For millions of Americans, “home” is a condo. There are roughly 6.2 million financed condo units, according to RealtyTrac, and with the publication of new Federal Housing Administration (FHA) rules on Nov. 13, they should now be easier to finance and refinance. With financial barriers reduced, condo sales and values will likely get a boost and that’s good news across the housing market.
But has the FHA gone far enough? The new FHA rules are both “temporary” and unlikely to fully please the housing industry. For many the changes could have been far stronger and the result is that the matter may well be fought out on Capitol Hill.
Title to a “little house with the white picket fence” is usually in the form of what is called “fee simple” real estate. That means the owners own both the property and any “improvements” on it such as a house. Fee simple owners have the largest possible “bundle of rights” for the property — within local zoning and housing laws they can finance and refinance it as they like, rent it, remodel it, or use it only on Tuesdays. The owners can paint it puce if they like and the neighbors can do nothing more than shield their eyes. Most importantly, those who own fee simple real estate can easily get financing because the rights of ownership are so clear.
In contrast, a condo typically represents a form of shared ownership. Condo owners hold exclusive title to the unit in which they live plus they have a non-exclusive right to all common property. In turn, condo owners agree to abide by the rules of the condo association as a condition of ownership. This means the condo association can determine when the pool will be open and what architectural restrictions will be in place.
Financing a condo is a lot more complicated than financing a fee simple property because now the lender wants to see not only the owner’s information but also condo documents and budgets. Is the association solvent? Does it have reserves? What percentage of the units are rented? What percentage of the units are in foreclosure? Does the association have adequate liability insurance for common areas? Is the unit subject to a huge “special” assessment?
These questions are important because the financial stability of a condo unit is not solely related to the owner. If enough units are foreclosed then the condo association will not collect the dues it needs to fund the amenities and common areas and that means lower values for the lender’s collateral. Or, if a large percentage of units are rented then all properties will be treated as investment real estate, including those which are owner occupied. In that case new buyers will need to finance with investment mortgages even if they intend to occupy. Since investment mortgages typically require 10 or 20 percent down versus 3.5 percent for FHA financing, individual unit sales and prices will take a hit if the entire condo project is defined as “investment” property.
Industry FHA Complaints
For a very long time the real estate industry has complained about FHA condo standards and with good reason: according to the National Association of Realtors “FHA data show approximately 60 percent of condo projects seeking approval in 2013 were denied, that’s up from 2011 when only 20 percent of projects were denied.”
Why are so many condo projects denied FHA approval? According to NAR the top reasons for denials include “financial instability, pending litigation, insufficient insurance coverage and outdated or missing documentation, among others.”
Access to FHA financing is hugely important because FHA loans are often the best form of financing available to first-time buyers and individuals with limited incomes. If a condo project does not qualify for FHA financing then the pool of potential buyers is far smaller so there is less demand and thus less pressure to push up prices.
Alternatively, if the FHA has to have special condo rules — and it does because condos have different ownership and financial characteristics when compared with fee-simple ownership — can the rules be loosened without driving up FHA insurance claims?
New FHA Condo Standards
On Nov. 13, HUD announced new FHA condo qualification standards — with the stipulation that they were “temporary.”
In Mortgagee Letter 2015-27, HUD described three condo rule changes.
First, the recertification process has been eased. Now, says HUD, it will no longer require a complete document package every two years but only paperwork showing important changes since the last approval.
Second, the standards change the way the owner-occupancy percentage is calculated. HUD still requires that at least 50 percent of all units must be owner-occupied, but now HUD says all units will automatically be non-investment properties unless they are tenant occupied, listed for rent, vacant and listed for sale, or under contract to an investor. If a condo unit is used as a vacation property it will be considered “owner-occupied,” a big deal in Florida and other vacation areas.
Third, the insurance standards for homeowners’ associations (HOAs) have been eased, something which should cut costs.
The changes made by HUD are unlikely to satisfy industry players. Normally after a HUD announcement that pleases the housing sector reporter mailboxes are filled with glowing news releases which praise the brilliance and insight of government officials. This time the reaction has been muted, all of which brings us to the industry fall-back position, H.R. 3700.
A few weeks ago, before the HUD changes, industry leaders were on Capitol Hill to support H.R. 3700, the “Housing Opportunity Through Modernization Act of 2015.” Sponsored by Rep. Blaine Luetkemeyer (R-MO), the proposed legislation would reduce the required owner occupancy level from 50 percent to 35 percent, meaning that a condo owner could still get FHA-backed financing even though most of a project’s units were rented out. Also, the bill would make it easier to get FHA financing when as much as 50 percent of a project’s floor space is used for commercial purposes. This latter provision is designed to encourage the development of mixed-use projects.
“H.R. 3700 includes changes to FHA policies that will give current owners and potential buyers of condos access to more flexible and affordable financing and a wider choice of approved condo developments,” said NAR President Chris Polychron in Capitol Hill testimony.
The Luetkemeyer bill if passed would substantially change the condo market. For instance, at this time Fannie Mae and Freddie Mac require investment financing for projects where 51 percent of the units are rentals. If the FHA policy was at 35 percent, then a huge number of condo loans would flow into the FHA program.
It’s often hard to predict how proposed legislation will fare but H.R. 3700 is likely to get a serious review. Why? Despite headlines to the contrary, the economy remains fragile, condos represent about 9 percent of all mortgaged properties, and the housing industry could still use help, especially help which does not cost taxpayers a dime.