Hang Together or Hang Separately?

Selling a Distressed Common Interest Development

as a Single Parcel: Is Partition an Alternative

to Losing it to Individual Foreclosures?

To view the future of many common interest developments take a look at the present-day reality of those recent condominium conversions that were born with serious maintenance issues and a major cash deficit. The financial condition of these projects shows us what other associations will encounter as their need for maintenance and repair overwhelms their budgets.

If an association cannot pay for essential maintenance, the value of the units will drop, similar to the recession-caused loss of value today. But they will fail to sell notwithstanding lower asking prices, and the owners, many now under water, will stop paying their assessments. When the association gets to the point where it cannot pay for essential services or do critical maintenance, the local municipality will have to decide if the units remain habitable. If the answer is “no,” condemnation may be next step.

But the owners may not have to wait for the local municipality to act. The O’Toole case which was discussed in a previous post (November 17, 2008) decided that a board of directors of a community association not only has the obligation to pay the debts of the association, it also has a duty to specially assess the members sufficiently to pay those debts, and not only that, a receiver may be ordered to insure that these obligations are carried out. So then the question arises--what if an owner decides to sue the association for failing to adequately maintain the project and the owners cannot afford the special assessment levied to pay the resulting judgment? If a court orders an assessment that the owners cannot afford, the next logical step would be for the court-appointed receiver to initiate foreclosure of the properties to collect the unaffordable assessment!

Whether this is a likely scenario or not is irrelevant--it is one of the few legal options available if a court-ordered assessment were to exceed what the owners have the ability or the willingness to pay . With no way for the homeowners to satisfy the court judgment, foreclosures would no doubt ensue. If the owners could not afford the assessment or if the assessment exceeded their equity, (again not surprising, especially in the seriously depressed market that exists today,) a court-appointed receiver may have no choice but to empty out the development, substituting banks or other lenders in place of homeowners and most likely turning the property into a rental apartment that would be owned and maintained by the foreclosing lenders, who would likely also take a loss on the deal. The court in O’Toole obviously ignored an essential truth--that while it may ultimately be up to the owners to pay for maintenance and repairs, if they lack the cash to do that, the project will likely default to multiple lender ownership and no one will win.

But there may be yet another alternative. In California, and in other states, there is a legal remedy for an obsolete common interest development, its called "Partition." Now, "partition" may sound like division, but actually it allows an entire project to be ordered sold as a single parcel. California law allows partition of a community association in one of three instances: (1) Material damage or destruction occurring more than three years prior to the partition request and repairs have not been made; (2) At least three-quarters of the project has been damaged or destroyed, and 50% or more of the separate interest owners oppose re-construction; and (3) The project is 50 or more years old, is obsolete and uneconomic, and more than 50% of the owners oppose restoration.

Many associations are approaching the 50-year mark. But even before that, could a seriously deteriorated infrastructure qualify as “material damage” to the point where it would qualify under the statute above? Would a court, looking at a project that has deteriorated to the point of becoming uninhabitable amid claims of improper maintenance, order partition in lieu of ordering the owners to pay an unaffordable assessment? Could a majority of owners force the project to be sold in its entirety to avoid individual liability for such a judgment, and if they did would they realize more value than trying to sell their individual unit in a badly deteriorated project?

The answer is, that in the right circumstance with the right facts: yes. What are those facts? If the special assessment necessary to achieve basic habitability exceeds the ability of the present owners to pay, you may not need anything else. A majority of owners, or a court, could force a partition of the property and sell it as single parcel. We have discussed many times the possible greater value that an older project may have sold or redeveloped as a single parcel than as a collection of individual condominiums.

This situation, played out over time, may await many common interest developments today. They are under-funded for critical maintenance, values have fallen, and owners have no incentive to contribute additional capital. But rather than wait for a judgment creditor or lenders to foreclose, the association should look critically at the possibility of selling the entire project and thus potentially realize greater value from a sale or redevelopment as a single parcel than as multiple individual interests that cannot continue to survive on their own.

This may seem like a draconian reaction to an inability to raise sufficient funds to maintain a common interest development, but if the owners wait long enough without taking any alternative action, their individual interests may become worthless. So rather than watch the project deteriorate to the point where it is no longer habitable or is vulnerable to lender takeover, owners of severely distressed common interest developments might want to consider an outright sale of the entire project.

Clearly, we are talking about a project in a great deal of financial distress, but our experience with hundreds of old and aging projects tells us that some are already there. If you believe that this situation may exist in your association, talk to your legal advisor about your options. Using partition to maximize the value of the project by selling it as a single parcel could be an alternative to handing it over to the banks and walking away.

The "Soft-Story" Problem and Earthquake Safety

Another Issue for Condominium Conversions

A recent article[1] in the Los Angeles Times[2] highlights an old problem that may have new consequences. The Northridge earthquake occurred 15 years ago and many southern California apartments suffered extensive damage as a result. One complex in particular however, was deadly. The Northridge Meadows apartment complex collapsed on January 17, 1994 and killed 16 residents. The collapse was due to a weak first story. Since the Sylmar earthquake in 1971, experts have known about the problem where parking or big windows exist under the upper floors of a building, and there were efforts in many cities to beef up building codes to prevent building collapse in a seismic event.

The article points out that many landlords took steps to perform interim structural repairs, but that in many cases those repairs were not permanent or were not done at all. The small posts, for example that support upper floors over carports cannot withstand the movement that occurs in an earthquake.

“In the case of Northridge Meadows, the magnitude 6.7 temblor caused the second and third floors to crumple right down onto the lower floors, leaving some cars poking out of the sides of the buildings. Its collapse caused the largest number of deaths in a soft-story building. The 16 people who died were on the first floor”[3]

Government agencies have not exactly been on a fast track to force repairs. Fremont is reported to have sent out notices to the owners of 28 apartment buildings in 2007, the year its enhanced codes went into effect, but only two have completed the necessary retrofit. In Berkeley where 320 buildings have been identified with soft first stories, only half have applied for correction permits.

Our concern, however, is for the numerous condominium complexes that have been converted from older apartment buildings. We have seen many that were built before 1994 and some which appear to have soft first stories--mainly where parking exists under the second or more stories of the building. Our experience is that Boards of Directors of community associations responsible for these buildings barely have sufficient funding to do routine painting and roof repairs. The cost of a seismic retrofit is not only unbudgeted, but probably could not be funded short of a large special assessment which would have to be approved by the owners. An expense of that magnitude could be the difference between economic survival and obsolescence.

We recommend that any suspected “soft-story” condition be immediately inspected by a structural engineer. If the conversion has been recently done, the seller may be responsible for the costs of a retrofit if one is necessary. But in any case, the Board and the owners will need assurance that if the “big one” hits the Hayward or the San Andreas Fault, Bay Area communities will not suffer the same fate as they did in Northridge.

---

[1] My thanks to Fred Pilot and Evan McKenzie for providing this article.

[2] Chong, “Quake vulnerability of ‘soft-story’ apartments in state still widespread,” Los Angeles Times, January 17, 2009

[3] Ibid.

A Reader Views the Future of His Community

Jack Denman is a reader and our occasional correspondent and President of his homeowners association. Taking our concerns to heart, Jack has worked hard to stave off the financial obsolescence troubling many associations and of which we have so often written. Here is his account of the success he achieved in convincing members to raise assessments to stay even with the true cost of ownership. But the most interesting part of his letter is his discussion of future redevelopment and how to achieve a positive financial return while greatly improving the project. This is not fantasy--it is a glimpse into the future.  TPB

Tyler,

I became president of the board this year and had discussions with the other members on a monthly dues increase. Over the last nine years I alone made recommendations (and received support) to raise the dues from $186 in 1999 to $250 today. I'm still on the board. Who says that miracles don't happen nowadays!?

Since I knew it could be a "land mine" with the membership, I was able to convince the other members of the board to write a lengthy explanation to the membership to justify the increase. I wrote the original draft and the other members contributed to the final version.

NOBODY COMPLAINED TO THE BOARD ON THE INCREASE!

One member scratched off or scribbled something unintelligible on the first installment of the increase.

I prepared the latest budget because I have the most financial experience on the board. I took the last 8 years of data and did a linear regression analysis on each item and made a calculation, not an estimation on this most recent budget. On a few items I did an average where the correlation coefficient was low.

FYI:
I have included the letter of notification and justification and the latest budget.

It's "all your fault" that we are aging gracefully as a 40 year old association. Soon I will begin to lay the plans for redevelopment when we someday become obsolete. It's a long ways off, and I won't be here, but we should, if future residents are to maintain their equity. My idea for redevelopment is to rebuild from two stories to three, increase the living space by 50% in area, provide subterranean parking to reclaim lost space now consumed by carports, and finally to use all steel and aluminum construction and finally to sell new additional 40 units for enough to cover the cost of construction to the current 40 residents so that they pay nothing. I might look to the city of Fullerton for a bond issue to cover the cash gap until the new 40 units are sold. When the real estate market improves the city might look favorably on a bond because of the future tax revenue from the additional units.

My nephew, who owns a escrow company, and lives in San Diego, said "But where will the people go during the reconstruction?" I told him that they will leave one way or another because of obsolescence. It's only a case of coming back to something better than what they left when it's all over.

Happy New year,

Regards, Jack C Denman

Worshipping At the Temple of Greed: Fraud, Not Stupidity, Caused Our Economic Mess

In March of this year, we wrote a short piece entitled, "Who are the Brains behind the Housing Crisis?" (March 2, 2008) We questioned how so many of our best and brightest young people on Wall Street, from the very finest universities, working for well-respected companies like Lehman Brothers, Goldman Sachs, and Merrill Lynch could err so badly. Later we found evidence that at least one computer program was in part responsible for what we believed were miscalculations. In the article, "Who's Responsible for the Crash?" (October, 2008) we quoted Alan Greenspan who stated that "bad computer models" led to the current economic crisis.

This early analysis gratuitously assumed one trait of those who had a hand in our economic debacle--good faith. Our assumption was that everyone involved believed that they were doing something positive and were somehow victimized by bad luck or maybe a touch of stupidity. We were deluding ourselves. If you look back and begin to tally the now obvious "mistakes," a pattern of intent begins to emerge that doesn't take "CSI" to uncover. 

Start with the mortgage brokers who hawked no down payment, no proof of solvency loans to low and middle income people who would never, ever be able to repay those mortgages. If we heard one ad for such vultures, we heard thousands, day and night. Did they know that they were putting people into homes with loans that were destined for default? How could they not? They were the ones processing the paper, the applications, and dare we say, they were the ones encouraging the fraudulent statements, at the very least, by failing to demand adequate proof of ability to pay, and at worst, by  creating  information they knew was fraudulent.

Continue with the investment houses that packaged this bogus paper into "equity" interests that were then sold as "collateralized securities" which were bought by funds and included in retirement plans, foundations, endowments, charitable organizations, as well as investor portfolios worldwide. Did financial institutions like Lehman, Bear Stearns, Merrill Lynch, and others, just not question the value of the assets underlying these securities, or did they know they were worthless all along, and thus were part of the scheme?

Finally, look at Bernie Madhoff and those around him. No question there. Out and out theft. Fraud of such massive proportions that we can hardly envision it, except that we can't avoid the stories that fill our newspapers and the television news every night. And does it stop with Madhoff? Who knows? And who knows how much more fake gold exists that people believe is real?

Who or what encouraged this mass misrepresentation? Look in the mirror.  The culture of wealth that rose in this country over the past decade  that made all of this possible was embraced by millions of ordinary Americans.  We reveled in their success as if they were rock stars. It had entertainment value. We wanted it. Millions of dollars in Wall Street "bonuses." Wealth beyond anything that we can remember in our lifetimes. And not just in the United States. Arab sheiks building extravagant cities in the middle of the desert that put anything in Las Vegas to shame. Russian oligarchs, growing rich on the ruins of the old Soviet empire, and petty dictators made large and powerful by oil money produced by their otherwise poor and downtrodden nations. A culture of wealth ruled the world and  cash was the dominant icon since at least 9-11.  

The money god that we worshipped as a country has now proven to be false, but it was not until the temple crashed around us, taking a lot of innocent people with it, that we began to question the religion itself. Did our nation, and our government enable people like Bernie Madhoff and the gurus at Lehman, Goldman, and Merrill to do what they did? Yes we did. Did we hold them in high esteem because they were good upstanding individuals who served as role models for our children? No. It was because they created mountains of paper wealth for themselves, but also for others, and for no other reason.

As a nation we have always admired the entrepreneurs, the industrialists, the inventors who could take a creative idea and build an industry around it, enriching themselves, but also millions of working Americans as well.  But this was different. This was not real wealth. This was an ethereal bubble built on imagination to be sure, but without substance and with lots of hype. If you divide a worthless asset into a thousand pieces, are all of those pieces together worth  more than the single worthless asset? Are they worth anything?  No, of course not. And they won't have value even if a hundred economic gurus swear that they do. It's either valuable or it's not, and if the millions of pieces of worthless paper that contributed to this gigantic economic bubble were fraudulent to begin with, selling them from an ivory tower with the blessings and encouragement of Harvard-trained financial wizards won't make them any less fraudulent. Or less worthless.

And what did all of that bring to us? An illusion of wealth to be sure, but also a  flagrant  violation of the respect, albeit falsely derived, of a nation. And now it has been exposed.  Have we learned anything? Can we recover our direction and self-respect? Can we trust our leaders? As recently as this week, we have seen that the massive government bailouts have  apparently opened new opportunities to reward the financial sector with large bonuses, this time using taxpayer cash, shedding new doubts upon our government's ability or desire to grasp the enormity of this problem or its terrible effect on the national psyche.

Maybe this will all get so bad that government will have no choice but to truly crack down on this shameless looting of the public trust and restrain the wretched excess. Perhaps the new administration, with its promise of a major course correction, will impose some much needed regulation and some new ethics and discipline on the financial sector such that it will begin to apply its considerable economic might to rebuilding our sick economy. Perhaps we will begin to worship a proper god once again. 

We'll see.

Your Homeowners Association is Broke

Who do you Pay When the Cash Runs Out?

         We’re living in troubled times. The American economy hasn’t seen anything like this since 1929 and we won’t likely be out of it for several years. Homeowners associations, like the rest of the country, have entered a period of uncertainty, but more to the point, they have entered a period when the cash pool is drying up. Foreclosures, layoffs, bankrupt developers, and owners conserving cash by not paying assessments—it doesn’t matter which, the end result is fewer assessments being paid and way less cash in the association’s coffers.

            Collection actions don’t do much good when the owner is out of work and can barely feed his or her family. Homeowner assessments are way down the list of priorities and what are the association’s options? Record a lien and foreclose? And then what? The lender has a senior lien and it is very doubtful that there is any equity in the property anyway. Small claims court? Sure, and you’ll get a judgment for the unpaid assessments quickly, but after that you have to execute. On what? The fact is, many owners see no value in continuing to pay a mortgage, much less homeowners association assessments, on a condominium unit that has absolutely no equity whatsoever. And you can’t garnish wages that don’t exist.

            So now what? It’s time to start prioritizing expenses. Who and what does the association pay? What does it pass over? Yes, that may very well be the subject of an upcoming board meeting in many associations, so we might as well deal with reality now. What is the most important obligation of the homeowner’s association? The health and safety of the owners, for sure. What threatens health and safety if it’s not paid? Garbage collection? Yes. The water bill? Of course. The bill for common area electricity? Yes, especially when there are elevators, pathway and corridor lighting. After that, we would put security services and payment of the premium on the liability and fire insurance premium. Management and accounting services come next so that there is someone to pay the bills that have to be paid. Contributions to reserves should continue with any cash left.

            The items at the bottom of our list would be the gas bill for the spa or pool heater; some or all landscaping services; such things as window washing and last of all the cable bill for the clubhouse television! Yes, most of this is obvious, but no board of directors has had to face a situation like this and we want to re-assure them that massive cutbacks in services to accommodate a shrinking budget is not only legal, it would be a breach of their fiduciary duty to sacrifice the health and safety of the owners just to keep the lawns mowed!

            So consider what you will do as a board member when the cash runs out. Think of the personal safety of the owners first and you will usually make the right choices.          

No Right To Refuse Payment

The Court Turns a Right Into a Duty as it Orders a Board to Assess its Members to Pay a Creditor.

A 2005 decision of the California

Second Appellate District Court of Appeal in JamesF. O'Toole Company vs. Los Angeles Kingsbury Court[1] answers the question: can association members be forced to pay, by special assessment, debts incurred by their association? Essentially, O'Toole upholds a lower court order requiring a community association to levy a special assessment to pay a judgment creditor. The importance of O'Toole is not that a community association was required to pay its debts--every person or entity should pay what it owes. The importance of O'Toole is that the court required the board of directors to levy a special assessment upon the members, one that the members had specifically rejected, to pay the obligation. The court also appointed a receiver to enforce collection of the assessment, and pay the creditor.
[1] JAMES F. O'TOOLE COMPANY, INC., v. LOS ANGELES KINGSBURY COURT
OWNERS ASSN., 126 Cal. App. 4th 549; 23 Cal. Rptr. 3d 894 (SECOND
APPELLATE DISTRICT 2005).

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Are They Building Condos Better?

Do New Construction Methods and New Materials make a Better Product?

 Here was the typical multi-family building as constructed 25 years ago: Wood siding, single pane aluminum windows, flat roof, a one or two-ply built-up roof membrane, and galvanized iron water pipes. To make matters worse, the siding often wasn't real wood. Wood substitutes like Masonite, essentially sawdust mixed with glue and pressed in a steam press to resemble wood planks, was used extensively. This was a design formula for disaster. The siding dissolved over time. The flat roof usually didn't stay flat, it deflected causing water to collect because it had nowhere to drain. These “ponds” stayed on the roof until they evaporated. The roofing materials used then could not resist this continued immersion in water and failed prematurely. The plies became separated and the water quickly found its way into the interior of the building. Or, the moisture that the material absorbed heated within the plies and the resulting vapor caused huge blisters to appear on the roof, blisters which eventually cracked and became yet further sources of water leaks. The iron pipe corroded over time, of course, and many buildings had to have all of it removed and replaced with copper.

Many single family houses were built the same way, but since it was up to the owner to deal with all of this, it never gained much attention, because if the owner wanted to maintain the value of her property, she had to repair these problems by re-siding, re-roofing, including adding slope to the roof, and eventually re-piping. But the condominium association saddled with this nightmare had a more difficult problem—it had to find the cash to do the repairs, cash that has always been in short supply. We've written for years about the long-term effect of an association's inability to maintain its buildings—a gradual deterioration of both the physical plant and the value of the individual interests.

But over time, some things have changed...

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