FHA Has Just Released New Condominium Regulations

by J. Christopher Kinsman and Adam P. Chenell

this article was published by the Colorado Real Estate Journal, December 2-December 15, 2009 issue. Click here to view and download a PDF file of the article.

On November 6, 2009 HUD issued two new guidance letters regarding approvals for FHA mortgages at condominium projects. The first guidance letter (Mortgagee Letter 2009-46 B) sets forth new standards for condominium projects seeking FHA approval with an effective date of December 7, 2009; the second guidance letter (Mortgagee Letter 2009-46 A) modifies or waives certain provisions of the first guidance letter until December 31, 2010, these departures from the first letter are indicated below. Many of the standards set forth in the new guidance letters were first introduced in a guidance letter issued in June of this year. However, the June letter never took effect, and these new guidance letters take its place. In summary, the new letters provide as follows:

Pre-Sales. At least 50% of the total units at the project must be sold before an FHA loan on a unit may be closed; however, FHA will recognize executed sale agreements with evidence that a lender is willing to make the loan as counting toward the pre-sale requirement. A secondary residence can only be included in the pre-sale calculations if it is not a vacation home and the borrower will spend less than the majority of each calendar year at the home.

Note that the second guidance letter decreased the pre-sale requirement to 30% until December 31, 2010 for new construction.

Owner-Occupancy Ratios.  At least 50% of the units at the project must be owner-occupied or sold to owners who intend to occupy the units. If the owner-occupancy ratio includes pre-sales, FHA requires evidence that a lender is willing to make a loan to the buyer and that the buyer intends to occupy the unit, or that the developer provide documentation that lists all of the units already sold, under contract, or closed and that the documentation include a signed certification from the developer (a form of which is attached to the first guidance letter). For proposed, under construction or projects still in their initial marketing phase, FHA allows for a minimum owner-occupancy amount equal to 50% of the number of pre-sold units; however, the minimum applicable pre-sale requirement still applies.

The FHA owner-occupancy threshold in a project with legal phases is applied to the first phase, and then to subsequent phases cumulatively if the developer/owner of each phase is the same (for example in a project with two legal phases, the project must have at least half of units in the first phase be owner-occupied and when the second phase is annexed at least half of all the units in the project must be owner-occupied). Interestingly, FHA seems to say that if each phase is owned by a separate developer/owner, then the owner-occupancy requirement applies to each individual phase.

FHA Concentration.  In general FHA will not issue new loans on a project once 30% of the units at a project have FHA loans. The FHA concentration threshold in a project with legal phases is applied to the first phase, and then to subsequent phases cumulatively if the developer/owner of each phase is the same.

Note that the second guidance letter increased the 30% concentration level to 50% until December 31, 2010; and if the project meets the following additional standards, the concentration level may be increased to 100% until December 31, 2010: (a) construction at the project has been complete for at least one year as evidenced by the issuance of the final or temporary certificate of occupancy; (b) all of the units at the project have been sold and no entity owns more than 10% of the units in the project; (c) the project’s HOA budget provides for replacement reserves of at least 10% of the budget; (d) control of the HOA has been transferred to the unit owners; and (e) owner-occupancy is at least 50%.

 Investor Ownership.  No more than 10% of the units at the project may be owned by one investor. This limitation also applies to developers that rent vacant and unsold units, such that if a developer were to sell a number of units at the project and then stop marketing the units for sale and rent the unsold units under long-term leases, the project may lose FHA approval if the number of units being leased and not marketed exceeds 10%. It is not clear whether a project would lose FHA approval if a developer entered into short-term leases with buyers who also executed delayed purchase contracts and such leases accounted for more than 10% of the units at the project. The point is that there may be ways to structure a leasing program that does not violate the 10% investor rule.

Ineligible Projects.  Projects where 25% of the total floor area is used for commercial purposes or where the commercial and residential portions of the project are not similar or where the commercial use imposes adverse conditions upon the residential units are ineligible for FHA approval. In addition, condominium hotels and timeshare projects are not eligible for FHA approval.

Legal Phasing.  FHA allows for the legal phasing of condominium projects. FHA will not accept marketing phasing as an alternative to legal phasing. For vertical condominium projects (i.e. towers), legal phasing is acceptable if (a) the floors of the building are legally phased in groupings of no less than five floors, (b) at least a temporary certificate of occupancy has been obtained and all common areas and amenities in the project have been completed, and (c) a third party completion bond has been obtained.

Delinquent HOA Dues.  No more than 15% of all units can be more than thirty days past due in the payment of their HOA assessments.

Budget Review.  The HOA budget must (a) be adequate, (b) include allocations/line items to ensure sufficient funds are available to maintain and preserve all amenities, (c) provide for replacement reserves of at least 10% of the budget, and (d) provide adequate funding for insurance coverage and deductibles required to be maintained by the HOA. The HOA’s reserve study cannot be more than twelve months old.

Insurance Coverage.  The HOA must maintain hazard insurance in an amount equal to 100% of the current replacement cost of the project exclusive of land, foundation, excavation and other items normally excluded from coverage. In cases where the HOA hazard insurance does not include interior unit coverage, including replacement of interior improvements that the owner may have made to the unit, the owner must obtain a "walls-in" coverage policy, known as an HO-6 policy. The HOA must also maintain comprehensive general liability insurance covering all of the common elements, commercial space owned and leased by the HOA, and public ways of the project. In addition to the insurance requirements above, HUD has specific requirements for fidelity insurance and flood insurance where applicable.

Condominium Conversions.  Changes to condominium conversion requirements include: (a) Condominium conversion projects no longer have to wait one-year from formation for approval; (b) in the event that FHA is insuring a mortgage on a unit on a project undergoing remodeling or rehabilitation, the entire project, including the common facilities, must be 100% built; and (c) conversions of properties from non-residential or from rental, whether tenant-occupied or vacant, will be treated as new construction.

Recertification of Project Approvals.  Project approvals will expire two years after the project was initially approved by HUD, after which time the project will need to be recertified to confirm that the project is still in compliance with HUD’s owner-occupancy requirement and that no conditions exist which would present an unacceptable risk to FHA such pending special assessments, pending legal action against the HOA, or its officers or directors, and adequate hazard, liability insurance, and when applicable, flood insurance coverage.

Direct Lender Review/Exclusions from Review.  Until the issuance of the new guidance letters, condominium projects had to be approved directly by HUD. The new guidance letters provide for a process by which approved lenders can directly approve a condominium project; except for projects in Florida which still require direct HUD processing. This new approval process is called Direct Endorsement Lender Review and Approval Process (DELRAP). As part of this process, the lender is required to represent and warrant to FHA compliance of the project with FHA’s condominium regulations and with a certain set of mortgage insurance regulations found at 24 CFR 203. The CFR regulations are voluminous and may give lenders some heartburn when having to certify to them, especially since the new guidance letters provide that lenders using the DELRAP process are liable for material deficiencies associated with the project approval and any loan they originate and/or underwrite.

This of course is only a summary of these regulations, and their impact and interpretation will be the subject of ongoing debate for some time.

This Article is published for general information, not to provide specific legal advice. The application of any matter discussed in this article to anyone's particular situation requires knowledge and analysis of the specific facts involved.

Copyright © 2009 Fairfield and Woods, P.C., ALL RIGHTS RESERVED.

Comments or inquiries may be directed to:
J. Christopher Kinsman or Adam P. Chenell