Hidden Headache
HUD grants a one-year extension on a dormant FHA rule that would have made financing difficult for condo developers looking to sell or transfer vacant units.
For developers and condo associations concerned with an FHA policy that would make it harder to get condo loans, HUD has offered a one-year reprieve.
Late last month, David Stevens, assistant secretary for housing at HUD, released a memo that waived a clause making condominiums that place restrictions upon conveyance unable to receive FHA approval.
“The waiver was issued to allow condominium projects to receive FHA approval even though the condominium project may restrict leasing of units by unit owners,” says HUD spokesperson Lemar C. Wooley.
The FHA’s change comes after developers and industry consultants told Multifamily Executive that in two of the agency’s four regional offices, it has started enforcing a long dormant rule that prohibited restrictions on transferring a unit. If the complex placed restrictions on transferring individual units, it would have been removed from the list of FHA-approved buildings. In fact, prior to the one-year extension, news reports indicated that the FHA had taken steps to pull buildings off of its approved lists. For instance, The Chicago Tribune reported that in Illinois, 61 buildings since August “were denied FHA approval for reasons that ranged from outstanding litigation to the use of more than 25 percent of the building for commercial purposes.”
Of course, to comply with FHA rules that limited the number of rental units in a property to no more than 50 percent, developers had to limit the transfer of units so that investors didn’t own more than half of the total units available. That created a conflict for developers.
“If the FHA had begun to truly enforce that guideline, you would have had to make the choice,” says Kevin McDaniel, senior vice president of condominium operations of the Atlanta-based Novare Group. “Do you want to take all restrictions out and play to the FHA? Or do you leave them in?”
By changing their rules, Stevens says the agency hoped to achieve “proper governance of a condominium project by protecting against transient tenants and real estate speculators, both of which could have a negative impact on the market value of units in the project.”
The policy was greeted with approval from industry watchers. “It is important because it will make it possible for many more people to get FHA loans that were looking to buy in buildings where they had some type of leasing restrictions,” says Jack McCabe, founder and CEO of MR&C, a real estate consulting firm based in Deerfield Beach, Fla.
Grant Stern, president of Bay Harbor Islands, Fla.–based Morningside Mortgage Corp., expresses concern with one clause that says the “association may not require that tenants be approved.”
“Does that mean the FHA will not approve any condo project which screens tenants?” he asks. “If so, this could disqualify nine out of 10 projects from the FHA pool.”
Eventually, though, the rule will have to be revisited, at which time industry observers say the industry will have to reassess how to approach such projects in light of a continuingly difficult financing environment. The FHA continues to provide the majority of financing for the sector, though recently some other avenues have opened up. For a couple of years now, Novare has relied on MetLife to make loans in its buildings where it hasn’t reached Fannie’s presale threshold of 70 percent of the total units (though there are sometimes exceptions to this rule). Of course, MetLife requires 20 percent down, while FHA only requires 3.5 percent down, and that weeds out a lot of potential buyers.
“We relied a lot on MetLife to come and agree to underwrite loans prior to reaching presale requirements,” McDaniel says.
Outside of that, McDaniel sees other lenders starting to show interest in condo loans. “My opinion is that things have loosened up a little,” he says. “Two or three years ago, it was disastrous. From an underwriting perspective, I think things will continue to trend in that direction. But it hasn’t reversed course to where it was [in the mid-2000s], and I doubt that it ever will.”
And that’s probably a good thing. —Les Shaver
— Les Shaver
Despite this, the biggest hitch in nailing a condo deal right now is still financing—or the lack thereof. Many national and regional banks will issue recourse bridge loans for the acquisition, at fairly high prices. But finding permanent debt for a fractured condo acquisition is difficult, even once a project is stabilized—Fannie Mae, Freddie Mac, and the FHA have little or no appetite for them. “We go into these deals saying, it’s great to get financing afterwards, but you have to make sure they can work without it,” Del Rio says.
One of the first underwriting considerations is finding out whether the existing homeowners are paying their dues. “The solvency of the condo association is critical,” Del Rio says. “If the owners aren’t paying their dues, you’re buying into a problem, and nobody is going to lend you money then.”
Part and parcel to that is finding out how many foreclosures have already occurred at the property—a negative that can also be an opportunity, as a savvy investor may be able to pick up those foreclosed assets and add to their unit count.
For instance, the Kislak Organization, based in Miami Lakes, Fla., recently purchased 130 out of 170 units at Villas at Jasmine Park, a busted condo deal in Pensacola, Fla., as part of a three-property acquisition. But the company hopes to own all 170 units going forward.
“Owning 80 percent of the units, we’ll be able to have enough control over the place that we believe it’s a viable apartment complex,” says Tom Bartelmo, Kislak’s president and CEO. “But we’re going to be talking with the owners and the lenders on those purchased units to see if we can’t purchase them back at a fair price.”
Work Around
Many investors simply don’t want the headache of a fractured condo deal, regardless of the discount. Home Properties has looked at acquiring several such deals, but “it always feels like there’s too many legal issues, back taxes, busted homeowners associations, you name it,” says John Smith, chief investment officer for the Rochester, N.Y.–based REIT. “It’s just not worth it for us to jump in.”
Still, the company has been able to take advantage of a few projects in the condo sector. In 2008, it purchased the land around Cobblestone Square, a failed condo development in Fredericksburg, Va. Single-family builder K. Hovnanian had plans for eight buildings but stopped construction after completing just two.
Home broke ground in February for a planned eight Class A buildings, totaling 302 units, on the land around the condo buildings. “In 2008, it became clear that the economy was going south, and we were concerned about the rents we were going to be able to underwrite,” says David Gardner, Home’s CFO. “We mothballed it for a little while, and now things have started to thaw out.”
Home Properties doesn’t have anything to do with the two existing condo buildings, though some common-area costs will be shared with the condo association. The bigger issue is the precedent set by the luxury condos already there—Home is having difficulty measuring demand for high-end rental units in Fredericksburg.
