New FHA Condo rules kick in...

The new condo rules from the Federal Housing Administration (FHA) went into effect last week and they are already drawing fire. From an article by Ken Harney on the Realty Times Web site comes this report on some of the key features of the new rules -

Among the key make-or-break rules that condo marketers, buyers, lender and realty agents now need to know about are the following:

* FHA won't insure mortgages in buildings or complexes where less than 30 percent of the units haven't already been sold.

* At least 50 percent of the units in a project must be owner-occupied or sold to purchasers who intend to occupy them.
* No individual owner or investor can hold title to more than 10 percent of the units in the entire project.
* No more than 25 percent of the square footage of a condo project can be non-residential -- in other words, used for commercial purposes.
* No more than 50 percent of the units can have FHA insured financing on them. FHA doesn't want to “concentrate its risk” in any single project.
* No more than 15 percent of the units in a project can be 30 days or more delinquent on their monthly payments to the condo association.

Basically if a condo complex doesn’t meet these rules then it isn’t eligible for FHA financing and FHA-backed loans make up the bulk of the financing normally used these days. I believe that these rules are to apply only to true condo complexes and not the site condo developments that make up the bulk of Michigan’s new build developments. It would be an even bigger problem if these rules are applied to site-condo developments.

As it is, these rules probably will cause havoc in Michigan in regular condo complexes. With the economy in the dumpster there has been a rash of investor buys of condo unit. The investors normally rent out the units. There were also lots of live-work complexes built, which would seem to violate the 25% rule for commercial use of the complex space. There are also numerous stalled out condo complexes which may now prove to be very difficult to sell, because 30% or more of the complex may not have yet been sold. In my little town there is also a small, 5-unit luxury condo complex that almost certainly could violate 2-3 of these rules. In fact, in that complex, which has yet to sell a unit, the first buyer will take the complex over the 10% ownership by a single owner rule. How dumb is that?

At a time when FHA financing is the primary choice for properties under $300,000 (a range that includes most condo complexes) setting the 50% rule effectively discriminates against those who try to buy into the complex after the first half of the units are sold. That doesn’t seem fair, does it? Of course that might not happen anyway, since the FHA won’t insure the first 30% of the units to be sold. Maybe that is the Catch-22 in this crazy set of rules.

Break out the petards again...

Get your petards out, we may be about to hoisted to the yardarms again by new FHA rules that go into affect next month. Michigan is one of several states that allows a developer to build what we call "site condos" – single family houses on individual lots, but within a complex that is classified as a condominium, because of shared areas like roads or playgrounds or just the island at the entrance to the development. So, it looks just like a regular subdivision full of regular single-family houses; but, it’s not – it’s a condo complex, at least in the eyes of the FHA.

From a recent RealtyTrac article by Peter Miller comes these highlights of the new rules.

The FHA says that starting December 7th condos must meet several new standards:

• All projects not deemed to be used primarily as residential real estate are out.

• Because of noise worries, FHA insurance will be unavailable when properties are within 1,000 feet of a highway, freeway, or heavily traveled road; 3,000 feet of a railroad; one mile of an airport; or five miles of a military airfield. The FHA says that lenders “must avoid or mitigate” such conditions before completing their loan review process, but how does one avoid or mitigate an air force base? How much mitigation is enough mitigation? The obvious result is that with an abundance of caution lenders will be unable to finance properties with potential noise hazards.

• There will be no more FHA loans if the “property has an unobstructed view, or is located within 2,000 feet, of any facility handling or storing explosive or fire-prone materials.”

• Also, FHA loans are out if the property is located within 3,000 feet of a dump, landfill, or super-fund site.

• Not more than 25 percent of the property’s total floor area can be used for commercial purposes.

• No more than 10 percent of the units may be owned by one investor. This will apply to developers/builders that subsequently rent vacant and unsold units. For two and three unit condominium projects, no single entity may own more than one unit within the project; all units, common elements, and facilities within the project must be 100 percent complete; and only one unit can be conveyed to non-owner occupants.

• No more than 15 percent of the total units can be in arrears (more than 30 days past due) of their condominium association fee payment.

• At least 50 percent of the total units must be sold prior to endorsement of any mortgage on a unit. Valid presales include an executed sales agreement and evidence that a lender is willing to make the loan.

• At least 50 percent of the units of a project must be owner-occupied or sold to owners who intend to occupy the units. For proposed, under construction or projects still in their initial marketing phase, FHA will allow a minimum owner occupancy amount equal to 50 percent of the number of presold units (the minimum presales requirement of 50 percent still applies).

• Projects in designated wetland and flood zones will not qualify for FHA insurance.

So, how will this impact us here in Michigan?

Well, unless there are exceptions made for our site condo designation or some process put in place for exceptions on a case-by-case basis, this could have a disastrous impact upon our market. Developers have been using the site condo development approach almost exclusively since the 1980’s, so most of our newer homes are actually site condos. There were sound economic reasons for developing this classification and for developers using it to build single-family homes.

However, think about the new neighborhoods that you may have visited lately. How many are near what could be classified as a “busy road” or how many are near a gas station or railroad or airport? And the wetlands rules may impact vast tracts of land in Michigan, which has extensive wetlands areas. Some of the new rules won’t have much impact in these neighborhoods, since few site-condo homes are usually rented out; however, the rule about the percentage of the complex that has been sold could prove to be a showstopper issue for stalled out or abandoned developments. Do you know anyone who bought one of those foreclosed homes in a stalled out development? They may be royally screwed by these new rules.

Every time that FHA puts out new rules there is uncertainty about how they might be interpreted and applied to our site-condos. It may well be that they have enough experience with that issue already to have a good and workable exception policy already in place. It may be that much of our housing stock just became uninsurable with an FHA loan guarantee. We just won’t know until we get some time and some test cases under our belts. Let’s hope we don’t need to use the petards again.

Hoisted by our own petards...

Michigan is one of only a hand-full of states that adopted a condo-hybrid zoning category called a site-condos, as a way to speed up the process for developers to bring new projects to market. The old, traditional zoning category called a platted subdivision served the needs of developers for many decades, but the necessary approvals and the whole process, which involved extensive public hearings, had become cumbersome by the 80’s, and so the concept of the site condo development was born.

Here’s a quick explanation of the concept:

When you own a true condo you are not responsible for outside maintenance and you don't own the outside of the building. It is part of the common property owned by the association. The condo association takes care of the exterior of the buildings and the landscaping maintenance. A true condo community has common property that can not be divided and that can be used by all condo owners. It is property that all owners pay to maintain. Your condo may be detached, so there are no common walls, but you still don’t have responsibility for the outside.

As a homeowner in a site condo you own the house and your lot. You are responsible for the exterior of your home. Nobody else has an interest in your home. You have to take care of the landscaping, the painting, the decks. But remember as an owner of a Michigan site condo you do have to obey the condo association rules. You do have to belong to the condo association and pay association dues. The association is responsible for the common areas that will include the roads at a minimum, as well as any other common areas, like parks, play areas, and entrance islands.

There were other good reasons why developers adopted the site condo category:
- Homes can be built closer together (So builders can make more money because they can build more homes on the same amount of land. Which is also a benefit to home owners because the homes are less expensive)
- The roads can be private and built less expensively than city regulations. (Asphalt versus cement) Width of the road may be less sometimes. The association is responsible for snow plowing and maintenance of the roads.
- Common elements like pools, parks, and club houses can be built and supported by the association rules.
- Many time homes and the development can be built quicker because of the easier rules for condo complexes – plated subdivisions can take 8-12 months for the approval cycle in Michigan; whereas, site condo project plans can be approved in 2-3 months.

So, Michigan developers jumped on the site condo bandwagon wholeheartedly and almost every new single-family homes development over the last 2-3 decades has been a site condo.

Then in 2009, the FHA promulgated new rules concerning mortgage requirements for condos and lumped in all condo types, including site condos. The rules, which were apparently written by people who never had heard of site condos and didn’t understand the impact of what they were doing on states like Michigan, have requirements that may make sense for traditional condo complexes, but which are onerous for site condo owners and buyers.

The FHA rules require that a would-be buyer, who wishes to use an FHA-back mortgage, submit a Condo Questionnaire, which is normally filled out and signed by the Home Owners Association (HOA) Treasurer. That Questionnaire, which was again created fore traditional condo complexes, has questions on it about the percentage of units that are leased out, the percentage of units that are in foreclosure, the percentage of the total complex that is owned by a single owner (can’t be more than 20% to qualify for an FHA mortgage), whether or not the developer ever turned the complex management over to the HOA and other questions that seem to make more sense for a traditional condo complex.

Here’s the rub. If any of the condo questionnaire questions come back with even a single “No” as an answer, then an FHA-backed mortgage is likely out and the buyer will need a 20% down payment to go conventional. How easy is it for that to happen? Well here are some of the questions:

6. At least 90 percent of the total units in the project have been sold.
7. At least 51 percent of the total units in project are owner-occupied.
9. No single entity owns more than 10 percent of total units in project.
12. General maintenance level of common elements is acceptable and there is no deferred maintenance, based on the comments by the Appraiser and/or the pictures.
13. The owners association has a reserve plan and a reserve fund, separate from the operating account, that is adequate to prevent deferred maintenance.
14. (a) For projects consisting of over 30 units, no more than 10 percent of total units are encumbered by FHA insured mortgages.
(b) For projects consisting of 30 units or less, no more than 20 percent of total units are encumbered by FHA insured mortgages.

Now, think about that little in-build, site condo development in which you just listed a house. It only has 10 houses and four already have FHA loans. Oops! A buyer wouldn’t be able to get an FHA loan to buy your listing. Your seller is hosed. Or perhaps you have picked up 2-3 bank-owned houses in a failed site condo development, one where the developer gave up or went out of business. The development was only20-30% finished and the HOA was never formed. What now? You’re hosed again. And how about those people who bought in that development before it went bust? They are in limbo. Not only are they living in what likely looks like a wasteland, but also no one can buy their homes unless they can get a conventional loan and put 20% down.

So, here we are in Michigan, hoisted by our own petard (an old nautical phrase) and our love of site condos as development vehicles. Most of these requirements weren’t all that onerous when things were good, but with the current market, fewer and fewer of our site condo complexes can pass muster with the FHA Questionnaire. And those failed developments – fagetaboutit!

Is your state one of the others with site condo developments? How is this impacting your business? Has your state done anything to try to help out home sellers and buyers? What are you doing to prepare sellers and buyers for this problem?