FHA’s New Condominium Standards - Enlightening for Some Associations, Ignored by Others
By: Nena Groskind

Condominium attorneys and mortgage lenders have been talking about the Federal Housing Administration’s (FHA’s) new condominium loan requirements, and community association boards have been largely ignoring them, for more than a year. But as they learn more about the rules and the implications become clearer, boards are beginning to pay attention to the new standards and many are changing their policies so that units in their communities will be eligible for FHA financing.

Targeting the lax lending standards blamed for the subprime mortgage meltdown and the massive loan losses resulting from it, the new rules elimiminate the “spot loan” approval process that had allowed FHA lenders in the past to approve a condominium loan even if the community in which the unit was located was not FHA-certified. Under the new rules, lenders can’t approve an FHA loan unless the community meets the FHA’s new underwriting standards.
Until recently, that would not have concerned most community associations because relatively few borrowers obtained FHA loans. But scarce credit and tighter lending standards in the wake of the financial crisis have made it harder for home buyers with down payments of less than 20 percent to obtain “conventional” loans, leading more of them to turn to FHA-insured mortgages instead. Reflecting that trend, the FHA now insures an estimated 30 percent of all residential mortgages compared with only 5.5 percent just three years ago.
“If your community doesn’t have FHA certification, you’re writing off a huge segment of the market,” Barbara Kansky, CMCA, AMS, PCAM, general manager at Devon Wood Condominium, a 400 unit community in Braintree, Massachusetts, observes.

Liability Risks
For that reason Stephen Marcus, a partner in the Massachusetts law firm Marcus, Errico, Emmer & Brooks, is advising his community association clients to complete the certification process, not only because “it benefits the entire community, “ he says, but also because “some practitioners think boards may face potential liability” if the community qualifies for FHA certification and fails to obtain it. That risk could arise if an existing owner is unable to refinance or loses a sale to a buyer purchasing with an FHA loan. Although the courts have not yet addressed this issue, the litigation risk is an issue boards should consider when debating the pros and cons of FHA certification, Marcus suggests.
To obtain that certification, community associations must meet a laundry list of standards designed to assess their finances and management. Among the most significant: Delinquency rates on condominium fees can’t exceed 15 percent; FHA concentration levels (the number of units with FHA mortgages) can’t exceed 50 percent (a temporary benchmark that will eventually fall to 30 percent); and associations must allocate a minimum of 10 percent of their operating budget annually to reserves. (Communities that don’t meet the budget requirements but do meet other FHA standards can submit a current reserve study to demonstrate their financial stability, but the study can’t be more than 12 months old.)
Not surprisingly, it is the reserve funding requirements that are most likely to require attention in communities seeking FHA certification. The inadequacy of association reserves is a long-standing concern – the subject of endless articles in industry publications (including this one) and a frequent agenda item at conferences and educational programs. Industry professionals have been trying for years, with limited success, to persuade boards to obtain reserve studies, update them and follow their recommendations for setting aside the funds they will need to repair and replace aging components. It appears that the FHA requirements may be succeeding in advancing those arguments where other efforts have failed.
“My board is listening to me,” Kansky says. Trustees in the past had a more relaxed attitude toward reserve contributions, she observes. “They would make contributions some years, but skip them if they wanted to use the money for other purposes. Now, they realize this isn’t a choice; it’s a necessity.”
As they rethink their reserve funding goals, board members are also approaching financial planning for the community “more holistically,” Kansky has found. “They’re focusing on long-term maintenance requirements, not just on immediate essentials.” Although some balked initially at the idea of adopting policies simply because lenders are requiring them, Kansky says, board members are viewing the FHA certification requirements positively, “not as a big bear that we have to fight, but as a wellness tool,” like a good housekeeping seal of approval, an indication that the community is well-managed and financially secure.
A Reality Check
“As painful as the [certification] process is for some communities, it is improving their financial management,” Patty Raymo, vice president and chief operations officer at Mortgage Master, Inc., suggests. The FHA standards “are forcing boards to take a hard look at their finances and realize that their budgets aren’t large enough, their dues aren’t high enough and their reserves are under-funded,” she says.
Ralph Noblin, president of the engineering firm Noblin & Associates, would like to believe that is the case, but he hasn’t seen any evidence of a sea change in attitudes toward association reserves. While he has noticed a significant increase in the number of requests for reserve studies and updates since the beginning of this year, Noblin attributes that less to the FHA requirements than to the heavy spring rains, which made boards realize “that not only were their budgets under-funded, but their buildings leaked.”
Mitchell Frumkin, PE, RS, CGP, president of Kipcon, Inc., reports similarly that he has seen no FHA-related surge in requests for condominium reserve studies, tallying only “one or two” such calls, at most so far this year. But the FHA requirements are still fairly new, he observes. “The dust hasn’t settled yet,” he says, and when it does, it is possible that more communities, like the one Kansky described, will begin to approach reserve funding more realistically than they have in the past.
But Frumkin and Noblin both caution that the FHA’s 10 percent reserve funding target isn’t nearly realistic enough for most communities and could create a false sense of security, leading boards to assume their reserve funding levels are fine, when they are anything but.
“That [10 percent] is not a reality number,” Frumkin says. “It’s very misleading. A community could be making that annual reserve contribution and still be [seriously] under-funded.”
Hugh Shaffer, PCAM, senior manager at G&G Management a Needham, Massachusetts management company shares the concern about applying a standardized, ‘one-size-fits-all’ reserve guideline to all communities. Communities, he notes, “are unique” in their finances, their structures, and their funding needs. For a townhouse community without many amenities and little landscaping, a 10 percent annual reserve contribution may be too much, Shaffer notes, while for a high-rise building with multiple elevators and complex mechanical components, the FHA standard may fall well short of what is required.
A “Meaningless” Standard
Reserve funding requirements Noblin agrees, depend both on where communities are starting and where they need to be. “The 10 percent [standard] is kind of meaningless if the association’s reserves are one-tenth of what they should be at any given time.”
Noblin predicts that financial industry policy-makers will recognize that problem and begin requiring lenders to verify not only that communities are making “reasonable” contributions to their reserves but also that the reserve accounts themselves are “adequate” to meet anticipated capital repair and replacement needs.
That’s a prospect few community associations would cheer. Many are finding the current standards overly stringent, and while some communities are apparently moving quickly, albeit with varying degrees of enthusiasm, to obtain FHA certification, not all are convinced that it is either necessary or desirable. Robert Kravets, CMCA, PCAM, owner of Realty Corp. of Massachusetts, has explained the FHA requirements and the arguments for certification to his communities, and “in virtually every case,” he says, “they’ve opted to hold off.” At least thus far, Kravets says, his boards haven’t been persuaded that their communities need to qualify for FHA financing. “We haven’t seen a single person come in and say they couldn’t get a loan [because the community wasn’t FHA-approved],” Kravets says. “Maybe other mangers are having a different experience, but we’re just not seeing the market in that way.”
Shaffer reports a “mixed” reaction in the communities his firm manages. While one board moved quickly to begin the certification process, at the urging of a member who is a real estate broker, Shaffer says, others have not shared that sense of urgency. Like Kravets, Shaffer says he hasn’t seen that certification has provided any benefits, or that the lack of it has created any problems. “Long-term, I’m sure there will be more benefit, as more brokers and lenders become aware that communities are FHA-approved,” Shaffer adds. “But so far, I haven’t seen that it’s made any difference.”
A Different Animal
Some boards question the need for certification because they don’t think buyers purchasing units in their (more affluent) communities are likely to be seeking FHA loans. But Raymo suggests that they might want to rethink that assumption. It’s true, she says, that FHA loans in the past appealed almost exclusively to lower-income, first-time buyers unable to make more than minimal down payments. (The FHA requires less than 5 percent down.) But FHA loans today “are a completely different animal,” Raymo notes. Loan limits, which traditionally made FHA financing unworkable in high-cost markets, are much higher today – up to $729,000 – appealing to a much broader segment of the home-buying market. While some managers may not be seeing much interest in certification at their communities, Raymo says, Mortgage Master, which helps communities negotiate the certification process, is very busy. “I have one person working full-time on condominium certifications,” she reports.
The certification process itself is “daunting,” she says – cumbersome, paperwork intensive and costly. Among other requirements, lenders must verify that a community falls within the FHA loan concentration limits. The only way to do that, Raymo explains, is by entering all the units in a community in an FHA data base (accessible only to FHA-approved lenders) to see if any are linked to FHA loans. “That’s a lot of data entry,” Raymo says.
Certification costs, ranging from $3,000 to $5,000 according to some estimates, include the fee for a legal opinion letter and the fee most management companies charge for compiling the detailed and extensive information the FHA requires. Some mortgage lenders will also handle the certification process at no charge to the community as an accommodation for a borrower who is obtaining a mortgage from that lender. Although the 10 percent reserve funding requirement has gotten most of the attention, other FHA standards -- for delinquency rates and insurance coverage, may also prove problematic for some communities. But shortcomings in most of those areas can be addressed fairly easily, Marcus says. Communities that exceed the 15 percent delinquency rate “can get aggressive with collections,” and those that fail to meet the minimum requirement for the fidelity bond (three times the common area fees plus the association’s reserves) can increase that low-cost coverage. But some fixes aren’t so easy. For example, if someone owns more than 30 percent of the units in a community (the maximum the FHA rules allow), “there is no legal method of requiring that owner to sell,” Marcus says.
Delays Ahead?
Community associations can obtain FHA certification directly from the Department of Housing and Urban Development (HUD) or from an authorized FHA lender through HUD’s delegated approval process. Although the delegated process can be faster, few lenders have been willing to provide the certifications because penalties for submitting inaccurate information are severe – a fine of up to $1 million and a prison term of up to 30 years. At Mortgage Master, which is offering lender certification, Raymo says she is “comfortable” with the documentation procedures in the firm’s review process. Still, she admits, “every time I sign one of these [certifications], my hand gets a little shaky. I don’t look so good in an orange jumpsuit,” she laughs.
When the FHA rules were first announced, Raymo and other industry executives warned that, with most certification applications going directly to HUD, huge backlogs might result. That hasn’t been a problem thus far, according to Raymo, who says HUD approvals are taking an average of four to six weeks. But as more communities seek certification, she predicts, the processing time will almost certainly get longer, especially when communities with existing FHA certifications begin applying for renewals.
Certifications obtained before the FHA adopted its new standards will expire in December of this year, but HUD won’t begin accepting renewal applications until November. At that point, Marcus predicts, the agency “will be bombarded.” For HUD and for communities applying for new or renewal certifications, he fears “it will be a nightmare.”
Given that prospect, Raymo predicts that HUD may rethink some of the certification requirements – including the penalties for lenders under the delegated review process. In response to industry concerns, HUD officials are also reportedly reviewing the FHA pre-sale requirements which currently mandate that 30 percent of the units in a new or substantially renovated development (going up to 50 percent next year) must be pre-sold before the community can be certified; but for a conversion project, the pre-sale requirement rises to 90 percent.
Raymo says there is also a good chance HUD will ease the 10 percent annual reserve requirement for small (two-to-four-unit) condominiums. But she doesn’t think it is likely the agency will relax that requirement for larger communities. “Don’t hold your breath on that one,” she advises.
Some managers, Kravets among them, doubt the FHA standards will turn out to be as unyielding as they currently appear to be. “We’re going to see a lot of things start to loosen up over time,” he predicts, noting that lender demands for detailed information have a way of becoming less absolute as the closing deadline nears. “When a closing is on the line,” he says, “suddenly the 27 questions that must be answered boil down to two.”
Other industry executives are reporting the opposite experience, however; they are seeing lenders demanding more, not less, information from community associations, and becoming less flexible about the format in which they will accept it. Managers have become accustomed to submitting the information lenders require for all condominium loans on a standardized industry form, but lenders, increasingly, are insisting on using their own forms, Kansky says. The industry form “is no longer acceptable.” In the past, she says, if lenders wouldn’t accept the standard form, the answer from association boards and managers was, “Too bad. The borrower will have to go elsewhere [to get a loan.]” But these days, Kansky says, there aren’t many “elsewheres” to which borrowers can go. “We’re becoming a captive to that.”