PERSON OF THE WEEK: Within the housing industry, the condo market has seen more than its fair share of tumult. Grant Stern, president of Morningside Mortgage Corp. and Condo Terminators, both headquartered in Bay Harbor Island, Fla., spoke with MortgageOrb about the issues that continue to impact the condo market.
Q: What has been the state of the national condo market, in comparison to the single-family home market?
Stern: When the U.S. market for single-family homes sneezed, the condominium market caught the flu. Financing terms for condominiums were greatly restricted by Fannie Mae's ‘Shock and Awe’ campaign. Meanwhile, access to 96.5% loan-to-value (LTV), single-family-home Federal Housing Administration (FHA)-insured financing throughout the crisis has acted as a backstop for values.
Fannie's efforts to delegate all condo approvals in late 2007 fell through. In early 2009, Fannie reacted to perceived risk imposing major restrictions on project approval, capping LTV at 80% and ending delegated underwriting of all new construction projects. These actions caused a panic that constrained credit in the condo market deeply, leading to today's listless pricing environment and stunning buys for value investors, paying all cash, in the last two years.
By comparison, the single-family home loan guidelines by the government-sponsored enterprises (GSEs) and the FHA have barely changed in the last few years. Single-family financing since 2008 has seen the raising of FICO-score requirements by individual lenders for agency programs, which is applied to condos in addition to project approvals. This has been the primary means of keeping single-family financing more stable.Â
The ‘national’ condo market is concentrated primarily in California, Florida, the Sun Belt, the Southeastern coastal areas and Chicago. Once financing was proscribed from the market by Fannie Mae, condo prices sank below replacement costs, and many haven't recovered. Unfortunately, without a mechanism to correct pricing, and due to appraisal values in individual projects being highly correlated, it is difficult to maintain property values when a mass foreclosure event occurs in an individual project. Distressed pricing can spill over from project to project in densely developed areas, and this was most evident in areas with high rates of apartment-to-condo conversion.Â
Ultimately, the mispricing of condominium units should spur more private capital into acquiring fractured condominium inventories for the purpose of condo termination. The termination statute and process in Florida was streamlined in 2007 and promises to be the only way to create new ‘firebreaks’ between fractured projects, as well as to reduce excess inventories in a way that salvages some taxable value for municipalities.Â
Q: Your state has a significant volume of condominiums. How much of the tumult in Florida's real estate market can be traced to condos?
Stern: The condo market is causing a great deal of tumult, and not only in Florida's real estate market. The most obvious sign of this is numerous developers that have gone bust and new projects selling at a discount to construction costs. But what has really flown under the radar is that our urban and coastal local government budgets are also being wrecked because of condo valuation implosions.
Individual condominium units sell at a significant discount to apartment housing units, and the resulting tax assessments are creating grotesque distortions throughout the market that affect pricing in the single-family market as well. How so? As the tax base erodes with the real estate market correction, local governments are raising millage rates to compensate for some – not all – of the lost revenues. This means that single-family homeowners may see tax increases even in the face of property-value erosion due to the crash of their condominium owner's neighbors' homes.Â
Rising tax rates are a primary cause in the soft erosion of single-family home sales that we're seeing in middle-class areas. Higher taxes directly increase the cost of ownership and homeowners' ability to leverage their wages to buy homes.
Q: What impact will the proposed elimination of Fannie Mae and Freddie Mac have on the condo market?
Stern: Not much, at this point – they already destroyed the market. Theoretically, a functioning secondary market that does not scare the daylights out of its primary participants could lead the condo market out of the abyss. Perhaps if Fannie and Freddie's role in the condo financing market is replaced by new market makers, the GSEs' disappearance will have a positive effect on the market.Â
The scary thing is this interregnum between the establishment of new industry standards and the sunset of these large organizations. It could take years to wind down the GSEs, and nobody, in the mean time, is ensuring that this form of housing is supported with meaningful lending guidelines.
According to CondoVultures.com, more than 80% of the sales in Miami's downtown district were cash buys during much of 2010. This means that the majority of buyers are likely investors and not end users. Meanwhile, all of the guidelines are written to lock out projects whose ownership is primarily non-resident. All of the existing guidelines are not written to handle recent dislocations, nor do they have the flexibility to deal with the bulk-buyer phenomenon.Â
Q: The FHA was required to draft new condominium guidelines under the Housing and Economic Recovery Act requirements. How did these guidelines impact the condo market?
Stern: We're just about to find out how the FHA's new guidelines impact the market as the first set of project-approval expirations takes place at the end of this month. Since the new guidelines have been issued, their application has already interfered with approved condo lending. I agree with the concept of modernizing guidelines to meet current conditions, but the FHA's new guidelines are probably better suited to a stable market than they are a recovering one.Â
There were two main changes that have effectively devastated the market for developer sales using FHA financing of new projects: the FHA's decision to change the way lease-option sales are viewed and the ‘Single Investor Concentration’ requirements.
Previously, lease option sales counted toward condo occupancy requirements as ‘owner occupied.’ One of the oldest ways to sell real estate is the use of a lease with credit for payments toward the eventual purchase. Current requirements place those units into the leased category. I have got a draft proposal to reintroduce this time-honored way of selling property into the FHA insured pool of loans, and I would love to see that amended to assist the market.
Q: Why is that?
Stern: One of the base tenets of condo risk analysis has been the limitation of a single owner from holding greater than 10% of the condominium property. Fannie Mae won't lend into a condo with any single owner holding 10% of the property, excluding the developer. The FHA changed its rules to include the developer in its ‘investor concentration’ rules – provided that the developer is leasing the units.
This means that if a developer owns, for instance, 18% of the project, automatically, it is going to be hard to get a loan in this project. Why? You have to count how many units it is leasing of its holdings and calculate what the percentage of the project equals.Â
Then, the developer certifies this information to the lender (even if the project is already directly approved by HUD). The lender must then certify that information to the FHA, which, in turn will fine the lender substantially if the developer is lying. And somehow, the FHA catches them lying about their leasing figures sometime in the future. If one of these situations happens in a foreclosure, the FHA could seek to rescind their insurance altogether.
At what point will the FHA give up and say, ‘This is confusing’? I can't see many scenarios where new construction will be financed using FHA loans in this market because of the aforementioned rules. I still applaud the FHA for bringing the approval process from the early 1980s into the early 2000s, but it could be improved upon greatly.
Q: There is also a subsection of this market: the condo-hotel market. Can you comment on how this market has been holding up over the past few years?
Stern: The condo-hotel market has always been a niche within a niche market. There are two main types of units, and it is very important to distinguish between them: year-round occupancy condo-tels and hotel-condo units that lack the space or kitchen facilities to be a permanent residence for the owner. Often, these units are bought in cash, but the truth is that they were never favorites of lenders before the crash. The maximum leverage for a condo-tel pre-crash was 80% LTV, which I obtained for only one client for the purchase a hotel-condo unit on South Beach.Â
The year-round occupancy units are being snapped up in cash by investors around the globe who want second homes with full service. Moving forward, I am bullish on this form of second home/investor homeownership when it comes to the newer condo-hotel properties that are on the market in South Florida. I believe that in the future, we will see more of these properties developed and eventually reach par with the traditional apartment-condo concepts out there.
The outlook for hotel-condo units, on the other hand, is stark. These units – which are essentially studio apartments, often with efficiency kitchens – are showing their age as a useful property type. Lenders avoided them like the plague in pre-bust days, and nothing has improved.
In select areas, it still makes sense to develop these properties due to new development constraints, such as in the Florida Keys. Ultimately, they're not nearly as marketable as a year-round occupancy condo-hotel unit. Having personally seen one of these projects fall into receivership, I see it as one of the few bargains that isn't really a bargain.
