Friday, March 4, 2011

Condo Market Fractures Lending Standards

The deterioration of Condominium lending's standards between housing agencies has ruined the market for homeowners seeking financing.   Agency lending standards for Condos had been settled for nearly 30 years, with the four main housing finance authorities accepting each other's certifications for most projects. Recently, the two lead agencies in Condo financing - Fannie Mae and the FHA - updated their guidelines to achieve divergent risk management goals.  The end result is decreased access to credit, lower Condominium prices in comparison to surrounding single family homes and enhanced losses to mortgage holders.  The Condominium market needs a unifying set of approval standards and reciprocal agreements between housing agencies to revive normal lending activity.

A little historical context and legislative history illuminates the speedy evolution of Condominium Property rights and financing over the last 50 years.  Condominium real property exists as a purely legal construct, first recognized formally in modern law under France's Napoleonic Code of 1804.  The Condominium form of ownership began formally in the United States in Puerto Rico in 1951.

After ten years of lobbying, the National Housing Act of 1961's Section 234 allowed the FHA to insure condo mortgage loans.  Section 234 loans were wiped out  by the HERA Act of 2008.   HERA converted long used rules into flexible guidelines which HUD is open to interpret and change.  The FHA issued the first new Condominium approval guidelines since 1974 in 2009, with the intent of improving risk management.

Thirty years ago, attorneys from the (now) government agencies of Fannie Mae, Freddy Mac, FHA and the VA gathered to create a common standard for the needs of lenders to finance condo mortgages.   That document still provides some of the basic hoops every modern condo agreement should jump, such as minimum rental periods, recordation of documents with proper surveys etc.

Proceeding from those guidelines, there was a thirty year period of reciprocal acceptance of FHA Condo Approval by all parties, and over time, Fannie and Freddie virtually merged their standards with Fannie leading the way.  The former private market-makers also created condominium approval review exemptions (aka "limited reviews") based on the loan to value and occupancy of the borrower which exist today.

  Fannie Mae began changing their Condominium Approval process in 2007 by dropping direct reviews in favor of 100% lender delegated reviews.  After the real estate market calamity in December of 2008 Fannie issued harsh new lending rules for properties in Florida and nationally for new construction projects.   The agency has spent the last 24 months backpedaling from those tough guidelines, and spread fear throughout the market regarding condominiums.

Sadly, the fear spread by Fannie Mae's abrupt pullback sparked the consequences it sought to avoid, namely a collapse in condo prices throughout the market.   In a Minsky Moment, Fannie began quietly advertising to industry sources that even it's toughest PERS approvals would be flexible.  Eventually, they created a whole new approval category called "Special Approval Designation List".  This "SPAD" list is so special, no lender or correspondent wants to issue loans into those projects.

 The FHA was required by HERA to draft new Condominium Guidelines which they issued in late 2009.  The implementation is still being phased in today, after 20,000 expiring projects were given a reprieve from expiration this past December.  Unfortunately, during the break from past practice, Fannie Mae used the opportunity to cancel their reciprocity agreement.

The FHA's new guidelines have heavy emphasis on large cash reserve accounts, and restricting developers from renting unsold inventory while holding the units for sale or lease option sale.  Fannie's new guidelines aim to take a blood sample of each building and analyze the physical plant for flaws, this in addition to the usual financial checkups.

The two largest standard setters have gone in opposite directions.  As a result, the list of approved buildings for both agencies is shrinking.  Mortgage lenders who entered the market after 2005 have suffered losses even with loan to value ratios of 50/50 after some condo prices declined 90% or greater.    Condo owner/directors are rarely informed of the implications of sweeping changes affecting the marketability and price of their homes.   All of this has been happening without stakeholder input in Washington, D.C. aside from the  money center banks who now control vast swaths of the market for new mortgage loan originations.

 The privatization of Fannie Mae and Freddy Mac casts a long shadow at their standards departments during the interregnum.   It seems logical that new standards should be set in the private sector for Condos and the private non-profit corporations governing Condo property.

The fact that two large standard setters cannot agree, clearly indicates that there's no consensus on how to heal the wounded standards for what really separates a functional Condominium from a failed project.  The prolonged existence of the rift is eroding investors' trust in the legal form of Condo ownership's ability to withstand shock.  Ultimately, the condominium financing market needs new defining standards to resume normal functioning.