fees paid, which helped to balance that budget, then that's the smart way to go. And it's fairly easy. Question then becomes as we're interested in is who should be handling that rental, finding the person, getting it in there and accounting for the funds. We'll get into that in a minute, but staying on point with regard to the foreclosure issue, I've always looked at it as that an association, when someone's not paying, they're leaking oil for lack of a better word. They don't have all the money to pay their bills or fund their reserves, depending on what it may be. That's correct. So by getting someone in and getting possession, not clear title, because you foreclosed around the existing liens for lack of a better word, they start getting cash flow for the rent. So the question I ask you, as you know, maybe when an owner, let's just say you rented it for $1,000 a month, does that go towards the delinquency or is that just other income? No, it's other income. You cannot collect, as I understand it, the delinquency, late fees or anything like that, but up to a certain amount, and I'm not sure, up top of my head, whether it was up to six months or more, I think the law had changed sometimes, but to pay for the basic maintenance fee amount, you can collect that amount and apply it. Yeah, well, and just to help you with that is that at the time you have non-judicially foreclosed and the association takes possession, again, not title, they are now the owner of the association. And so when they rent it out, it's just rental income to the association. It's not applied to the delinquent owner's account. That account still remains in collection with the attorneys and still fully owed. So the amount that that owner is paying a rent would, number one, cover the maintenance fees since you took possession. So you're not getting any worse off. Correct. And then number two, you might be making a slight profit because of the fact that the rent of $1,000 might be more than the maintenance fees of maybe $400, so that's just extra additional income. Then in some ways, but cash flow strategy helps recover the lost cash flow of the former owner, but really not legally, as though the rent's not legally applied to the unit. Is that your understanding? That was my understanding in that the additional money above and beyond what that maintenance fear, what is owed, you have to account for that somewhere down the line, that was my understanding. Yeah, well, I think, you know, of course the loss changed so many times. One of the things that's interesting about that is that typically when they're not paying their maintenance fees, they're not paying their lender and the mortgage either. That's correct. And so what happens is, because we described the judicial foreclosure, which a lender would use, could take three or four years. At some point in time, the lender will get a commissioner appointed. Now, what happens to the rent once the commissioner's appointed? It's my understanding that once that takes place, then in fact, the ability and the ownership, if you will, for being able to rent, it stops with the association. The commissioner takes it over and the court has awarded it at that point. So the monies have to be accounted for to the commissioner. That's right. So in essence, the tenant would then start paying the commissioner the rent. However, the commissioner would still be obligated to pay the maintenance fees while he's in possession. So you're still getting your cash flow. The commissioner couldn't take the rent and not pay the maintenance fees. He would have to pay when the time he took over and the order was made with the commissioner, he would have to pay the rent to move it forward with respect to that. So anyway, let's kind of move it along a little bit, is so now you've had a situation, the association's not getting paid. They want to do a non-judicial foreclosure so they can get the cash flow, hopefully by renting it out. And they get possession because they get a non-judicial foreclosure. The first thing that comes up, they may have to put some money into the apartment to rent it just because it might be in bad condition. Correct. But then meanwhile, that kind of levels out, they'll evaluate the money they need to put into it versus the rental income typically because it takes so long for a lender to foreclose, there's usually plenty of time to recover any small investment you make in the property. So now you have this unit and you want to rent it out. And the big thing I get asked over and over and over again is the better for the association to rent it or the better for them to hire a realtor? And putting that in perspective, I'd like to approach this from, I hate to say the pros and cons of each way, so let me ask you this question about the bet. So if the association has possession, do they have the legal right to rent it out without hiring a licensed realtor? Yes. And why do they have that right? Well, because they basically are the owner, they own the unit and so it doesn't fall under the law of having to have a license if they're managing it themselves. Question I would always ask is, why would you want to take on that responsibility and what are those responsibilities? Yeah, there's a lot of liability with respect to that but in simple terms, the association could say we're going to rent it and either appoint a board member and or a resident manager to find the tenant. If you have an empty unit, let's kind of walk through the steps which you got to do. If you have an empty unit, what are you going to do? Well, the first thing you've got to do is you've got to market for it. You've got to make sure that it's ready to be occupied. You go through the marketing, that's a cost. You've got a screen when you start getting candidates, potential tenants. You want to make sure that you're doing credit reports. How are you going to do that? Who's going to pay for that? Who's making the decision that this person is qualified as far as income wise and how do you make sure that you're not violating any rules or laws as far as discrimination for some reason that you say we don't want a family that large or that small. Most of the people that are on the board or the resident manager doesn't have that background or training or schooling. So all those things have to be considered. And then once you get them checked in, someone's got to do the check-in. Someone's got to have some forms. Who's writing up the rental agreement? You need to have some kind of an agreement in writing. Who's going to do that? Where are you going to get it? Who's going to make sure that it's legal? And then once you've done that and you've put them in, who's going to maintain making sure the rent's paid? How are you going to account for that rent? If there's a security deposit involved, how are you accounting for that security deposit? All of these things, both the physical, the administrative and the fiscal responsibility of handling that unit and that tenant are involved. So basically under the landlord tenant code, even though it's an association owned unit run by the board of the resident manager, they're going to have to comply with all the landlord tenant code. And there are risks. If you don't pay the security deposit back on time or have very detailed records of the damages the tenant may have cost, by not following the statute by recollection is it's a deceptive trade practice and it's treble damages. In theory, you could have to pay three times back the security deposit if you haven't given all the right notices or if you're withholding some of the funds because of alleged damage. You have all sorts of legal requirements to do that you're now imposing on yourself or on the association. That is correct and that's why you should lean towards, I think, not that I'm a real estate broker and that we handle rentals, but that's what we're schooled for, trained for, have the experience for to take care of those things, to take on those liabilities on behalf of the board and to handle that for them so they don't have to get involved with that. But it could be very expensive if you make a mistake. And I think you should look at, I always like to look at the end product when I'm asked that question by a board, assume you do it on your own are you really going to save any money and let's say worst case something like you forget or you don't get the security deposit returned on time or you do it wrong and you don't have a written agreement and they take you to court or they take you to small claims court. Who's handling that? Does your insurance cover that? Is your insurance carrier going to help you? Well, there's a lot of liabilities on this and I want to spend some more time on that but we're going to take a short break for a minute and come back with Peter Wargo talking about renting an AOE loan unit, which is the better way to go. Be right back in a minute. We have this crazy thing going on today. I was just walking by and all these DJs and producers are set up all around the city. And I just walked by and I said, what's happening guys? They told me they were making music. It's a little talent and then sat down and kind of I saw it do it. Welcome back to Kondo Insider. We're sitting with broker Peter Wargo talking about when an association through a non-judicial foreclosure gets possession of a unit and the risks of renting it out themselves versus the rewards of maybe saving a few bucks at a real estate commission fee. And we kind of broke off. We were talking about the various steps you need to do to rent a unit. Obviously find a tenant, maybe do a credit check, sign a lease, a legal document. I think lease is mandatory. And then you have to make sure that they pay their rent on time and what happens if they don't. If you have to send notices, if they check out getting their security deposit back, for example, and there's all sorts of timing and inspections if you think there's a claim could they damage the unit? It seems like an awful lot of work. It is. And matter of fact, I think we're probably underpaid but when you look at trying to do all of that on your own and you're not an expert in that field, plus you have all your other duties, let's face it, board members are volunteers. And even if they gave them an increase in pay to do something like that, five times zero is still zero. They are volunteers. Highly recommend against doing a resident manager even if you get the association to agree to it. That's not what their job is for. That's not what they're supposed to be doing. And that's kind of putting a burden where it should not be. I know in a few minutes we're gonna get involved with what I call the horror stories. So examples of ones that went south or didn't work out too well because of the problem. But from my experience, the thing that I see as problematic, even if you had the best tenant and the best credit or whatever, is your managing agent really is handling the maintenance fees and the normal common expenses. It takes an extra step on their part to make sure you establish a rental unit in their system. You know that you're charging a thousand a rent so you see under the delinquency of it's not being paid. It becomes a whole accounting issue that when you signed your contract with your managing agent it really wasn't engineered with the thought of throwing on a rental unit or more to do that. And what happens, I've seen so many times because it wasn't handled and coordinated well with the managing agent. They lost track on the status of the property in the sense that they weren't getting paid on time when the rents weren't being paid properly. And so certainly having good accounting and holding someone with a license responsible, it seems to me to be a good business judgment safety check on that situation. Comments? Yeah, I agree. I for one, do not think it's proven or wise to have the management company that's handling the association to have the rental monies going through that accounting system. Number one, it's hard to keep track of even if you have separate lines for it. When you use a separate rental company there are requirements under the law under 521. For example, security deposits need to be put in a separate client trust account, counted for that way, a separate accounting for the operating account. You're providing that extra step in the layer of accounting and fiduciary liability. And you're actually assuming the fiduciary responsibility on behalf of the board. Well, let's talk about a couple of horror stories. And I think it was ironic that you and I before we came over today was talking to one of our community managers. And if I understood her correctly, in this particular case, the association decided to rent the unit themselves. And usually when you have a rental agreement, if there is one, it requires after five days, like a late fee and a penalty and notice. And as we were talking to this manager, just by accident before we were coming over and preparing for the show, she says, what do I do? We have a tenant. We can't find the lease because the association did it themselves. And we've discovered that they haven't paid his rent for the tune of about 15,000, if I heard it correctly. So that's what I heard too. That's about 10 to 15 months or whatever it may be of not paying it. And no one did anything about it. And meanwhile, they decided to do something about it. And the tenant died. That is correct. So let's get- It's a perfect storm. So I'm asking you to speculate because we are not lawyers and we don't know. That's true. So what do you think is gonna happen on that? I think bottom line is they're not gonna collect a cent. That would be my feeling. Number one, there's no written contract. It's gonna have to go to some kind of litigation, even if it's against an estate. Question would be, is there an estate? What's left? You have no written contract. You have no set standard policies and procedures. For example, no one was sending notices that you haven't paid. You haven't been accounting for the funds. Question comes to my mind. Who's been accounting for the funds? Who's liable? But I think the association and the board is just gonna eat that one. That's simple. Yeah, I don't know all the facts when we had a few minutes with her, but to me it goes back to my earlier comment about associations, managing ages. Unless they're really brought into the loop and you set up accounting of that, they're not gonna know. If you had a licensed realtor, they're responsible to make sure the rents are paid on time, send the relinquency letter or the late fee letter saying you haven't paid your rent, and identify to the board, hey, we haven't got the rent this month or next month, and be taking action yet to certainly fall into eviction based on the non-payment and not waiting 10 to 15 months, and I'm guessing in this case. What do I think? Because I don't know how they're gonna get their money because I'm assuming if the guy's renting, he doesn't have much assets, and now that he has a state that's gonna go to probate, you're gonna spend another 15,000 trying to make a claim for 15,000. It's not an easy situation. I agree, and I think the board and associations need to take into consideration that when you use someone who's licensed, there are other layers of protection. For example, when you have a real estate license, you have to answer to the DCCA. You have certain requirements that you must follow under the law. Most rental companies are gonna be members of the board of realtors. There's additional ethics requirements. So an association has several layers of protection to try to recoup additional funds than when they're just doing it on their own, and they have no accounting for it. That's gonna be the worst case on those, and it ends up going to some kind of litigation. To me, the judge, the ones I've been involved with is where's your proof? Where's the written documentation? How have you been accounting? What's your procedure? What are your standard operating procedures for handling this? And if your answer is we don't have any, Your Honor, I think you're not gonna go anywhere. Oh, I agree. Let's talk about one more hard case that, again, we will protect the names of the innocent or guilty, depending how you want to look at it. If you try to do it yourself, you really never know what the deal is and who you're running to. I've seen cases where there, I hate to call them insider deals, where the resident manager's friend or the board's friend, they rented it to them at maybe a lesson market rate or they rented it to them, there is no lease whatsoever and they just think they're doing the association of favor to not have to pay a commission. By the way, what is the typical commission for something like this? Normally, our management fee is 10% and again, it's negotiable, but that's usually kind of the standard that we look for based upon the effort and the amount of work that we have to do. But an example I just gave you, our store number two, in my understanding of this particular case, they didn't know who they was being rented and because there was no lease or the lease was done between, the unknown, unfound lease was done between the board president and an individual, that they ended up losing because it was an expensive place like $25,000 or $30,000 of unpaid rents because in that case, allegedly the president and the individual made a lease agreement, allegedly signed or no one has a copy of it, no one coordinated with the management company so it never appeared on the balance sheet on the delinquency page or anything. It's all of a sudden, well, we assume he's paying and he wasn't paying and all of a sudden, they then had to evict him, although I think he voluntarily laughed. It just seems that, does that meet the business judgment rule of a board? That's a good question, is the board meeting their fiduciary responsibility? Again, we're not lawyers, but if I was an owner, I would question that board pretty seriously and I agree, a number of horror stories just like that where we've been asked to take over a unit and it turns out that the board president or vice president's cousin was the one who was gonna handle the rental and by this time, behind no money, where is the money, and I think it puts the board in a precarious position. Well, let me say this, we're at the end of our show and first of all, I thank you for being here and sharing this with us. The title of the show is to do or not to do on condo rentals. Let me tell you that yes, you want a non-judicial foreclose, yes you wanna get possession, yes you want to rent them out and this show may be steered in your mind to the thought you should hire a professional realtor to rent it out and not do it yourself and yes, that's correct. That's the right answer. You really should hire a professional in your business judgment to protect yourself from potential claims of violation of the fair housing and the landlord tenant code. There's all sorts of high risk and costs to that. You're assured of knowing that the tenant's been properly vetted and you're assured of knowing you've set up processes and procedures to make sure you get paid. And so it sounds like we were kind of leading this to, that's what you should do, it's because we are because as professionals in the real estate business, I think you would agree, it makes more sense to protect the association by using licensed professionals when trying to rent out because I've seen more bad come from trying to save a few bucks by doing some kind of side rental deal on an association owned unit. And in the end, they usually end up losing more money than what they would have gained. Well, again, thank you for being here and thank all of you for tuning in to Condo Insider. This show is all about association living and the challenges we face. Next week we have a discussion about the Douglas trade show, the largest property management trade show in Hawaii. We have its head, I don't know what the official title is of Ken Cantor, but he's coming in, talking about all the seminars, all the education, all the things you can learn from attending the Douglas trade show and how to get a free pass. So anyway, thanks. We hope we'll see you next Thursday at three o'clock. Aloha.