The Fiscal Cliff Condominium Developers
Heard enough about the fiscal cliff? Condominium developers should take into consideration the potential liability for assessments on developer owned condominium units when structuring condominium regimes to avoid their own financial downfall.
Upon filing a condominium declaration, the subject property is instantaneously transformed into condominium units and common elements, regardless of whether or not anything is actually built. Until either Declarant control terminates or three years after declarant’s first conveyance of a unit, the declarant has the option to pay either (1) the operational expenses of the association, less the amount paid through assessments by unit owners other than declarant or (2) regular assessments allocated to each of the units owned by declarant. However, three years after declarant’s first conveyance of a unit, declarant must pay regular assessments on each declarant owned unit. This requirement could lead to a situation where a developer is responsible for paying assessments on units which were never constructed and may never be constructed, i.e. “paper units”.
To avoid this potentially endless financial obligation to pay assessments on “paper units,” condominium developers should phase condominium regimes. In phasing, a developer should only “create” units which the developer anticipates constructing and conveying in the immediate future to minimize the developer’s liability for assessments. Then, as units are constructed and conveyed, the developer can phase in new units. While condominium projects are often phased by developers to comply with various underwriting requirements related to unit sales, developers with price points outside of FHA/FNMA lending limits are more likely to forego phasing. However, developers should also consider phasing, especially in large scale condominium projects, to avoid assessment liability on developer owned condominium units.
The major impact that Hurricane Sandy had on the East Coast is a good reminder of the importance of the maintenance of sufficient insurance. All condominium projects in Texas (whether they operate under the current Uniform Condominium Act or, for projects created before January 1, 1994, are still operating under the original Condominium Act) are subject to the provisions of Section 82.111 of the Uniform Condominium Act.
Under the Uniform Condominium Act, if any portion of the condominium for which insurance is required to be maintained by the association is damaged or destroyed, the association is obligated to promptly repair or replace such damage. The cost of repair in excess of the insurance proceeds and reserves is a common expense of the membership.
Under the Condominium Act, the association is required to maintain the following insurance coverage:
• property insurance on the insurable common elements insuring against all risks of direct physical loss commonly insured against, including fire and extended coverage, in a total amount of at least 80 percent of the replacement cost or actual cash value of the insured property as of the effective date and at each renewal date of the policy [and for buildings containing units that have horizontal boundaries (stacked units), the association's property insurance must also include the units, but need not include improvements and betterments installed by unit owners]; and
• commercial general liability insurance, including medical payments insurance, in an amount determined by the board but not less than any amount specified by the declaration covering all occurrences commonly insured against for death, bodily injury, and property damage arising out of or in connection with the use, ownership, or maintenance of the common elements.
It should be noted that to the extent that any damages involve personal property in a unit or, in projects with stacked units, improvements made by the owner (improvements and betterments in the unit), the association has no liability to obtain insurance coverage on and no obligation to repair these items under Texas law.
In order to comply with Texas law and to prevent a situation where a special assessment is required to repair or replace portions of the project that should have be covered by insurance, it is suggested that association representatives present this information to their insurance carrier and confirm that the proper insurance for their project is in place. It is also timely for association representatives to remind their owners of the value of maintaining insurance polices for their personal property and unit improvements and betterments.
As the estimated amount of damage caused by Sandy continues to increase, now is a good time to make sure that your project has sufficient insurance coverage in place.
This is good news for developer and resident controlled community associations. CAI reported today that:
- Servicers must advance funds to a community association when notified by the association that the borrower is 60 days delinquent in the payment of assessments or other charges levied by the association if necessary to protect the priority of Fannie Mae’s mortgage lien
- Servicers must ensure any priority lien for delinquent association assessments is cleared promptly (no later than 30 days) after a foreclosure sale or acceptance of a deed-in-lieu of foreclosure.
- Servicers are responsible for the continued payment of association assessments following a foreclosure sale.
- Servicers must take appropriate action to change tax rolls to reflect Fannie Mae ownership following a foreclosure sale or acceptance of a deed-in-lieu of foreclosure.
- Servicers must contact the community management company or association to ensure that all bills for assessments or other association charges are forwarded to the servicer.
- Servicers must pay all association bills as they come due.
What does all this mean? It means several things: 1) You SHOULD include a lender notification at the 60 day delinquency mark OR EARLIER; 2) your association, management company, or lawyer SHOULD research the lien status of the property AT THE 60 DAY MARK OR EARLIER and SEND THE NOTICE TO THE LENDER (I said that, but it is worth repeating); 3) your assessment collection process should notify lenders AT THE FIRST STEP OF THE COLLECTION PROCESS. You do not do this, you may lose the opportunity to collect delinquent revenue.
Recommendations: 1) revise your collection policy to include a lender notice; 2) do some title research-this is how you find out, or at least, get the sniff that the loan is guaranteed by Fannie Mae; and 3) make sure whoever is collecting your delinquent accounts is proactive and creative. YOU SNOOZE YOU MAY LOSE !
How does this intersect with the new mandatory payment plan requirements of the 2011 Texas HOA Reform Laws? If it is a Fannie Mae insured mortgage, looks like you have a shot at the lender/servicer paying rather than the homeowner IF the proper notice is provided. It is not guaranteed in Texas since Texas is not a lien-priority state, but I believe it will increase the odds the assessment will be paid.
For you developer-controlled communities, this means if you have a good collection policy with lender notification, your developer subsidy may reduced. It’s all about the Benjamin’s, keep some in your pro forma with a thoughtful and proactive collection policy.
The Fannie Servicer Update is here. Fannie Mae encourages servicers to comply with these standards now but no later than July 1, 2012.
You and your colleagues are invited to register for a webcast hosted by the State Bar of Texas.
Winstead Shareholder, Robert D. Burton, will be one of three presenters speaking on Texas HOA Reform Laws: Developers & Declarants.
Tuesday, April 3, 2012
2:00 p.m. – 3:30 p.m.
Registration Fee: $125.00
Click here to register at TexasBarCLE.com
Continuing Education Credit
-MCLE Credit: 1.5 hrs
-MCLE No: 901236492
Approved for State Bar College Credit and Texas Board of Legal Specialization Credit in Civil Appellate, Civil Trial and Real Estate Law.
In 2011, the Texas Legislature passed 19 bills that comprise 39 brand-new “HOA Reform Laws”. A few of the new laws are specific to the development process. Some have unintended consequences for development. And many regulate HOA operations even while the developer controls the HOA. In short, the regulatory landscape for the development and operation of HOA subdivisions has changed.
This 90 minute program focuses on the 2011 HOA Reform Laws from the perspective of a subdivision developer. It is designed for the practitioner experienced in drafting and implementing HOA documents, particularly lawyers who counsel developers, their lenders, and homebuilders. This is not an overview of all the 2011 HOA Reform Laws or “everything you need to know” about drafting documents for developments with HOAs.
- Which new laws are developer-specific.
- Why separation of architectural control and control of HOA governance is newly important to developers.
- How the new laws affect developers of subdivisions started before 2012, and what to do about it.
- Issues for developers who sell lots to builders–the new laws can be tricky.
- New hazards of using the 40-year old concept of Class A/B membership to maintain development rights. (There’s a better way!)
- Why developers must attend to HOA governance from Day One – new legal duties.
- State’s new definition of “development period” in the HOA context ~ more to it than you’d think.
- Developer’s bottom-line may be impacted by new laws regulating HOA assessment collection.
- New development related laws that are not in Prop Code Title 11, such as transfer fees and re development of open spaces.
- New laws that pertain specifically to developing or marketing condos, especially in Houston.
- New requirements for home sales contract, for the corporation’s registered office, and for decisions by interested directors on the board of a nonprofit corporation
With the rise in interest in community associations and community association living (both positive and negative), we thought it would be interesting to briefly outline a few important moments in the origin of the community association.
Based on data compiled by the Community Association Institute, in 2011, 62 million Americans were members of a community association, a 2,866% increase from data compiled in 1970. The growth of community associations over the last 40 years is a response to changes in our society, the expectations of home ownership, and competitive pressure. As a response to expectations and competitive pressure, developers began to build specialized amenities and adopt specific rules for their developments. At the same time, fiscal contraints have forced municipalities to focus on core services–there is a limit to the tax burden their constituents will bear. These trends, among other factors, have conspired to create a financing and regulatory gap for the community association to fill.
We spend most of our time with the day-to-day administrative and management needs of the community association. Let’s step back for a moment and look at a few important events in the rise of the community association.
- Late 18th Century: London institutes the practice of maintaining private parks with funds provided through subscriptions from or trusts composed of adjacent land owners.
- 1831: Samuel Ruggles, a New York developer, lays out Gramercy Park. The park is conveyed to a trust for the benefit of adjacent lot owners who are charged with maintenance and upkeep (Assessments!).
- 1844: 24 lot owners executed an agreement to maintain, in perpetuity, Louisburg Square in Boston (Association!).
- 1871: Based on advice from Fredrick Law Olmstead, setback and construction restrictions were imposed on the Riverside residential development in Chicago, Illinois (Restrictions!).
- 1890: Edward Bouton incorporated use restrictions in the Roland Park development in Baltimore, Maryland.
- 1914: J.C. Nichols created the first mandatory membership association in the Mission Hills development in Kansas City, Missouri.
- 1929: The Ohio Supreme Court in Dixon v. Van Sweringen upholds the enforceability of private covenants.
- 1934: Congress creates the Federal Housing Administration. The FHA, in conjunction with its mortgagee guarantee program, encouraged developers to incorporate deed restrictions and mandatory associations within their developments. The Veterans Administration, created in 1944, adopts similar recommendations.
- 1951: Puerto Rico adopts the first condominium statute within the United States or its territories. The statute calls for the creation of a council of owners to administer and maintain common area.
- 1962: Congress adopts the National Housing Act which makes FHA mortgage insurance available to condominium unit owners. FHA publishes a model condominium statute. By 1967, almost every state had adopted a legal framework for condominium ownership. Each statute calls for the creation of an organization to administer and maintain common areas.
- 1978: Voters in California approve Proposition 13 which limits the ability of local government to raise property taxes to cover the costs created by new development. As a consequence, local officials require that certain local services be provided by private property associations. This trend in “load shedding” by municipalities, as a pre-condition to the development approval process spreads to other states.
So there you have it. Once the proverbial cat was out of the bag, amenities such as pools, sidewalks, parks, community centers, ball fields, etc., were no longer a burden shouldered by the taxpayers at-large. Rather, such amenities were initially installed by the developer. But who would pay to maintain such items once the developer was gone? And how? The residents of each community through assessments levied by their community association. These new private “taxpayers” have enabled community associations, and the amneities they provide, to grow and thrive.
Today, the House Financial Services Committee met to review the HUD 2013 budget, and drumroll please…the difficulty associated with FHA condominium financing and approval process was a raised by members during the hearing. You can read about it here in the HousingWire. FHA Commissioner Galante suggested in her testimony that some adjustments to the condominium approval may be warranted. A couple of changes suggested by lawmakers is to relax the 15% delinquency requirement and to permit approval for those associations that have levied special assessments.
In my view, FHA should take a closer look at raising the number of permitted FHA loans in a project from the current 50% concentration, especially in stable and rising markets, and increasing the number of units which may be owned and leased by the developer during the marketing phase of the project.
On Thursday, February 23, 2012, FHA published a request for comments to a proposed rule which will place limits on the amount a seller may pay toward a homebuyer’s closing costs. In FHA parlance, these contributions are referred to as “seller concessions.” Currently, seller concessions are limited to 6% of the home sales price. The proposed rule would limit seller concessions to the greater of $6,000.00 or 3% of the sales price (but such amount may not exceed the buyer’s actual closing costs).
The proposed rule also narrows the definition of acceptable seller concessions to exclude HOA assessments and other payments usually made by the buyer post-closing, such as mortgage interest. In essence, FHA is now proposing to clearly characterize the pre-payment of HOA assessments as an “inducement to purchase” rather than a closing cost. The seller’s payment of a buyer’s closing costs has always been permitted (within the FHA limits noted above). However, FHA has had a long-standing rule that an inducement to purchase reduces the loan amount available to the buyer. In other words, if I offer you a car as an incentive to purchase a home, the home’s value (for the purpose of determining the loan limit) is actually equal to the home sales price less the value of the car.
Interesting Statistics From the Request For Comments-
- 65% of all FHA loans involve seller concessions. FHA notes that this percentage has not changed as a result of the housing downturn.
- By far, the highest defaults occurred for loan amounts greater than $360,000.00 when the seller concessions were 4% or more of the sales price.
- FHA market share in 2007 was 3.4% (77 billion in insurance issued). In 2010, FHA market share has increased to 17% (33% of all home purchase mortgages and 319 billion in insurance issued).
- 70% of loans up to $180,000.00 have closing costs which exceed 3% of the loan amount. For loans above $240,000.00, only 26% have closing costs which exceed 3% of the loan amount.
- 82% of all buyers who obtain FHA insured mortgages make only the minimum down payment of 3.5%.
Comments to the proposed rule are due by March 26, 2012.
We are very excited to bring you Common Interest 360. For the past 30 years, Winstead PC has had the good fortune to help design and administer some of the best master planned communities, mixed-use developments, and condominiums in Texas and the United States. We have developed Common Interest 360 to share our thoughts, ideas, and experiences. The title of our blog and information portal reflects our unique expertise. We not only create communities, we also administer communities during developer and resident control. Our expertise and experience means we can close the circle…we create it and we help communities live it. We have 360 degrees of experience in the legal design and administration of common interest communities.
Whether you are a developer, lender, investor, community leader, or property owner, we hope to provide you with valuable and timely information.
Co-Chair, Planned Community, Mixed-Use and Condominium Practice Group
You have no doubt heard (Click here to read: MBA Tracks $380.6B of 2012 Commercial/Multifamily Loan Maturities) about the volume of commercial loan maturities over the next 2 to 3 years. These loans must be refinanced, but the difficulty with refinancing, of course, stems from lower asset values, tighter underwriting requirements, and a smaller lender market. The math is pretty straightforward:
In a typical situation, a building that was worth $100 million in 2007 was financed with 80 percent debt, or $80 million. Now the loan—which was interest-only, meaning no principal was paid—is maturing. The borrower owes $80 million, but the value of the property has also dropped, to $80 million. This means that the ratio of the loan to the value of the property is 100 percent. Lenders have little appetite in this market environment for highly leveraged loans, so in one increasingly common outcome, the borrower will recapitalize the property by finding an equity partner to inject new capital into the deal, thereby lowering the overall amount of debt on the property. (Click here to read: Anxiety Mounts Over Maturing Real Estate Loans)
I am not about to tell you that condominiums can solve this problem once and for all, but I will tell you that for some mixed-use vertical projects segregating different uses within the project through the condominium form of ownership might give you a few new options. Let’s take a look at two projects here in Austin: Block 21 and 360 Condominiums. Block 21 is a mixed-use vertical project with 5 discrete uses: hotel, residential, office, retail, and an entertainment venue. 360 has 2 discrete uses: residential and retail. Each developer elected to segregate each use into a single master condominium unit. Why? The principal reason is that each use is now legally capable of being sold, separate and apart, from other uses. Does use segregation mean you can solve a refinancing problem by selling a use and releasing capital? Maybe, maybe not—but without segregation banish the thought!
As we previously alerted you, House Bill 1228, passed in the 82nd Texas Legislative Session, eliminated non-judicial foreclosure for homeowners associations (“HOAs”) assessment liens in non-condo HOAs. House Bill 1228 provided that as of January 1, 2012, an HOA must first obtain a court order in an application for expedited foreclosure under the rules adopted by the supreme court in order to foreclose on an assessment lien. House Bill 1228 gave the Supreme Court of Texas until January 1, 2012 to adopt rules for the expedited foreclosure proceeding.
On October 17, 2011 the Supreme Court of Texas amended the Texas Rules of Civil Procedure to establish rules for use by an HOA in an expedited foreclosure proceeding, such rules to take effect January 1, 2012. The Supreme Court of Texas amended Rules 735 and 736 of the Texas Rules of Civil Procedure, previously setting forth procedures related to home equity loan foreclosure, to include procedures related to the foreclosure of HOA assessment liens. Foreclosure of home equity liens, transferred property tax liens, and HOA assessment liens are all liens which require a court order for foreclosure.
Although referred to as expedited judicial foreclosure, in reality, foreclosures under Rule 736 are actually non-judicial foreclosures preceded by a judicial proceeding. Prior to a hearing under Rule 736, the non-judicial foreclosure process is started when the lienholder sends notice of default and accelerates the debt. Then the lienholder files an application for an order allowing foreclosure. Importantly, no discovery is permitted and no cross claims, counterclaims, third party claims, or other independent claims for relief may be asserted. The only issue to be considered in a Rule 736 proceeding is right of the applicant to obtain an order to proceed with foreclosure of the lien. After an order is obtained, a person may proceed with the foreclosure process. You can read the new rules here.