Palm Springs calls Pacaso a timeshare, orders it to cease operations

The City of Palm Springs has issued a letter to fractional ownership real estate company Pacaso saying it considers the business a timeshare operation.

The letter, sent in early December and obtained by The Desert Sun through a public records request, orders Pacaso to cease operations in the city "immediately." It calls Pacaso's position that the city's timeshare ordinance doesn't apply to the company "not legally tenable."

The city letter includes several other complaints against Pacaso, including that the company does not have a business license and has not paid any business tax to the city, that its model worsens the city's "affordability crisis" by taking homes off the market that could be resided in full time and that its creates end-experiences for many residents similar to short-term vacation rentals.

The Palm Springs letter has far-reaching implications for the $1.5 billion real estate investment and management company.

Timeshares are banned or heavily restricted in many areas across the country, including much of the Coachella Valley. A broad consensus that Pacaso is a timeshare operation could push the company out of many of its key markets or force major fundamental changes to its business model.

Pacaso has vehemently denied that its fractional ownership model is akin to a timeshare. The company sued the Nappa Valley city of St. Helena last year when that municipality called its model a timeshare and ordered it to cease operations.

That lawsuit is still working its way through federal court, although a judge dismissed part of it in the fall in a minor win for the city.

Pacaso spokesperson Colin Tooze declined to discuss the letter or how the company was addressing the issue, and noted simply that "we've been encouraged by the positive dialogue we've had so far, and the opportunities it has provided to educate stakeholders on the benefits of co-ownership while allowing us to address any concerns."

The Pacaso representative said his company looked "forward to continuing to help aspiring buyers to own a second home in Palm Springs."

The company hired a lobbyist to help it deal with the letter, according to a lobbyist registration statement filed with the city on Jan. 26, although it's unclear what, if anything, that individual has done so far.

Pacaso still had at least three Palm Springs homes on its website Tuesday, indicating that it has not complied with the city orders to cease operations.

Palm Springs city representatives did not immediately respond to requests for comment regarding whether they had taken — or planned to take — any enforcement action against Pacaso.

What are the city's complaints?

Founded by former Zillow executives, Pacaso's business model centers on buying high-end homes in popular vacation markets and selling shares in them to investors. These homes are purchased under newly-created limited liability companies, or LLCs, which serve as the financial vehicles for the Pacaso transaction.

Once all shares in a home are sold, Pacaso transitions to a property management role. It arranges service and maintenance on the property and coordinates co-owners' use of the home through a digital scheduling platform. Pacaso charges a $99-per-share monthly fee for these services, which serves as a secondary source of revenue for the company.

Owners of Pacaso shares are allowed to book use of their homes up to 44 days per year, per share. Each share entitles owners to one "special date" per year, which includes peak-demand periods such as Christmas. Pacaso owners are not allowed to rent their homes for any length of time, although they can give their allotted time to family or friends.

The company says this fractional ownership approach makes second-home ownership achievable for a wider range of people, democratizing access to real estate investment and wealth-building.

It has also proven popular among investors, driving breakneck growth for the company. Over its roughly one year of existence, Pacaso has expanded to popular second home markets across the U.S. such as Napa Valley; Miami, Florida; Aspen, Colorado and Lake Tahoe and established a toehold in Europe last fall.

The Coachella Valley has been an important market for Pacaso, which has bought properties in Palm Springs, Palm Desert, Indian Wells and La Quinta.

Despite this growth, Pacaso's fractional ownership approach has been controversial. Some observers — now including the City of Palm Springs — have said this model is not materially different than a timeshare.

Timeshare arrangements can vary significantly, but the basic concept is that a buyer is purchasing the right to use a vacation property for a specific length of time and frequency. While still popular in many vacation destinations, they have become notorious for hidden fees and predatory sales practices, which leave owners financially drained over time from what they mistakenly thought was a real estate investment.

In their best form, "deeded timeshares" give owners the right to a specific vacation rental unit for a specific week each year. In an article under the heading "Timeshares, Vacation Clubs, and Related Scams," the Federal Trade Commission notes that these deeded timeshares are legally "considered real property that your heirs may inherit."

In its letter, the City of Palm Springs said Pacaso meets the definition of a timeshare as detailed in its municipal code, citing the following definition:

"Purchasers of a Pacaso LLC receive the right, in perpetuity or some other period defined in the LLC agreement, to the recurrent and exclusive use of the lot on which the residence is located," wrote city attorney Jeffrey Ballinger in the letter. "The right to such use is on some periodic basis, for a period of time that is allotted under the LLC agreement."

"Thus, by its terms," Ballinger continued, "the City’s ordinance applies to a use such as Pacaso’s. As such, Pacaso’s operations are not permitted in single family-zones within the City of Palm Springs, California."

The city letter cited a range of factors justifying the ban on timeshares in single-family residential zones, chiefly issues relating to housing affordability and negative impacts on nearby residents' quality of life.

"For every house that Pacaso sells to one of its limited liability corporations to be used as a second vacation home, that house becomes unavailable to a buyer or renter who could live there full time," wrote Ballinger. "This necessarily reduces the amount of housing stock that is available for full-time residents in the city. The reduction in housing stock, in turn, feeds the affordability crisis, making the remaining houses within the city more costly."

The city argued that Pacaso's model would also create "secondary effects" on neighborhoods similar to short-term vacation rentals, with multiple different occupants, guests and cleaners cycling through a home in a week.

"To a neighbor, that impact is very much the same as if the occupants were short-term vacation renters," wrote Ballinger.

In a Jan. 21 response letter sent to the city, Pacaso disputed the timeshare classification and pointed to a different section of Palm Springs municipal code indicating that timeshares are divided into 12 or more time periods.

"On its face, the city’s ordinance does not apply to Pacaso," wrote Pacaso attorney Bruce Bauer in the letter. "The ordinance only applies to entitlement to use or occupy any real property or portion thereof has been divided into twelve (12) or more time periods of such rights or entitlement. As pointed out above, Pacaso’s model does not divide the real property into time periods and title to the home is vested in the LLC, which is owned by a maximum of eight co-owners."

The company also said the shares it sells in its homes were "starkly different" from timeshares, and provide owners "a real property asset in a single-family home that includes real property interests, rights and obligations, such as the right to possession, to control, to use and quiet enjoyment, to privacy and to exclude others, to sell the property, to make improvements or refurbish the property."

In response to the charges that Pacaso had not obtained a business license or paid business tax, Bauer argued the company did not meet the definition of a business that required a license under Palm Springs municipal code. He cited the definition reading: "'Business' includes professions, trades and occupations, and all and every kind of calling whether or not carried on for profit."

"That definition does not apply to Pacaso, nor would it apply to any entity that purchased residential property in the city for its own use," wrote Bauer. "The only function that Pacaso serves is to support owners as a program manager and possible property management services."

Pacaso also disputed the city's assertion that its model reduced affordable housing stock. In its letter, the company argued that it instead helped address the affordability crisis by consolidating second homebuyers into a single residence.

James B. Cutchin covers business in the Coachella Valley. Reach him at james.cutchin@desertsun.com.

This article originally appeared on Palm Springs Desert Sun: Palm Springs calls Pacaso a timeshare, orders it to cease operations