This piece originally appeared in the June 2022 edition of MReport magazine, online now.
In January of 2022, new Fannie Mae condo and co-op lending guidelines created broad changes in how condo and co-op loans must be underwritten. Freddie Mac followed suit shortly thereafter in February. In just a few short months, these sweeping changes in how lenders now must evaluate condo and co-op properties prior to closing loans on condo and co-op units have had massive impact on mortgage availability and board member liability.
Lenders have known about the changes coming to condo and co-op lending as early as October 2021. However, it was impossible to understand how much of an impact these measures would have. Today, we have a much better idea of the new reality that is emerging in condo and co-op lending. In short, what was hard just got a bit harder.
Why This Is Happening
The new GSE guidelines require a near-forensic examination of the structural stability, mechanical components, deferred maintenance on those components, and special assessments in every condo or co-op building where a mortgage is provided. This is, of course, in addition to the normal scrutiny that condo/co-op buildings must go through to be deemed “warrantable” for lending.
This increased scrutiny by the GSEs is a direct result of the tragic condominium collapse of the Champlain Towers in the Miami suburb of Surfside, Florida. As we now know, the board members of that building continued to kick the proverbial “Maintenance Can” down the road for more than 20 years.
So how did this happen?
Repair and maintenance work was deferred year after year by newly elected board member after board member because no one wanted to increase maintenance costs for owners in the building. Shocking as it may seem to be, this is the same mindset among thousands of condo and co-op board members across the country.
This is not a hatchet piece on condo and co-op boards. I have seen many thoughtful, caring, and responsible board members make very tough decisions that have financially impacted hundreds of homeowners.
But no two buildings and no two condo/co-op boards are alike. Peppered into the responsible decision-makers on many condo and co-op boards are members who have been voted in just to keep maintenance costs low.
There are other familiar challenges that condo and co-op projects face that ultimately have an impact on lenders, especially considering the GSEs’ new lending guidelines.
The Day of Reckoning
The problem with keeping maintenance costs low and not addressing mechanical and structural component repair is that repair costs often increase over time. As a result, condo and co-op boards that have not been diligent in completing routine maintenance and repairs tend to have larger repair costs that accumulate in the future. It is not uncommon, in fact, for a minor roof leak to turn into a major structural issue down the line.
Over the last 30 years of my career, I have consulted with thousands of condo and co-op boards. During that time, I have heard countless problematic comments that are far from unique or unusual:
- “We’re not putting money into reserve because I won’t be alive when the repairs finally get made.”
- “Many of our unit owners are selling their units over the next five years—we’ll just let the new board handle this issue.”
- “If repairs need to be made in the future, then we’ll just create a special assessment.”
- “We do not care if people can get mortgage financing in our building. If people cannot buy their unit in cash, they should not be living here.”
- “No one gets Fannie Mae/Freddie Mac/FHA loans in this building. The average sales price is much higher than agency loan limits will allow.”
- “Why don’t we churn the same $150,000 we have in reserves? Take it out of one account, add it to another, and pretend that we are following the guideline.”
Suffice to say, issues involving condo and co-op project maintenance are exceedingly complex, even in the best of times. So, let us discuss how to uncomplicate these issues.
Just the Facts
Here are three basic facts about condo and co-op lending in 2022. Regardless of how you or I feel about them personally, they present the truth of where we are today:
- Fannie Mae and Freddie Mac’s new lending guidelines are meant to ensure that homeowners are made aware of possible structural and mechanical issues in the buildings they own or are buying units in.
- All condo and co-op lending has been impacted by the release of these guidelines. This includes conforming agency mortgage lending, jumbo mortgage lending, underlying mortgage lending for cooperatives, and lines of credit for condo properties.
- For mortgage financing to be available to borrowers in condo and co-op properties, property managers and board members must immediately do several things: adopt new reserve funding policies, abandon the special assessment repair funding method, complete needed structural and mechanical component repairs, and obtain an engineering inspection and/or reserve study to determine component condition and capital requirements.
So, how do lenders ensure these things are accomplished?
That will not be easy. But there is a general rule we see emerging that may at least help lenders see the bigger picture.
The 70/20/10 Rule of Lending Compliance
On average, our team is involved in the review of upwards of 2,000 condominium and co-op properties a month. As we perform these reviews, there are a few clear distinctions that are emerging.
Approximately 70% of condo and co-op properties that we review are compliant with the new lending guidelines. This 70% share of these properties that are compliant are easily financed, and there are abundant resources for Fannie Mae, Freddie Mac, and portfolio jumbo mortgage financing available for them.
Being compliant means that these properties meet several key criteria, which includes establishing a reserve account that has a substantial amount of capital to pay for future repairs and replacement of common area mechanical and structural components.
Compliant properties also have a reserve study or an engineering study performed in the last 36 months that is available for review. This ensures board members and property managers are informed of the condition of different components, that reserves are appropriately being collected in an annual operating budget, and that future repair and replacement costs are being collected to avoid future special assessments. Compliant properties also have a baseline questionnaire that has been completed for the property which addresses the new questions that the GSEs require to be answered, either by attaching an updated reserve study, engineers report, or equivalent for review.
Approximately 20% of the condo and co-op properties that we review are not initially compliant with the new lending guidelines, but could be made compliant with a little effort. Generally speaking, these properties meet some of the criteria outlined in the new guidelines, but require additional information to be reviewed to determine warrantability.
For example, properties that fall into this category may lack confirmation that a 10% reserve line item appears in the operating budget and the condo/co-op has amassed capital for future repair of structural or mechanical components. They may also have a special assessment in place for a large mechanical or structural repair, but the work has already been completed. In some cases, the condo or co-op board does not want to answer questions involving deferred maintenance on structural and mechanical components on the questionnaire, but they have an engineer’s report, and a reserve study that they provide that may help clear things up.
Overall, these 20% of all condo and co-op properties have more limited access to mortgage financing and require additional oversight or compliance to be performed. Access to portfolio mortgage financing is often possible, but access to conforming lending is more challenging.
The final 10% of the condo and co-op properties we review are non-compliant with the new lending guidelines and have serious issues that will prevent almost all lending on the property unless the issues are rectified. For example, the property may have an operating budget that has no reserve contribution listed, or there is a reserve account, but it has very minimal capital accrued.
There may be a special assessment in place to fund a large mechanical or structural component repair, but the repair has not yet been completed.
Some of the more serious issues in these properties include multiple components that have not been adequately maintained or replaced and are suffering from deferred maintenance. A property may even have a violation that outlines an unsafe condition that can impact the habitability of the property.
For this approximate 10% of reviewed condo/co-op properties, access to mortgage financing is incredibly difficult to obtain, and it is simply impossible to obtain Fannie Mae/Freddie Mac approval.
Only in unique circumstances can portfolio lending be offered on these types of properties, and when it is, borrowers are typically offered much higher interest rates with much lower LTV’s.
The Bottom Line
At the end of the day, there is no longer any way for a condo or co-op property to operate without reserving adequate capital for component repairs. If they do not comply with the new guidelines, financing will not be available … period. From now on, buildings must obtain professional evaluations of components, set aside appropriate funds for future capital repairs and complete repairs to components whose maintenance has been delayed or overlooked. For many condo and co-op lenders, the best response to this new reality will be to look for outside expertise to help.
Otherwise, we can only hope the new reality created by the GSEs’ guidelines—as challenging as they are—will introduce a new era of more transparent, proactive, and safer condo and co-op properties.
If it does, the work we all put in will be well worth it.