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.

FHA Gives Condo Lending Market Reprieve

As reported by Realtor.org and  Mortgage News Daily this morning at 9 am, FHA announced a Condo Project Approval extension after the article Condominium Financing Markets Lose Government Insured Lending Supports was published to this blog and set for 7:30am release.  HUD held an "industry call with Gary Long and his partner in the condominium policy department in Washington DC and revealed numerous facts about FHA's condo program through the years, as well as the implications of the new project approval changes.  


Condo Projects will have a staggered expiration based on when they were approved starting at year end and proceeding through September 30th, 2011.    

FHA condos extensions are by year approved.  Projects approved with number of affected projects in parenthesis:

1972-1980 (403) and 1981-1985 (1800) expire 12/31/2010

1986-1990 (7800) expire 5/31/2011

1991-1995 (5700) expire 7/31/2011

1996-2000 (3800) expire 8/31/2011

2001-2005 (2000) expire 9/30/2011

2006 - Sept. 2008 (1700) expires 3/31/2011

HUD clarified that it will accept loans with an FHA Case Number issued up to and including the expiration dates, which clarified a point of lender concern that approval expiration was date based, not case based.


HUD's new FHA condo lending homepage contains current condo guideline resources including recertification processes which will be handled by a contractor with HUD supervision for the "HRAP" process.  Once a condo has expired, it has 6 months to re-certify.  Afterwards it will have to re-apply from scratch.  Florida condos must use the HRAP process to re-apply directly through HUD.  HUD's goal is to have a 30 day recertification process.


During the call, HUD also announced that the temporary guidance guidelines issued last year is also administratively in the extension approval process.  These guidelines require all Florida condos to go through HUD review and allow certain leniencies as well.  However, re-certifications can be handled by lenders using the DELRAP process if the original review was completed by HUD.

Condominium Financing Markets Lose Government Insured Lending Supports

At the stroke of midnight last night, December 7th, the FHA officially invalidated the condominium approval list that it spent the last 30 years to create.  With this last salvo against the condominium financing market, FHA is signaling the bottom in Condominium lending has just officially begun.  The evolution of condo lending standards has devolved into a cacophony of competing standards.  Clearly, lenders are unable to properly evaluate counter-party risk, building management practices and capital structure using any of the competing standards in Condo evaluation.    The lack of end user Condominium financing amounts to the erection of an Ivory Tower to guard new condominium towers from commoners and homeowners.

The condominium market upon which most of the pre-2007 standards were built, reflected realities for fairly small apartment housing projects with shared ownership starting in the 1970s.  Nobody at the time realized how much more complex and active the market would become when untethered from oppressive Co-Operative Housing Corporation rules and restrictions, when coupled with it's exposure to the mortgage interest tax deduction.

Condominium lending started slowly with the FHA in the early 1970s and by the early 1980s had an organized process to approve condominium projects directly through HUD.   Over the decades, HUD amassed thousands of project approvals covering the 50 states, and available through the "FHA CondoLook" database.  (link: https://entp.hud.gov/idapp/html/condlook.cfm) ***  

  The HERA Act of 2008 wiped out the old statute authorizing condo lending, and shifted funding authorization to the Single Family housing statute.  This law caused expiration hard project approval rules, which FHA replaced with administrative guidelines.   The FHA set out a complete refresh of their condominium project approval rules, and these went into effect 1 year ago.  

Notably, the FHA guidelines are used to enable end user borrowers to place 3.5% down payments.  After deducting the 1% financed FHA insurance premium, these buyers are borrowing 39 times their down payment.

The new guidelines discarded a 30 year old legal guidelines agreement between Fannie Mae, Freddy Mac, VA, FHA and HUD.  In addition, FHA the approval process, due diligence practices and eliminated on site inspections.  It placed new emphasis on budget reserves and site insurance analysis, while eliminating on site inspections and the bulk of new construction projects.  As a result, both Fannie Mae and the VA cancelled their approval reciprocity with the FHA earlier this year.   

Meanwhile, Fannie Mae spent 2008 implementing tough new "PERS" Condo Project Approval standards and mandatory national reviews.   By the start of 2009, their failed "get tough on the market" approach yielded to a new "Special Approval Designation" list known as the "Spade" list by industry insiders.  "Spade" approvals are so special that it has taken 9 months for initial lender adoption, mainly because this list included nearly every highly distressed project imaginable.  In fact, it was virtually a case of creating an approved black list by Fannie Mae, since entry on the list virtually guaranteed that local banks and portfolio lenders shunned included projects.  

As of today, Fannie accepts loans through it's PERS process, Special Approval Designation, "Full" Review and "Limited Review" (25% down payment by borrower minimum for no review) or absolutely no review at all for "Refi-Plus" loans.  Got that?  Complicating matters are state by state guidelines for Private Mortgage Insurers who exclude some of the largest condo markets entirely, such as Florida, leaving "Conventional" borrowers with a minimum 20% down payment on all condominiums.

The onslaught of exotic lending products pushed our multi-family single unit financing market is at it's nadir today.  No single project standard is accepted across the secondary market for mortgage lending.  Today's mass expiration of government insured lending eligible condominiums is a blow to every potential owner occupant looking for a starter home in condominium communities.  Until project approval standards are re-evaluated altogether, from today forward, the Condominium finance market will be stuck in neutral until further notice.


(SEE UPDATE at 4:30pm today)