Sub-Prime Backlash?

Will New Lender Rules Cut Availability of Condo Loans?

Last month we asked the question: “Will the sub-prime crisis impact community associations?” (www.condoissues.com, March 20, 2008) We predicted that mounting foreclosures of condominiums and town homes would greatly impact community association budgets as owners abandoned properties leaving unpaid assessments. Lenders holding first mortgages on these properties would have no obligation to homeowners associations to cover these deficiencies, leaving large gaps in association funding.

Now, a new issue is looming. Rules for government-backed mortgages and some private mortgage insurers are being re-written to toughen lending standards for condominiums. ..

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The Board's Dilemma

I had a call the other day from a woman (let’s call her Mrs. X) who was very troubled over recent increases in her homeowners’ association assessment. “I probably can’t live here much longer if this keeps up!” she said. Turns out the board of directors had raised the assessments by 20% on top of similar increases a year ago. They also levied a special assessment to fix some unexpected problems with the buildings. “You know what they did when I complained?” She said, “They handed me your book and said to read it!” She was referring to the treatise we wrote a couple of years ago entitled “The Uncertain Future of Community Associations” (See link on the left) a discussion of the perils of under funding association reserves. According to my caller, the board was using the book as at least part of the justification for the assessment increases...

Read the Full Publication: "The Board's Dilemma" --Click the Title link or Download link on the left...

If Density is the Key to Economic Growth; Are Condos the Key to Density?

We recently wrote that older suburbs may become the new urban cities if public policy in those areas would favor density (See below, "Will the old suburbs become the new urban core?).  Now, Richard Florida, writing in The Wall Street Journal, April 12, 2008 gives us the economic justification for such policies, he states: "...our public policy must work toward, not against, density. Nearly every expert on the subject agrees that innovation and productivity are driven by density. For the better part of a century, we've subsidized suburbanization."  He goes on to show that big cities and economic "mega-regions" are the primary creators of wealth.  Suburban areas with low density populations consume, but rarely produce sufficiently to meet their own consumption. 

If so, condominiums and multi-family rental housing are the key to higher density and conversion of old inefficient suburbs to productive, high energy economic zones. We're talking urban condominiums, however, not suburban projects that spread over acres of open space without proximity to transportation and jobs. Urban, high-rise condominiums fit the model of the new urban areas we discussed earlier, and if, as Florida holds, higher density produces more innovation, then greater use of high-rise housing in an urban environment should be a national priority.

Will the Sub-Prime Mortgage Crisis Impact Community Associations?

How many associations have seen units in their project enter foreclosure? How about yours? For every home that is in default on its mortgage, its a pretty sure bet that the assessments on that unit are also in default. Worse, however, while the lender might recover a % of its loan upon sale of the unit, the association will likely recover nothing. This is because an association's lien for assessments takes second place to the first mortgage. When the mortgage is foreclosed, so is the association's lien unless the community association takes the highly unusual step of bidding in at the foreclosure sale and buys the property. Otherwise the lien is lost and so is the right to the assessment unless the association wants to pursue the delinquent owner personally. Bankruptcy, or just plain disappearance of the owner can prevent even that, so the chances of recovering a delinquent assessment when the owner has no equity in the property are slim to none. This is not a small problem. There are over 200,000 community associations in California and many are in areas where foreclosures have risen rapidly. If your association has been effected, please tell us. We will be watching this situation closely in the weeks to come. 

Community Maintenance Trusts--Could They Make Maintenance More Affordable?

It isn't often that a complex problem can be solved with a relatively simple solution, and the criticism of skeptics is excused until the problem is truly solved-but a simple solution to the problem of providing new affordable housing, and saving existing projects, may be at hand...

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Who are the Brains behind the Housing Crisis?

by Tyler P. Berding

Market melt-down! As I write this, the DJIA is down over 200 points this morning alone, and has dropped almost 15% from its high last year. The news is thick with comment about the possibility of “recession.” The economy has supplanted the Iraq war as the most talked about issue in the presidential campaign. The pundits know how all of this got started: the bursting of a housing bubble fueled by cheap and available mortgage money with few rules in place about who could borrow it. Worse, usually reliable and successful investment banks packaged these questionable loans into securities that were sold to a huge number of investors all over the globe for enormous sums of money. And now the bubble has burst, the loans are in default, and the securities are becoming, if not worthless, at least worth a whole lot less than they were six months ago.

And it doesn’t end there of course. Without loans, no one is buying houses. As housing sales tank, developers and lenders lay off employees and tighten lending so consumer purchases can no longer be financed, leading to further layoffs in other industries, and eventually, if it gets bad enough, to a recession, where “deflation” replaces “inflation” or even modest rises in consumer prices, leading to more fall off in consumer spending, etc, etc. In the meanwhile, all of this scares the bejeezus out of the stock market and investors pull out leading to further price dives in a broad base of securities, scaring people even more and causing them to hold back on purchases, and on and on until somebody does something, usually the government with various “stimulus” packages, to get the economy going again. The process can take anywhere from a few months to a couple of years, depending on the depth of the slowdown.

In the meanwhile, of course, people lose their jobs and maybe their homes, businesses fail, retirement funds shrink, and the economy and the mood of our nation and perhaps other nations, is depressed and ugly. Candidates and other politicians blame each other, the private sector, and whoever or whatever else is handy and culpable. Most of the parties upon who the blame will be hung are, in a sense, “innocent” participants in the entire process, but there are some who certainly should have known better. So, where are the brains in this outfit?

We send our best and brightest young people to Wall Street to learn investment banking and figure out new ways to attract investment funds and enrich their firms and themselves. Usually, many are successful and the economy and the country benefit from this economic stimulus that creates capital for investment in new industry, thus creating jobs and purchasing power. So what happened here? Who were the “brains” behind this housing crisis? Which genius or geniuses decided that it was prudent or even smart to lend to people who could not afford to repay their loans and then use those loans as security for other investments? Wasn’t a crash inevitable under those circumstances?

The lenders and the investment bankers knew in advance that certain borrowers were not credit-worthy; would not have sufficient incentive to repay their loans; did not have the income necessary to meet the projected payments, and yet, in what can only be considered a mass delusion, made these loans anyway. Was it greed? That’s a tempting thought, but even the greediest money managers can sense a disaster in the making and find ways to avoid it--perhaps like not making the loans in the first place? No, that would be too simple. I think it’s more a case of a lot of professional people who were too used to believing in the infallibility of their decisions coupled with the pressure to churn out enormous profits to keep their positions intact. A form of “greed” to be sure, but way more sophisticated, at least on the surface. Here we have a large number of very smart people who perhaps were too insulated from the real world. Maybe a sabbatical as a board member of a community association, especially one that now is suffering many foreclosures, would bring them back to reality.

 A quote from Warren Buffet in his annual letter to investors:

"As house prices fall, a huge amount of financial folly is being exposed. You only learn who has been swimming naked when the tide goes out--and what we are witnessing at some of our largest financial institutions is an ugly sight."

Amen.

When Market Value Slips Out the Back Door

Are Owners stealing value by underfunding reserves and then selling out?

By Tyler P. Berding

We have written a lot on these pages about the damage that reserve underfunding can do to a community association. For ten years we have tried to focus attention on the long-term effects of failing to adequately save for the inevitable reconstruction or replacement of major building components. Nevertheless, we still see every day examples of what happens when a board fails to budget to meet these needs. Associations with less than half of the funds needed for a major re-construction project are common. Associations with no funds at all are less common, but becoming more so all the time. Other authors have also discussed this topic over the last few years, so it's not just our imagination!

With the evidence of underfunding so widespread, what I have not been able to fully understand is why more owners have not raised this issue with their boards. Why hasn't the subject of failing to fund proper maintenance and repair been raised at election time as a reason for turning out the board? After all, a properly funded budget adds real value to all of the units in the project. The answer is simple. No one likes to spend money, no one likes higher monthly assessments, and the condition of the reserve fund is often too esoteric of an issue to be fully understood by either boards or owners. Also, the pressure to keep assessments low easily outweighs any concern that might exist over the condition of the building until it gets so bad that no one can hope to sell their unit at anything close to market value.

I recently ran across the following quote in a memo from the Department of Real Estate:

"All condominium associations face the problem of high and ever increasing costs to maintain a condominium project, including reserves. To compound the problem, a number of condominium boards cannot, or will not, make 'hard and unpopular' decisions of raising maintenance fees to meet this problem and facing any criticism.

The law requires condominium association boards to study the project's particular maintenance and replacement needs of the common elements and to collect and establish reserves so that funds will be on hand when repairs and replacements are needed as well as emergencies. The law was enacted to provide relief for the vast majority of condominium associations, although a good number of well-managed condominium associations were already providing for reserves. If the reserves are properly calculated, each owner's share should only be what the owner ought to be putting aside each month for the true cost for
repairs and replacements. The law tries to prevent owners from taking value out of a condominium property by underfunding reserves, selling out, and leaving subsequent purchasers to pay for the underfunding...

Any delay in confronting and controlling reserve situations will not change the condominium association's need for repair or replacement or the common elements nor the need for funds. The Commission's research reflects that those condominium associations deciding on 50% funding of reserves and/or are substantially underfunded, especially if they face
major common area repairs and replacements in the near future, will have to dramatically increase maintenance fees, make special assessments and/or take out a loan."

Pretty timely stuff, right? Nope. That memo was written thirteen years ago, in 1995--By the Hawaii Real Estate Commission. The problem has obviously been around for a long time, and not just in California. Two statements from that memo stand out. Those associations that have decided to only fund their reserves at 50% or less had better start looking for alternate funding. It cannot be put off forever, and underfunding cannot usually be made up by merely increasing monthly assessments alone. It's too late for that ten years down the road. Special assessments coupled with bank loans (which also require monthly payments) are usually necessary, making the financial hit on the then owners that much greater and make units harder to sell.

But the statement that really had an impact on me was this one:

"The law tries to prevent owners from taking value out of a condominium property by underfunding reserves, selling out, and leaving subsequent purchasers to pay for the underfunding...."

That's exactly what happens when an association bends to political pressure and tolerates an
assessment level that is less than what is necessary for predictable maintenance and repair. The board allows current owners to take value out the back door by passing on the liability to future owners. The seller has taken value by failing to pay his share of the maintenance
and repair costs.

You could argue that the condition of the building and the budget will be reflected in the sales price. Perhaps it will be, if the seller's disclosures are adequate and/or the buyer is sophisticated enough to ask the right questions. However, more often than not none of this is apparent to the average owner who simply assumes everything is as it should be and no discount on the asking price is demanded. Underfunding should, however, be quite obvious to board members and managers who have a better working knowledge of the true financial health of the association. Their duty is to present and future owners when determining the proper level to set reserves.

So how do boards discharge this duty? By not permitting owners to walk away with value they didn't pay for. The way to do that is always the same: raise monthly assessments enough to reflect the true cost of ownership regardless of political pressure. Anything less is the easy way out.