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FHA’s New Rules: More Pain For Condo Market

Is the Federal Housing Administration taking a back-door exit away from condos — a key real estate segment in which it’s recently built up market shares of 40 percent and higher in many urban areas?

Could the agency be tightening its rules in order to cut loan volume in the months ahead, potentially putting thousands of unit sellers, buyers, homeowners associations and realty agents in a mortgage-money squeeze?

FHA adamantly denies that it’s doing anything of the sort, and insists that new rules rolled out at the end of last month represent prudent responses to the serious risks the agency’s insurance funds confront.

But condo industry executives and community managers say FHA’s tougher regulations have a wet-blanket effect on associations’ ability — and willingness — to get their projects approved for financings by the agency. Without an entire project certified, potential buyers of units cannot obtain FHA-backed loans, which in turn makes it more difficult for current unit owners to sell and could depress property values.

Mark Lewis, executive vice president of Associa, the nation’s largest community management firm with 10,000 projects and 2 million homeowners in 31 states, said that he’s “getting complaints hourly” from condo boards of directors who are balking at seeking certifications or recertifications for FHA financing because they can’t deal with the new, stringent rules.

“We’re getting frantic calls from Realtors saying, ‘Oh my god, this deal is going to fall through,’ ” unless FHA financing is available. But because of the new rules, he said, the project may no longer qualify.

FHA’s low down payment minimums — 3.5 percent — and relatively generous credit and debt ratio policies have made it the go-to financing source during the past several years for moderate-income buyers who previously would have sought conventional mortgages. With high-cost-area mortgage limits of $729,750 — at least until Oct. 1, when they are scheduled to drop — FHA has even become a player in some upper-end condo communities.

The biggest complaint about the new FHA rules, said Lewis, is the requirement that anyone who signs an application for certification or recertification of a project must assume full responsibility under federal law for the accuracy of every piece of information contained in the submission.

The penalties for subsequent findings that information was inaccurate or omitted can be severe — ranging up to $1 million in fines and 30 years in prison for the worst infractions.

Since the certification package submission covers myriad items that can be difficult to pin down precisely — such as the percentage of units currently occupied by renters on a given date, or whether project documents are in full compliance with every state law and regulation — many association boards and managers are reluctant to stick their necks out to guarantee accuracy of the unknowable under threat of future federal fines.

“We’re not the Gestapo,” said Lewis. “We can’t go door to door to find out who’s in there and whether they’re renting or they own.” Also, many of these condos drafted their underlying documents years ago and have not necessarily kept them up to date with relatively minor changes in state law.

For example, he said, some condos prohibited flying of flags in their original documents, but state laws have since overridden that prohibition.

“There’s just no way you can certify to FHA that you are in full compliance with every change that’s occurred” since the original documents were adopted. And yet, Lewis said, a strict reading of the new guidelines requires it.

Condo boards, unit owners and managers also are upset by other rules from FHA, including:

1. A requirement that no more than 15 percent of all units in the project are no more than 30 days delinquent on their condo assessments, including bank-owned (REO) units, which are notorious for nonpayment of fees.

Often condo boards can’t even determine who actually owns a foreclosed unit, said Andrew Fortin of the 30,000-member Community Associations Institute trade group, “so how can FHA expect volunteer condo boards to find this information and collect the assessments?”

Worse yet, he said, most boards or management companies don’t learn about delinquencies on assessments until well after 30 days.

Plus, FHA’s new rule conflicts directly with some state laws, such as in North Carolina, where boards are prohibited from even seeking to collect fees until they are more than 30 days delinquent.

2. A requirement that not only must condo boards carry fidelity insurance on their officers, but that management companies must carry policies as well.

According to Fortin, that requirement conflicts with state law in Maryland, where condo boards already must purchase fidelity insurance for their management companies. Under a strict reading of the rules, he said, that means management companies will be forced to buy what amounts to double coverage.

3. A variety of technical rules that may hamper condo conversions and so-called gut rehabs.

For example, Philip Sutcliffe, principal of the condominium consulting firm Project Support Services, said FHA’s new rule requiring full, professionally prepared studies of financial reserves will be too expensive for many projects to afford. Sutcliffe said he sometimes wonders whether “anyone at (the U.S. Department of Housing and Urband Development) truly understands how condominiums work in the real world.”

As a consequence of these and other concerns about the new rules, recertifications of existing condo projects for FHA mortgage insurance are lagging. An FHA official confirmed to me that just 1,000 of approximately 12,000 projects eligible have done so in recent months — a no-show rate that critics call ominous.

In response, FHA officials argue that most of the agency’s rules track similar requirements in the conventional financing marketplace. Moreover, they say, at a time when condo projects have taken especially hard hits in the housing downturn — and many projects in places like Florida, Arizona and Nevada have experienced soaring rates of delinquency and foreclosure — they have a duty to protect FHA’s insurance funds against avoidable losses.

Asked whether a calculated phasedown of FHA’s condo volume lurks behind the toughened rules, Lemar Wooley, a spokesman for the agency, said “that is not the case. FHA is committed to continuing its mission of providing affordable, sustainable homeownership opportunities while managing and mitigating risk. Our new condo guidance is consistent with that commitment.”