Locked Out: The Growing Crisis of Condominiums Blocked From Government Backed Financing

BY JACOB HAILPERIN-LAUSCH & DEBORAH ZIELINSKI –

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On June 24, 2021, at approximately 1:22 a.m. EST, Champlain Towers South, a 12-story beachfront condominium in the Miami suburb of Surfside Florida, collapsed causing the deaths of 98 people. The implications of that disaster were far reaching, and the reverberations are still felt today by condominium associations (“Associations”) and the boards of trustees that govern them (“Boards”), which include the inability of potential buyers to obtain government backed loans not only hurting the unit owner but potentially catastrophic for the Association.

In the aftermath of the Surfside collapse, Fannie Mae and Freddie Mac (Government Sponsored Entities that collectively guarantee or (re)purchase 50% of the residential mortgages in the United States) promulgated new guidelines to determine whether a buyer or owner of a condominium unit could obtain a government backed loan secured by the condominium property. Eligibility factors include deferred maintenance, insurance, percentage of owner occupancy, litigation, and other issues that might impact the health and safety of the occupants. Fannie Mae and Freddie Mac have also issued bulletins that require lenders who want to be authorized sellers/servicers to increase their scrutiny of Associations, which include sending a lengthy questionnaire to Boards. In addition to this added scrutiny, authorized seller/servicers are required to report non-compliant Associations. Non-compliant Associations are placed on an “unavailable for lending” list. This blocked list existed before the Surfside disaster but its explosive growth since the disaster is extremely concerning. Since the disaster, the blocked list has grown from a few hundred Associations to over 4,500 or from approximately 5% to 35% of Associations nationwide. The list is growing rapidly, sometimes adding several hundred new Associations per month.

Due to this rapidly growing blocked list of ineligible Associations, many unit owners who hope to sell their condominium unit must find buyers willing to pay cash or willing and able to find financing at well above market rate as the government backed loans are unavailable to them. Many buyers are unable to do this and thus the units remain unsold or must be sold below market rate. This raises a broader concern of an “Association death spiral” or feedback loop, where an Association on the blocked list and ineligible for government backed lending cannot attract new owners and cannot collect necessary assessments to be removed from the blocked list. This could potentially result in this Association falling behind on maintaining its property which in turn may drive owners away (this is without mentioning the fact that many lenders who are not seller/servicers follow the Freddie/ Fannie lending guidelines and Associations often cannot obtain loans or lines of credit if they are on the blocked list). The rest of this article will briefly address some of the key reasons Associations are placed on a blocked list and options to avoid these problems.

The most common reason for an Association to be placed on a blocked list is due to inadequate insurance coverage. [See graph on the next page of “5 Most Common Reasons for Condo Mortgage Ineligibility” generously provided by CondoTek] To comply with the Fannie/Freddie guidelines, Associations must maintain insurance with a deductible that is not more than 5% of the replacement value of the building(s). In recent years (think post-pandemic) insurance premiums have increased from 30% – 300%. At the higher end of the spectrum is insurance for properties at increased risk from fire and flooding due to climate change and this assumes that insurance is even available. Because of the increased premiums, many Associations have decided (or have been forced) to accept increased deductibles to offset the increased premium cost. Upon review of an Association’s non-compliant insurance policy by a seller/servicer this will cause the Association to be reported to Fannie/ Freddie and likely be put on the blocked list. Returning to the Surfside disaster, maintaining the condominium building(s) is a key area of concern because of the potential impact on the health and safety of the occupants. As inflation has increased above historic norms, Associations are deferring maintenance. This can be disastrous if the maintenance is related to the structural integrity of the building(s). If the maintenance is deemed critical (Freddie Mac Bulletin 2021–38 — critical repairs are those that “significantly impact the safety, soundness, structural integrity or habitability of the project’s building(s) and/or that impact unit values, financial viability or marketability of the project”), the Association is automatically placed on the blocked list even if the repairs are in progress or stalled by events outside of the Board’s control, such as building permits, contractor, or building material delays. Even if the maintenance is not a health or safety issue, deferring maintenance over several years could result in more costly repairs than if the building(s) was regularly maintained and will likely result in surprise special assessments that the unit owners will not be able to afford.

The best way to mitigate the issue of deferred maintenance is to have the building(s) inspected regularly as part of a “reserve study” regime. A reserve study is performed by a third party consultant, an engineer or other qualified person, who inspects the building(s) and determines the amount the Association should have in reserve to keep up with the building(s) maintenance. The reserve study will provide the Board guidance on how much the regular assessment should be so that, outside of extraordinary circumstances, there will not have to be a special assessment. Some states (New Jersey and Florida, for example) require condominiums to have regular reserve studies. Ohio does not require a reserve study, but under O.R.C.§5311.081(A) (1) Boards are required to maintain reserve amounts adequate to perform regular maintenance without the need for special assessments. To conform with this mandate, regular reserve studies are recommended.

Now a final “lightning round” of three additional recommendations for staying off the lending blocked list. First, Boards should maintain good corporate record keeping and governance practices. Lenders may request to review Association meeting minutes, the insurance policies, and other records. Good corporate governance will help avoid litigation, which is a red flag for lenders and often depletes the Association’s reserve funds. Second, under Ohio law, Boards are required to carry a special type of insurance, fidelity insurance, which protects against the misconduct of Board members or the Board’s professionals with access to Association bank accounts, protecting the integrity of the Association’s reserve accounts. Third, the Board should adopt a policy regarding an owner’s ability to rent their unit, short or long-term, because a low percentage of owner occupancy in the Association is a red flag for lenders.

Overall, while a hard pill to swallow, the cost of being a unit owner is rising, in some places it is rising rapidly. From rising maintenance costs, rising insurance costs, completing reserve studies, or hiring a lawyer to help with legal compliance, costs are rising faster than many unit owners anticipated or planned for. We have attended several annual meetings recently where Boards have had to have difficult conversations with unit owners about continuing to increase their assessment, sometimes significantly more than what the owners were historically accustomed and many of whom are now on a fixed income. For the attorneys who may have condominium clients it is important to educate your clients about their rights and obligations under Ohio law, for example, about reserve studies, and about corporate governance best practices.

On a broader policy level, we need to grapple with rising insurance costs due to climate change and inflation. Finally, Board members need to have access to quality educational materials about how to be the best stewards of their Association. With better Board governance and some key governmental interventions, we are hopeful that most condominium units will remain eligible for government backed financing.