What do you think Fannie Mae has against the condominium and co-op markets? It looks and feels like one big vendetta but obviously Fannie has no heart which, I think, is necessary in order to want revenge. Perhaps they want to rid the country once and for all of apartments in the sky attached to a mortgage. That’s got to be it. What’s your paranoid theory?
Pick one, any theory, but Fannie is doing it’s dead level best to turn the condominium market into a trash heap and ruin condo and co-op owners and render developers as good as toast. The developers, buyers and lenders didn’t see Fannie's new requirements and underwriting guidelines coming when they signed up. The reaction is like a deer in the headlights. And it’s just poor sportsmanship.
This seems so far off the radar and news screen, except to industry insiders, that many of you may not have a clue what I’m talking about, so let’s delve into Fannie’s “dirty little secrets.” Too dramatic? Not for condo developers and owners.
new restrictions – condominiums and co-ops.
Note: When referring to “condos” I am including both condominiums and co-ops. Please excuse my lazy habit.
Premise: The retail mortgage business relies on the secondary market to buy the loans they originate. If there is no secondary market, the retail lender has less incentive to make the loan since they then have to hold the loan in their portfolio. Hence the importance of Fannie Mae and Freddie Mac who purchase those conforming loans written under their guidelines. That, in a nutshell is why jumbo loans are harder to come by and more expensive - there is no secondary market for them right now.
For additional background information on Fannie’s overall guideline revisions see the Real Concepts' post, Fannie Piles on Fees to Mitigate Mortgage Risks.
Effective March 1, 2009, Fannie Mae implemented condo guideline changes “in light of the current condo market and the need to mitigate risk on condo loans”. These changes will affect a buyer’s ability, and cost thereof, to obtain conventional condo loans for many new and established condos.
Fannie Mae now requires a .75% add on fee and an additional 1.75% for investors for conforming condo loans unless the buyer makes a down payment of at least 30 percent. And the buyer has to have perfect credit. Multiple dwelling buyers (duplex, triplex, etc) will be will be charged a flat 1% add-on from Fannie, even if they’ve got FICO scores above 800 and make 50% down payments.
Overview of the new Fannie Mae condo guideline changes and additions:
• For new construction and newly converted condo developments, 70% of the units must be pre-sold (closed or under contract). This is being increased from 51%.
• No more than 15% of a condo project units can be more than 30 days delinquent on HOA dues. This is an existing guideline that is now being applied to new condo projects. The calculation was also changed from being 15% of HOA fee payments to 15% of total units.
• Fidelity insurance will be required for condos with 20 or more units, ensuring that homeowner association funds are protected. Presently, this requirement applies to new projects and is now being extended to include established condos.
• A requirement that borrowers must now obtain a condo-owners insurance policy unless the master policy provides interior unit coverage; coverage may not be less than 20% of the assessed value. A condo-owners policy, known as an HO-6 policy, covers personal property, personal liability, and the physical unit from the studs and in. Many policies also include special assessment coverage or the option to include a special assessment coverage rider.
• No more than 10% of a project can be owned by a single entity.
• No more than 20% of a project can consist of non-residential space.
• The homeowners association must have at least 10% of its budgeted income designated for replacement reserves and adequate funds budgeted for the insurance deductible.
Buried further in Fannie's Selling Guidelines of 12/08 was a further stipulation that renders a condominium project ineligible for Fannie Mae delivery:
"New projects where the seller is offering sale/financing structures in excess of Fannie Mae’s eligibility policies for individual mortgage loans. These excessive structures include, but shall not be limited to, builder/developer contributions, sales concessions, HOA or principal and interest payment abatements, and/or contributions not disclosed on the HUD-1 Settlement Statement."
Also in the Selling Guidelines are the procedures for Fannie Mae project approvals.
Here are the causes of the condominium heartburn:
1. 70% of a condominium project must be sold or under contract before Fannie will approve the project. In this market that is going to prove very difficult, particularly in cases where a block of condo units may have been rented by the developer. If the developer has rented 35% of his condo units, he will not be able to meet these requirements until the at least 5 percent of the leases expire and those units are sold.
Another scenario: Take a two hundred unit highrise that was financed and built without presale requirements. The building is nearing completion and with fall out from presales only has 40 contracts still hanging in. The developer wants to close the forty contracts as soon as Certificates of Occupancy can be issued. With the new Fannie guidelines, another 100 units will have to be sold before Fannie will accept the project. How long will it take to sell that many additional units in a terrible market. One year? Two years? Three years?
As the developer works toward additional sales the forty presale contracts start falling out because they cannot take occupancy. If lenders will not close loans in the building until the Fannie Mae 70 percent sold guidelines are met (and they know there is a way to sell the loans) the problem continues to repeat itself in a vicious circle.
2. Next problem … Projects can not contain more than 20% non-residential space. I find this particularly onerous. All smart growth advocates and proponents of building and living green have encouraged the mixed use, "live, work and play" concept. Local governments have encouraged the lifestyle as a way to cut the carbon footprint and relieve road congestion.
Any highrise building that contains an office building, retail, and/or hotel on the lower floors (that comes to more than 20% of space) is now ineligible for Fannie Mae’s approval. Probably half of the new highrise buildings in large urban centers have the mixed-use configuration that violates these new guidelines. As if these developers did not have enough to worry about. Huge, huge, huge problem.
Could Fannie possibly know the repercussions this will have to the overall housing market? The players in the business agree that this has to be changed but can it be accomplished in time to save the developers?
3. No more than 10% of a condo project’s units can be owned by one entity. If a developer has been driven to seek distressed asset buyers for a portion of the units, this new guideline could hurt the balance of the unit sales by rendering the project as ineligible.
The nature of highrise condos brings an inordinate amount of units on the market at once (unless presold) and the investor has always been an important part of the developer’s sell-out at lower early prices. The investors then re-release the units for sale as the market dictates.
Yes the and speculators, have made a mess of things during the height of the bubble, but by not grandfathering existing buildings, this could have dire consequences for the developer or individual owners of existing condos who want to resale their units.
4. The following explanation of ineligibility is not entirely clear: “where the seller is offering sale/financing structures in excess of Fannie Mae’s eligibility policies for individual mortgage loans. These excessive structures include, but shall not be limited to, builder/developer contributions, sales concessions, HOA or principal and interest payment abatements, and/or contributions not disclosed on the HUD-1 Settlement Statement." But I think it means the developer cannot give away the kitchen sink in order to sell a unit. Does this render a building ineligible or just the individual loan?
5. The rest of the guidelines – no more than 15% HOA delinquencies, insurance requirements, reserves – are good sound underwriting guidelines.
I hate to see condominium developers thrown under the bus. Their exuberance may be their downfall but they don’t need the government to dig the grave and push them in. They’re doing fine all by themselves.
I've written many times about the nature of the highrise condo market where every building is several years in the making and can not react on a dime. Once embarked on a highrise, there's no turning back. There may be an an overbuilt condo market now in many cities, but when these projects were started they were probably market appropriate.
Take this example that I wrote about in an earlier post about the Atlanta condo market. At the end of 2005 there were 4,455 new condo units finished or under construction which, at the time represented a one year supply. Since it takes years to bring a condo tower to completion, this signified anything but an over supplied market. But by the end of 2008, Atlanta was sitting on 5,100 new condo units, which based on the 2008 sales pace, was an eight year supply.
It is totally unreasonable for our government (Fannie in Conservatorship) to change the rules - in mid stream - so dramatically as to devastate a huge portion of the country's housing market. By Fannie declaring condo loans a high risk they are fulfilling their own prophesy.
Many politicians and economists have proclaimed that we can not regain our economic strength without fixing the housing market. Fannie in one fell swoop is ruining a huge part of that market. With all the government is doing to stem foreclosures, to fix the economy, repair the banks and bring back growth, I don’t understand why they have set down such a damaging policy to a very large, and very important part of the housing industry.
All indicators point to a more urban, higher density lifestyle in the future for a myriad of very good reasons. If you believe that home ownership is good for the economy, then somebody needs to convince the government that condos and co-ops are an important part of the housing market.
Time to get on board Fannie.