Thursday, November 12, 2009

FHA Modernizes Condominium Lending

The Federal Housing Administration released their new Condominium lending guidelines this past Friday and with the stroke of a pen wiped 29 years worth of dust off of the most sought after lending certification in the country. The new guidelines include a major overhaul to the process by which lenders approve projects and modern requirements, which increase discretion in some areas while providing strong guidance in others. The changes were mandated in HERA Act of 2008 (link:, which moved the statutory source of funding from a condominium only pool into the general housing pool. More importantly, FHA is using this guidelines change to simultaneously improve their standards and process, while eliminating cumbersome red tape that will reward condominiums in good standing that were previously locked out of the pool. The FHA was wise enough to issue Temporary Guidance simultaneously, which will allow new buildings that qualify to sellout their remaining inventory in 2010 and support distressed markets in a responsible way. I believe that this FHA condo program renovation is a great first step in laying a long-term foundation in the recovery of the condominium housing markets.

A little background information (link on the Department of Housing and Urban Development aka HUD (link is in order to understand the workings of the FHA. The National Housing Act (NHA) of 1934 established the FHA to stem the tide of foreclosures during the Great Depression; prior to the NHA typical home loans were 5 year term loans (interest only) after which the entire principal balance was due in full - the FHA insured loans for up to 30 years, in essence creating the 30 year fixed rate mortgage which is the standard loan issued today. The FHA's activities are spelled out (in detail) in the NHA and any activity it undertakes is authorized by that statute.

The FHA's revisions are a concrete result of the HERA Act of 2008 enacted by the Democratic Congress and signed into law by President Bush. Back when Section 234 of the NHA was authorized, the condominium was still a novel new method of shared ownership, and Cooperative Housing Corporations were the mature way to distribute ownership in multi-family housing projects. Prior to HERA, the FHA issued condominium loans exclusively under Section 234 of the NHA and single family home loans under Section 203. This entailed different pools of funds, and when sold to investors, different pools of loans, some with condos, some with detached single-family homes. Once the new guidelines are fully implemented, this division will cease entirely, and the FHA will recognize condominiums in a formal way as legitimate single-family residences contained within a multi-family dwelling.

The installation of a single approval standard, coupled with modern standards is a boon for all condominium owners. The Full and Spot system confused all parties as to the approval requirements for any particular project. Using the Spot Approval system, buyers had to pay for certifications each time a loan was to be issued, and go through the process as if it was the first time. Even worse, half the questions on the Spot checklist were boilerplate requirements which provided little useful underwriting information. The Full approval process contained major gray areas in important matters such as budgeting and insurance requirements, which had a chilling effect on applications due to the expense and complication applying.

The most significant individual guidelines change was the allowance of the Right of First Refusal in condominium documents - so long as this Right does not conflict with the Fair Housing Act. The FHA’s rationale was that violations of the Act are criminal anyhow and many associations have the Right - while few are prosecuted for non-compliance. There are new caps on HOA dues delinquency percentages; however, the prior rules eliminated all buildings with special assessments under Spot Approval. The new Budget review guidelines adopt a Fannie Mae form which can now become the standard for lender communications in the area and only lead to more clarity for all parties.

When it comes to matters of process, the removal of the legal certification requirements is quite possibly FHA's greatest slice into housing red tape since 1934! Under the prior rules, a condominium had to hire an attorney to review the Condominium Documents and certify to the FHA that they met a 37 page legal standard, which was drafted in December of 1980 during the waning days of the Carter Administration. Every time I encountered a building with fewer than 100 units and had to inform them that the certification costs alone would run $2000 it pretty much killed their interest in FHA approval. However, that was after a 6 months long search to find a practitioner willing to create a specialty in those types of reviews. The first building, which I processed for approval, the Bank Lofts Condominium, is a gut condo conversion project, and was certified by Andrew Fritsch from the West Palm Beach office of Broad & Cassel. He drafted the condo documents and issued a certification, but balked on certifying projects to which he had not been the original author. "The rules require you to flyspeck someone else's documents", Fritsch said, "and the risk to reward ratio is terrible."

Lastly, the FHA issued temporary guidelines, which are in effect for the coming year that should help local developers sell units to local buyers in South Florida with financing. Chief among these is the reduced pre-sales requirement in new projects which allows projects with 30% pre-sales to earn approval and sell up to 30% of their units to financed buyers with FHA loans. Two weeks ago, I visited the HUD Headquarters building on L'Enfant Plaza in Washington, DC to meet with their Condo Standards staff and learn the rationale behind their revisions and presented specific case studies in projects in our approval pipeline as well as statistics generated by Condo VulturesTM. The main topic of conversation was the stigma placed on loans into projects approved with Fannie Mae’s new process. The FHA wisely looked for guidance in the core logic of Fannie Mae's guidelines intended to protect the institutions that back these loans. However, Fannie’s initially stiff guidelines, rapid implementation with little input and then relaxation of the rules created the impression that the whole process was a sham. Now that there is discretion in the standards, the staffers were sensitive to the reality of the situation; that their decisions today will effectively pick winners and losers in the condo market. By issuing temporary rules alongside the new program, it sends a strong signal that the FHA understands the market, and that this is a process with real standards, but open to buildings experiencing temporary dislocations in this market.

The FHA was originally created to backstop the national housing market and is visibly providing much needed support to the market, in a responsible fashion. FHA’s handling new shift from a rules based statutory condo approval process to a guidelines based process is providing much needed modernization to their programs and leadership to the market as a whole. The updates are modern, well considered and should promote condo lending, while simultaneously protecting the insurance pool from damaging claims in excess of premiums. The improvements to process should result more condominium approvals with lower costs to consumers as well as developers. It’s a credit to the Obama administration that his political appointees and career staff at HUD truly learned the lessons of Fannie Mae's disastrously erratic implementation of the condominium guidelines. These FHA condo updates will really gain traction in the 3rd and 4th quarters of 2010, for the buildings that qualify they are the light at the end of the longest tunnel.

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