The concept of using a Limited Equity Cooperative (â€œLECâ€) to convert a proprietary owned mobile home park to resident ownership is not new. The LEC has been used both in California, and throughout the United States in a number of mobile home park conversions. In some instances, the LEC was used by a non-profit because the non-profit entity had prior experience utilizing LECs in apartment conversions. In many instances, the use of the LEC was abandoned in favor of another form of conversion, because the LEC is generally very impractical in mobile home parks. In spite of this, some parks have been purchased and continue to operate as LECs.
Unfortunately, a large part of our experience with Limited Equity Cooperatives in manufactured housing has been working with the residents in LECs to help them clean up violation of the rules governing LECs after the corporation was in being for a relatively short period of time. In many of these cases, the residents unknowingly treated the entity more like a mutual benefit corporation than following the rules which bind the LEC, and we were asked to not only clear up their violations, but to train the Board of Directors, and in many cases the residents and management company in the proper operation of an LEC.
A Limited Equity Housing Cooperative is defined in the Health and Safety Code at Section 33007.5. This form of corporation must be â€œany of the following:
- Organized as a non-profit public benefit corporationâ€¦. (IRS 501(c)3); or
- Hold title to real estate as the beneficiary of a trust providing for distribution for public or charitable purposes upon termination of the trust; or
- Hold title to real property subject to conditions which will result in reversion to a public or charitable entity upon dissolution of the corporation; or
- Hold a leasehold interest of at least twenty years duration, conditioned on the corporationâ€™s continued qualification . . . and providing for a reversion to a public entity or charitable corporation.â€
You can see that this is not an investment in which a member has the opportunity to profit from the use of the LEC, and when the time for a sale or dissolution arrives, the members get nothing. In most cases, this is not what the residents seek long-term, or even believe they have purchased. Even though the expectation of the lower costs and reduced rents may be attractive near-term most residents believe that ownership equals profit and not a straight trade across for what they paid, or even a loss when they leave.
In a LEC, the bylaws or the articles of incorporation require the purchase and sale of stock or membership interest of resident owners who cease residing in the park at no more than a transfer value per the articles or bylaws, but shall not exceed the aggregate of:
- Consideration paid by the original membership;
- Value of any improvements installed at the expense of the members with prior approval of the board;
- Accumulated interest or an inflation allowance based on C.O.L. or other rate measures;
- No matter what is determined above, the value is limited by a 10% per annum increase based upon the original member purchase price.
The law requires the board to sell a membership to new residents or members as set forth above.
Additionally, there is a concept residents should be aware of which is referred to as â€œcorporate equityâ€. Corporate Equity is defined as the excess of the current fair market value of the property over the sum of the value of all memberships, reduced by the present encumbrance remaining on the property.
It is generally very simple to determine the increased value of the property over time. Given inevitable appreciation, combined with a very small initial equity on the part of the homeowners, it is easy to see how the corporate equity can far exceed the member cumulative values.
Additionally, the LEC is burdened with the following disadvantages:
- As long as there is an outstanding encumbrance, equity cannot go to members, except only for:
– The benefit of corporation through improvements of real property;
– Expansion of the corporation by acquisition of additional real property (also encumbered);
– For public benefit or charitable purposes.
- If the property is sold, the corporation dissolved or where property title requires termination of the trust or reversion of title (as in a lease) the equity is to be used and transferred to a public or charitable purpose.
- If any bylaws or articles change, it requires a two-thirds vote of all members.
- In order to dissolve such an entity, an application must be made to and approved by the stateâ€™s attorney general.
The limited equity housing corporation is justified as a vehicle to maintain low cost housing for those who need housing, but have limited income. In many cases, an LEC is utilized in an apartment complex conversion. The LEC is generally not, however a proper vehicle for conversion of mobile home parks given the duality of ownership (i.e., divided ownership of home and land). The unique nature of tenant rights in mobile home parks, and the mixed nature of ownership seems to strike at the intent of the limited equity concept, as it may allow the mobile home to reach unjustifiable price levels by limiting the membership value. This phenomena is similar to what often occurs in rent control jurisdictions where the land value (rent) is restricted, resulting in home values far exceeding the actual fair market value (in the absence of rent control). If you reduce or maintain the rent level in an expanding economy, the other part of the equation (the home) will increase in value far beyond what is justifiable and that seems to destroy the intent of providing low cost housing for the elderly and those who are of lower income.
In order to attempt to equalize this problem, the local jurisdiction or participatory agency or entity may use one of several approaches to maintain the affordability intended:
- One method is to severely limit the sales prices of the homes and membership to some level of affordability. Thus your home and membership have a set value to begin and can only be escalated by a percentage or a percentage plus any costs of improvements. This creates valuation problems and questions of equity, depending upon the starting point for values and the escalation factors selected. A 10% increase on a low priced membership is not too difficult, but if a home has a $60,000 initial value , a 10% annually escalation factor suddenly yields an unaffordable community.
- Another method which seems to be somewhat more equitable is to limit the sale by a low income person to another low income person who may only spend 30%Â± of his or her income for total housing cost. This keeps the various income categories as relatively stable but can be viewed as an advantage for some and a detriment for others. It does, however, keep profiteering out of the equation for the very low, low and moderate income households. That is after all what you are attempt to protect for the present and the future by use of the LEC.
If one to form a limited equal cooperative, and if it qualifies under Business and Professions Code Section 1103.4, it does become exempt from the Subdivided Lands Act which eliminates the need to obtain a public report before sales of membership.
The conditions noted are:
- HUD, FHA, COOP Bank, Cal HFA, or CA HCD or city or county redevelopment agencies in which the coop is located directly finances or subsidizes at least 50% of the total construction or development cost or $100,000 whichever is less or if the property was sold for development of the cooperative and has a regularly agreement approved by HCD for the term of the permanent financing;
- No more than 20% of the total development cost of a limited equity mobile home park . . . is provided by purchasers of membership shares;
- A regulatory agreement . . . for a term of at least as long as the duration of the permanent financing . . . has been executed between the coop and either federal or state agencies or the local public entity providing financing (standards are set by HCD):
The regulatory agreement shall:
- Include assurances of completion,
- Include governing instruments providing for control by the members,
- Provide for ongoing fiscal management of the project,
- Include complete membership reports in detail,
- Require that the entity which executes the regulatory agreement must review and sign off as approved all coop documents,
- Require that an attorney opinion letter be provided stating that the coop meets requirements of Health and Safety Code Section 33007.5 and the exemption provided by Business and Professions Code Section 11003.4.
Finally, if the developer elects to be governed by this code section then it can achieve the exemption but must still file a claim of exemption with, and obtain approval of the Department of Real Estate.
Under California non-profit corporate law, there can be no distribution of corporate assets to members, except a qualified LEC may allow membership to be purchased and sold so long as the corporation is organized under Health and Safety Code Section 33007.5.
As pointed out above, except for membership transfers which are limited the assets of an LEC upon dissolution or sale goes to the state or another public benefit non-profit entity.
In summary, the LEC is of very limited use and is generally favored in situations where dealing with low income housing for the vast majority of residents and not for a large mobile home park where the broad spectrum of income levels are presented. If the memberships are sold in an LEC, the results are often linked to the home prices in one of several ways. The regulatory agreement which must be approved by the state will either limit sales prices directly or limit sales to persons of like income which may be acceptable to members, but they need to be so addressed before venturing down this rather tenuous road.
Some may ask if all the funding we need from those selected sources is $100,000 why not do this. The response is look at the regulatory agreement first and then if you really mean to limit the membership price, you can also look at the use of a mutual benefit non-profit corporation as a substitute.
With the mutual benefit non-profit corporation, you can without government control, obtain financing of membership and still obtain financing through the state and local government sources. Just be sure you examine the full impact of the LEC before you proceed. The mutual benefit non-profit corporation will be separately discussed in this series of articles.
Gerald R. Gibbs, President, The Gibbs Law Firm, APC
About The Gibbs Law Firm, APC
The Gibbs Law Firm, APC has represented clients in all aspects of Real Estate and Business Transactions for more than 33 years from its office in San Clemente. Gerald R. Gibbs, and his son David Gibbs have a combined 48 years experience representing mobile home park owners and residents in a variety of legal matters, specializing in the sale of parks to its residents. Mr. Gibbs is generally acknowledged as one of the pioneers in the field of mobile home park conversions and subdivision, having represented Cities and other local jurisdictions, park owners, nonprofit entities, resident groups, and having testified in court and before legislative and administrative bodies on the subject of mobile home parks and conversion. Mr. Gibbs has worked with other industry leaders on shaping the legislation governing park conversions. For more information about this transaction or about the firm, please call David L. Gibbs at (949) 492-3350.