Fractional home ownership and land use regulation

The community is buzzing about Pacaso, the new, well-funded corporation offering fractional home ownership. Already challenged by AirBnB, vacation rentals and vacant second homes, residents are justly worried about Pacaso and its approach to home ownership and how it will affect neighborhoods. A neighborhood without stable neighbors ceases to exist.

The Pacaso model presents some unique legal challenges to land use regulation. Customarily, government can regulate land use but not land ownership. Land use is regulated through zoning, the assignment of allowed uses in particular areas or parcels of land. In Sonoma, residential zoning does not allow commercial uses, for example. Because AirBnB short-term vacation rentals are a commercial use, they are banned in Sonoma’s residential zones.

Pacaso, however, argues that its fractional home ownership model is not a commercial use, and therefore not subject to land use zoning regulations. By purchasing a residence, forming an LLC that holds the deed, and offering one-eighth shares in the LLC to unrelated parties who then each can schedule time living in the residence, Pacaso claims it is simply fractional ownership, not a commercial activity. It’s a murky approach and legally complicated.

From Pacaso’s point of view, one can argue that it’s not unlike a home that’s inherited by eight children from their parents. In such a situation, the eight siblings can arrange how to share the home between themselves. Government, Pacaso might argue, has no right to regulate the use of the home just because it is jointly owned by eight siblings, and how and when the siblings choose to use the home is their business.

On the other hand, Pacaso is soliciting offers from unrelated parties to buy shares in an LLC, and this appears to have more in common with the sale of a security, like stock, than true home ownership. Each home offered is akin to offering an IPO in a new LLC corporation. And Pacaso has a continuing relationship with the shareholders, providing software to schedule the sharing of the home and other services. When stock is sold by an underwriter in an IPO, it is a commercial relationship and highly regulated; a prospectus outlining all risks must be provided, and investors must be qualified. Thus, government could argue that Pacaso is engaging in a commercial activity, and its use of residential property in residential zones could be deemed unlawful.

Unfortunately, resolving this matter will require lengthy and expensive litigation. Pacaso is already suing the City of St. Helena, arguing that St. Helena’s use of its ordinance banning time shares in residential zones is illegal because joint home ownership is not a time share. Like many legal issues, this one may come down to which party has the deepest pockets. From all reports, Pacaso has access to enormous capital, and given that their entire business model is at stake, will most likely pursue legal avenues aggressively.

In the meantime, cities like Sonoma and entities like Sonoma County are unprepared to resist Pacaso’s incursions, and Pacaso will continue to buy homes and offer them to investors. It’s possible a court ruling to enjoin Pacaso from continued activity until the underlying legal issue is resolved might be issued, but that will require legal action on the part of government. It’s likely to be a long and costly fight, and may well end up in the California Supreme Court, which will have to decide whether Pacaso is engaged in commercial activity or not. Don’t hold your breath.