FHA’s Sensible Solution to Transient Use Problem Eliminates another Condominium Certification Obstacle

Published on: September 17, 2013

FHA_ApprovedDealing with the Federal Housing Administration’s (FHA’s) condominium certification requirements has been a little like coping with young children:  Just when you think you’ve gotten a handle on one phase, your kids begin to go through another one.

With the FHA, whenever condominium association boards and industry professionals overcome one obstacle in the FHA certification process, it seems, agency staffers identify another issue, creating another certification problem that has to be resolved.

The most recent of these problems surfaced several months ago, when the FHA decided that the “transient use” provisions that are standard in the governing documents of most condominiums were unacceptable. Those provisions, which prohibit the rental of units for less than 30 days, typically contain a carve-out excluding foreclosing lenders from that restriction. After routinely approving certifications without noting the transient use concern, the FHA suddenly began rejecting applications because of it.

 

New Problem – Old Conflict

It seems the carve-out for foreclosing lenders violates the National Housing Act, which prohibits transient uses, with no exceptions, in properties financed with FHA loans. That conflict isn’t new; the National Housing Act has been in place for decades.

But until fairly recently, the FHA didn’t insure many condominium loans, Joann Kuczma, director of the Office of Single Family Program Development in the Department of Housing and Urban Development (HUD), explained in a recent conference call with industry executives,. And the loans it did insure were processed under reciprocal agreements with Fannie Mae and Freddie Mac; the FHA automatically accepted any loans those agencies approved without independently reviewing them. (One interesting side-note: It was Fannie and Freddie who insisted on the transient use carve-out to which the FHA eventually objected.)

When the financial markets imploded five years ago, the FHA emerged as one of the major sources of financing for residential mortgages, including condominium loans. As the agency’s market share grew from miniscule to more than 30 percent, FHA officials developed their own guidelines for condominium loans and began scrutinizing condominium governing documents they had not reviewed in the past.

That explains (more or less) why the FHA wasn’t questioning the transient use language five years or more ago, but it doesn’t explain why the agency staffers who have been reviewing condominium documents for the past three years didn’t notice the problem until earlier this year. Maybe this was one of those details that just slipped under everyone’s radar.

 

Bump in the Process

When the blip began to flash on underwriting screens, the certification process, which had been operating fairly smoothly, hit a major bump and certification rejections began to pile up. The Community Associations Institute (CAI) reported the problem to FHA officials, who began looking for a solution.

The cure they proposed initially was for condominium associations to amend their documents to eliminate the transient use carve-out for foreclosing lenders. But CAI and other industry executives pointed out that obtaining the super-majority vote required to amend a community’s governing documents is difficult, time-consuming and not always possible. So the agency approved another alternative: Condominium boards could submit a letter attesting that no units in their community are currently rented for less than 30 days, and specifying that no residents receive “services commonly associated with a hotel.” The letter must be on association letterhead and it must be signed by a board member; it can’t come from a manager, attorney, or anyone else representing the association.

Although FHA officials no doubt viewed amending the documents as the most appropriate fix, to their credit, they also recognized that it wasn’t practical. The solution they came up with makes a lot more sense – it seems to work reasonably well for everyone.

Unfortunately, a number of communities seeking certification were left in limbo while the FHA was working internally on the problem, and communities whose certification bids were rejected because of the transient use concern will now have to reapply, which will be frustrating for them, to say the least.

In the conference call explaining the FHA’s new policy, Kuczma indicated that if their applications are more than 90 days old, communities will probably have to submit updated financial information, but other documentation “should be ok,” she noted.

As with previous certification glitches, the angst caused by this one will no doubt be temporary. Condominium boards and industry executives who deal with the certification process will adjust to the new documentation requirements and eventually become comfortable ― or at least more comfortable ― with them. But there is an element of waiting for another shoe to drop. It is hard not to wonder when the FHA will discover other previously undetected problems, triggering new certification crises in the future.

 

Improving the Process

Hoping to reduce that risk, CAI, has joined three other real estate industry trade groups (the National Association of Realtors, the National Association of Home Builders, and the Institute of Real Estate Management) in asking the FHA to consider several changes in the condominium certification process, designed to make it less complicated and less burdensome for condominium associations.

CAI_logoCAI estimates that only about 10 percent of the approximately 150,000 condominium communities in the country are FHA-certified; FHA statistics indicate that 60 percent of the 3,500 condominium certification applications submitted this year were rejected.

Standardizing the condominium certification requirements and streamlining the certification process ― two of the “enhancements” the trade groups are suggesting ― will address the concerns about cost, complexity and rejection risk that discourage many communities from seeking FHA certification, even though they recognize its importance. If a community is not certified, prospective buyers interested in purchasing units and existing owners who want to refinance an existing mortgage cannot obtain FHA loans ― no small consideration given the agency’s still significant share of the mortgage market.

“Complicated paperwork collection requirements, consultant and attorney fees, the volume of program requirements, and seemingly arbitrary interpretations of program rules create an environment where boards simply do not believe FHA approval will provide a sufficient return on investment,” the trade groups note in their letter to the FHA. “When association boards know that 60 percent of condominium associations that seek FHA approval are denied, the decision not to submit an approval package seems prudent.”

The trade groups are also suggesting that the FHA increase the recertification time frame from every two years to no more than every five and establish an electronic data filing system so communities will not have to resubmit information they have already provided ―an idea that would benefit the FHA as well as condominiums.

Although the road has been bumpy at times, but the FHA has been moving generally in the right direction in addressing the industry’s concerns about the agency’s condominium policies. The sensible solution to the transient use problem suggests there is good reason to expect that will continue to be the case.

 

By Stephen Marcus