Builders and Developers Should be Wary When Relying on HUD’s Single Family Residence Exemption


In our many years of experience in advising clients on the application of the Interstate Land Sales Full Disclosure Act (“ILSA” or “ILSFDA”), we have heard a multitude of incorrect theories from developers and builders as to why they do not need to register with HUD.  For those developers and builders who have heard of the ILSA, we have been told countless times that they have been told by local counsel, sales managers, marketing personnel and others that they comply with an exemption from the registration requirements of ILSA.  One of the most commonly sought ILSA exemptions is the Single Family Residence Exemption (“SFRE”).  Unfortunately, many of the offerings we have reviewed for developers and builders who thought they qualified for this exemption do not comply with every requirement of the SFRE.  As a consequence, these developers and builders run the risk of losing prior sales, having to return deposits and buy back property from purchasers. 

 

It is incorrect to assume that simply because “everything is in” that you comply with the SFRE.  Have you conducted marketing programs where you offer discounts on travel, hotel or golf if purchasers visit your subdivision and sign a purchase contract?  Did you know that such offers are prohibited if you are relying on the SFRE?  Do you provide an estimate in your purchase contract as to how much it would cost the owners association to maintain the roads over the first ten (10) years?  Is the subdivision property zoned for single-family residential use only?  Are you sure the subdivision is zoned residential?  These are just a few of the problem areas we deal with all the time.  Failure to comply with any of these requirements (and others) can negate the exemption, allowing purchasers to demand their money back for up to three (3) years after they sign their purchase contracts.  This rescission right survives closing.

 

The SFRE's requirements are strict and fall into two distinct categories: 1) subdivision requirements and 2) lot requirements.  Importantly, a developer must comply with every requirement of the SFRE in order to take advantage of this exemption.  If you have been told you qualify for the SFRE, you may wish to reconfirm compliant status or seek a HUD advisory opinion; otherwise, the sales you made could be at risk for rescission actions by purchasers.

 

ILSA, as well as its regulations outline the criteria for each of the requirements.  The following is a brief description of the various requirements of the SFRE.  Because each requirement has its own specific elements, we urge developers interested in seeking the SFRE to discuss this exemption with counsel to ensure a proper analysis of your subdivision offering is performed.

 

Subdivision Requirements:

  1. Local standards compliance.  The subdivision must comply with all subdivision development standards mandated by your local government.   
  2. Uses of gifts, trips, dinners or similar promotions are NOT permitted in the promotion of the subdivision.  In the promotion of the subdivision there can be NO offers, by direct mail, telephone, email or website offerings, of any gifts, trips, dinners or use of similar promotional techniques to induce prospective purchasers to visit the subdivision or to purchase a lot or unit. This restriction encompasses popular “discovery” packages, “buy and fly” programs, discounts at hotels or at local golf courses and similar promotions.  If a subdivision is properly registered, or qualifies for a different ILSA exemption, these marketing techniques may be permitted; however, if a developer is relying on the SFRE, then these marketing techniques may not be used and could void the applicability of this exemption.

 

If you are able to pass the Subdivision Requirements threshold, you can then move forward to the specific Lot Requirements of the SFRE.  If you fail to satisfy ALL the Lot Requirements you will either need to register the subdivision with HUD or comply with a different exemption. 

 

Lot Requirements:

  1. The subdivision must be regulated.  The ILSA regulations specifically enumerate those areas of development that must be regulated; if any of those areas are not regulated by your local municipality, county, or state then you will not satisfy this requirement. In many rural counties, minimum standards for lots are not specified.  There are often ways to meet these requirements without local standards, but such are complicated and must be established prior to commencing sales. 
  2. Zoned for single family residence.  Each lot must be zoned for a single family residence by the unit of local government.  If there is no zoning ordinance, then you may look to covenants or restrictions that limit the use to single family residences.  Properties zoned agricultural or other categories do not qualify even if covenants limit the use to single-family residential purposes.  As a consequence, this requirement must be reviewed carefully to ensure strict compliance.   
  3. Lot situated on a paved street.  The lot or unit must be situated on a paved street or highway which has been built to standards established by the State or unit of local government.  If the roads are not complete when the purchase contract is signed, there are additional financial assurance requirements.  There are specific guidelines as to the completion, composition and maintenance of the roads as well. 
  4. Maintenance of the streets and roads.  Either the local government or an owners association must have formally accepted or be obligated to accept the maintenance of the roads.  If the association will maintain the roads, you must provide purchasers with a good faith written estimate of the cost of carrying out this responsibility over the first ten (10) years of ownership.   
  5. Utility services.  At the time a purchaser is scheduled to close on their lot or unit, water sewer, and electric lines must be extended to the lot or unit.  If they are not extended, then the local government must be obligated to install them within 180 days after closing.  This requirement often generates confusion for developers, which results in their failure to comply with it.  It is not sufficient for a developer to post a bond or letter of credit with the county to satisfy this requirement.  Additional restrictions may apply if the subdivision is one in which buyers will use wells or septic systems. 
  6. Delivery of deed.  The purchase contracts must state that a warranty deed will be delivered within 180 days of signing the purchase contract.  This time period cannot be qualified or modified in any way.   
  7. Title binder or title opinion at closing.  At closing, a title insurance binder or title opinion reflecting the condition of title must be in existence and issued or presented to each purchaser.  The title binder or opinion must reflect certain representations as specified in the regulations.  
  8. Personal on-the-lot inspection.  The purchaser or his/her spouse must make a personal inspection of the property prior to the signing of a purchase contract.  You must be able to show this by independent evidence. 

 

While some condominium developers believe they comply with the SFRE, upon even a cursory analysis these developers fail.  Remember, failure to fully comply with each and every requirement of the SFRE can negate the exemption and keep developers exposed to rescission for up to three (3) years after a buyer signs his/her purchase contract, even if a deed has been delivered.

 

For developers who believe that they comply with the SFRE, we recommend obtaining a HUD advisory opinion which can at the very least provide guidance as to whether the developer’s belief is accurate.  Although HUD advisory opinions may not be relied upon in a court of law, a HUD advisory opinion can be a useful vehicle to determine what steps need to be taken to comply with the SFRE and other ILSA exemptions.   

 

Should you have further questions or need an evaluation as to whether you comply with the SFRE or other ILSA exemptions, please contact Frank Carmel at fcarmel@carmel.us or (202) 237-1700.