The collapse of Champlain Towers South in Surfside, Florida, in June 2021 resulted in a terrible and tragic loss of life. Although it pales in comparison to the deaths of 98 people, the loss of property also was substantial. And while this catastrophe and the loss of human life is unusual, much of went wrong in Surfside is being played out in other condominium associations around the country.
Things like poor management by board personnel in condominium associations, opaque condo laws, a lack of disclosure to buyers and substandard finances are commonplace. And all of these factors are precisely what led to the Surfside disaster. (These also are issues for warrantable condos, which are properties that can be purchased using a conventional loan backed by the government-sponsored enterprises or a government loan.)
Mortgage lenders and their insurers must wake up and actually underwrite a condo association before granting or insuring loans within them. Originators will need to understand that tighter underwriting standards may be part of the equation of condominium financing in the future.
For starters, the monthly dues that accompany condominium ownership are almost entirely an illusion. Standard assessments for condos are actually much like a negatively amortized mortgage — you’re allowed to make a low monthly payment, but the accruing deficiency is being added to your account on the back end.
Condo boards and the associations they govern want low dues, even if they’re inimical to prudent budgeting and responsible management. What board member would vote to raise their own monthly payments to cover future construction repairs when they might not even be alive or living in the building when such a repair becomes needed?
Condo owners want low dues for their own monthly expense considerations, as well as when marketing their property for sale. Low dues are a selling point for most buyers, who are under the mistaken belief that the fees tied to a homeowners association (HOA) are a true and accurate reflection of what the current and future cost of maintaining the association actually is. And if you doubt low dues are such fiction, there is often documented evidence that betrays this fact. This document, known as a reserve study, is something that most states require an association to order every three to five years.
The reserve study’s function is to analyze current projects and any upcoming maintenance projects against the cost of construction. In doing so, it outlines what the reserve contribution should be every month. The operative word here is “should,” because while an association is obligated to order a study every three to five years, there is no state law that requires it to be followed.
To make matters worse, many associations seem to choose to ignore the law and don’t order the reserve study at all. This saves them money along with the irrefutable, documented proof that the dues are much too low and insufficient for covering the capital repair projects when the time comes. Ignorance is bliss, especially for the seller. In the absence of a study, they have no bad news to disclose to the uninformed buyer regarding any deficiencies.
Inescapably, the chicken comes home to roost in the form of a special assessment, which is an expense on top of the monthly dues to cover any repairs. This lump sum — which typically arrives out of the blue — is not only a financial gut punch but is the usual way that an HOA fiscally operates.
Although an owner can pay the entire amount upfront, many opt to obtain a loan to repay the special assessment. This is a loan and attendant payment the mortgage lender never accounted for when calculating the borrower’s debt-to-income ratio. While latent to a loan underwriter, the paper trail and inevitability that is certain to follow is crystal clear to the trained eye.
Champlain Towers South had considered a special assessment for years, as evidenced by the board’s meeting minutes. The board was found to be in the process of passing a special assessment for $15 million at the time of the disaster. This amounts to an average of $110,000 per unit which, if calculated on a 20-year amortization at 8%, yields a monthly payment of $920 for each owner. Goodbye, back-end ratios.
Unfortunately, this problem is only going to get worse. Many existing condominiums were built in the 1980s and ‘90s. Now, decades later, they are facing the major repair projects that induce large special assessments and empty the pockets of homeowners. Similarly, inflation and skyrocketing construction costs are conspiring to challenge the financial planning and level of dues for even the most financially well-managed associations.
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In light of the Champlain Towers South collapse, mortgage lenders and insurers would be wise to rethink their current risk assessments for condos, which haven’t changed significantly in years. Financial practices and policies for condo boards are discoverable with a thorough and knowledgeable underwriting of the associations.
Such scrutiny would allow buyers to negotiate with sellers for better, fairer prices when considering certain risks deemed present following an assessment or study. It also would enable companies to decline to lend or insure within these buildings when conditions warrant. These poor management habits have and will continue to produce further problems via bad condo loans and defaulted HOA dues, which bring with them another level of risk for mortgage lenders and their insurers. ●