New California Law Tracks Federal Financing Restrictions on Transfer Fees

Last session, California passed California Civil Code Section 1098.6 prohibiting the creation of new transfer fees effective as of January 1, 2019, unless the fee provides a “direct benefit” to the property, as defined under federal regulations.

A “transfer fee” means any fee requirement imposed by a covenant, restriction, or condition contained in any deed, contract, security instrument, or other document affecting the transfer or sale of real property (or an interest in real property), that requires a fee to be paid as a result of a transfer of the property.  Traditionally, a transfer fee would be instituted by a master community developer to underwrite the community homeowners association’s ongoing costs to manage the community. Unfortunately, some developers started treating transfer fees as a permanent source of income and began implementing them even where they would not be used to manage the community. This abuse gave rise to Civil Code Section 1098.6 last year and, earlier, certain federal regulations limiting federal financing of property encumbered by transfer fees that do not benefit the property.

In the conservation easement arena, a transfer fee is sometimes incorporated into a conservation easement by the easement holder as a means of funding monitoring and enforcement costs, which may increase due to a change in ownership. However, many land trusts do not earmark the transfer fees received for a specific property, but rather add the funds to the organization’s general account. Land trusts should take note that, for transfer fees in conservation easements recorded after January 1, 2019, any fees received should be earmarked for the particular property for which the fee was received. Otherwise, the fee provision may not be enforceable per Section 1098.6, because it will not provide a “direct benefit” to the property.

As defined under Federal Housing Finance Agency (FHFA) regulations, “direct benefit” means either:

(a) the proceeds of a transfer fee are paid to a “covered association” and used exclusively to (i) support maintenance and improvements to the encumbered properties and/or (ii) acquire, improve, administer, and maintain property owned by the covered association of which the owners of the burdened property are members and used primarily for their benefit;  or

(b) the proceeds are used for cultural, educational, charitable, recreational, environmental, or other similar activities that are conducted to protect the subject property or contiguous/adjacent property, or other property that is used primarily by residents of the burdened property.  [emphasis added]

The FHFA regulations define “covered association” to include nonprofit mandatory membership organizations made up of owners of interests in real property, charitable organizations under Code Section 501(c)(3), and social welfare organizations under Code Section 501(c)(4). Even though a land trust would fall within the definition of covered association, the fee received by a covered association must support the subject property or other property used primarily for the benefit of the landowner. This means that if a land trust wishes to include a transfer fee provision in an easement, that transfer fee must be used to directly benefit the property and land trust will need to separately account for those funds.

The purpose of the FHFA regulations reaches back to 2008 when the FHFA was created to regulate and strengthen federal oversight of Fannie Mae and Freddie Mac following the foreclosure crisis.  The regulations prohibit Fannie Mae, Freddie Mac, and the Federal Home Loan Bank from purchasing mortgages on properties encumbered with a transfer fee unless the fee conveys a direct benefit to the property. Due to the fact that these government-sponsored enterprises purchase or back approximately 60 percent of private mortgages, the effect of the federal prohibition was to make it increasingly difficult for master community developers to institute transfer fees on the community’s parcels, since buyers would find it difficult to obtain mortgage financing.

In California, before the passage of Section 1098.6, developers and land trusts could nonetheless incorporate transfer fees where the buyer or landowner would not be seeking financing. Now, regardless of financing, a transfer fee will be unenforceable unless it will directly benefit the subject property.