LEGAL/LEGISLATIVE UPDATE – JULY 17, 2018

Published on: July 17, 2018

FANNIE EASING

Fannie Mae is making it easier to finance investment condominiums. The agency announced recently that it will allow “limited reviews” of condominium properties instead of insisting on more detailed and costlier full reviews required for these loans. Fannie has been allowing limited reviews for loans on owner-occupied condos with down payments of at least 10 percent, but has insisted on full reviews for investment condos, regardless of the down payment size. The new rules will now permit limited reviews for buyers making down payments of 25 percent or more.
In another significant rule change, Fannie is now allowing lenders to apply its “Property Inspection Waiver” program to condo loans, giving them the option of closing some loans without obtaining formal property appraisals.
Reporting on these recent changes in National Mortgage News, columnist Matthew Graham notes: Fannie Mae has made condo financing faster, cheaper, and far more predictable. More predictable loans mean more closings, higher condo values, happy buyers, sellers, agents, and lenders. It’s a big win for everyone.”

TAX AND CONSEQUENCES

The new federal tax law is having an impact in some areas, and it’s not positive. Home sales have plummeted in Westchester County, where the cap on property tax deductions is discouraging purchases of homes in this ultra-high-end market, which has the nation’s highest property tax burden. Existing home sales fell by 18 percent year-over year in the second quarter, the fourth consecutive quarterly decline. Federal tax rules now cap deductions for state and local taxes at $10,000. The median property tax in the Westchester market is more than $17,000; the median price was $525,000 in the third quarter.

Separately, economists at the Federal Reserve Bank of San Francisco are reporting that the tax cuts, which represent the core of the Republican tax bill, are unlikely to provide the economic boost its advocates are predicting. Slashing taxes can have a positive impact on a weak economy, the economists, Tim Mahedy and Daniel Wilson, acknowledge in a letter posted on the San Francisco Fed’s web site. But in a strong economy, they note, the cuts can be counterproductive, increasing the deficit and limiting the Fed’s options when the economy slows.

Dismissing projections of a 3 percent or higher increase in economic growth as “overly optimistic,” the economists describe the tax law as “in essence, a large, mostly temporary tax cut hitting a hot economy.”

REVERSE MORTGAGE REVERSAL

The federally-insured reverse mortgage program is in trouble. This is not a new story. The Home Equity Conversion Mortgage program, overseen by the Federal Housing Administration (FHA), has been struggling with large losses and regulatory shortcomings for more than a decade. And agency officials are in “fix-it mode,” trying to identify the underlying problems. FHA Head Brian Montgomery, who spearheaded efforts to overhaul the reverse mortgage program when he headed the agency in 200-2009, is directing a similar effort now.

Losses on HECM loans slashed the agency’s reserve ratio from 2.35 percent to 2.09 percent last year – close to the minimum 2 percent buffer federal law requires.

“Interest rates are still relatively low, house prices have returned in most areas, yet here we are hemorrhaging money out of that portfolio,” Montgomery said in an interview with National Mortgage News. “[We’re asking], why is that?”

While Montgomery is focusing on reverse mortgage losses, some industry executives are noting, with concern, the shrinking of the reverse mortgage market. Lenders originated fewer than 3,000 loans in June – the lowest volume since 2005, according to Reverse Market Insight, which tracks industry trends. John Lunde, RMI’s president and founder, attributed the decline to “significant changes” mandated by the FHA, which, he told Housing Wire, “restricted access and desirability” of the product.

Lenders say they are responding by developing alternative reverse mortgage products that aren’t federally insured. And Lunde thinks those efforts will help solve the industry’s problems. “The path back is likely a combination of non-FHA products being rolled out to address more of the potential borrowers with a potentially better origination process and pricing benefits as the consumer perception of the product continues to improve,” he noted in the Housing Wire interview. “All that is, of course, easier said than done” he acknowledged, “but those are the broad strokes.”

WARMING TREND

Summer temps have been heating up but the employment market cooled slightly in June. Employers added 213,000 workers for the month, beating less optimistic expectation, but lagging May’s total of 244,000 – revised upward from the 223,000 reported initially. A revision in the April data added another 16,000 workers to that month’s total. The unemployment rate ticked up to 4 percent from 3.8 percent, while wage gains held steady, with average hourly earnings rising five cents (0.2 percent) compared with a 0.3 percent increase in May.

Analysts attributed the higher unemployment rate to an increase in labor participation, as the strong economy lures more unemployed workers into the market. The consensus view also sees the wage gain, though still modest, as positive─ strong enough to put more money in workers’ pockets but not strong enough to ignite inflationary fears at the Fed, which boosted its target rate in June for the second time this year and has signaled that two more hikes are likely between now December.

Underscoring the Fed’s confidence in the economy, Fed Chairman Jerome Powell told reporters after the June Federal Open Market Committee meeting, “The decision you see today is another sign that the U.S. economy is in great shape. Most people who want to find jobs are finding them.”

Some simmering concerns shade what are generally viewed as upbeat economic reports, primary among them, the lack of qualified workers to fill available positions.

“That’s the number one issue” for Dan North, chief economist for Euler Hermes North America, a national credit insurance firm. “We’re desperate for labor,” he told Politico.

NEW MONTH – OLD STORY

The scant inventories, rising prices and higher interest rates that have impeded sales all year persist. Existing home sales fell 0.4 percent in May compared with April – the second consecutive month-over-month decline, as the annual sales pace remains stuck below 5.7 million units. Scant listings, especially at the lower end of the market, pushed sales 3 percent below the year-ago level.

  • The National Association of Realtors’ pending sales index also slipped again in May, falling by 0.5 percent compared with April and 2.2 percent below May of last year. A decline in mortgage applications suggests that the June report isn’t likely to be much better.
  • On a somewhat brighter note, inventory levels actually improved a bit in May, increasing by 2.8 percent. But the hole is deep. Inventories were still 6.1 percent below the year-ago level, extending to 36 the consecutive monthly year-over-year declines.
  • New home sales increased by 7 percent in May compared with April, as the dearth of existing home listings pushed more buyers into the new home market. Sales for the month beat the year-ago total by more than 14 percent.
  • Housing starts also rebounded in May after plummeting in April, increasing by 5 percent to a seasonally adjusted rate of 1,350,000 units—more than 20 percent above the May 2017 level. Single family starts are up 9.8 percent for the year-to-date. Single-family permits, however, declined by 2.2 percent, although the total topped the year-ago report by 7.7 percent.
  • After reversing a three-month slide in April, builder confidence, measured by a National Association of Home Builders index, slipped again in May, as growing concern about tariff-induced increases in building materials offset optimism about increasing demand for homes. “Builders are optimistic about housing market conditions as consumer demand continues to grow,” NAHB Chairman Randy Noel said in a press statement. But builders, he noted, “are becoming increasingly concerned that tariffs placed on Canadian lumber and other imported products are hurting housing affordability. Record-high lumber prices have added nearly $9,000 to the price of a new single-family home since January 2017,” Noel noted.
  • Home prices increased by 6.9 percent in April compared to the same month last year – slightly below the March pace, but still increasing affordability concerns for many buyers. CoreLogic now describes more than half of the 50 largest housing markets as “overvalued.”

“The best antidote for rising home prices is additional supply,” Frank Nothaft, chief economist for CoreLogic, said. But despite some recent improvement, he noted, “new construction has failed to keep up with and meet new housing growth or replace existing inventory.”

IN CASE YOU MISSED THIS

Economists and business executives are also becoming increasingly concerned about the impact of the trade war ignited by President Donald Trump, which appears to be escalating as other countries announce tit-for-tat tariffs in response to those the U.S. has imposed on them. The minutes of the June meeting of the Federal Open Market Committee (FOMC) indicated that Fed policy makers, though generally happy with economic conditions, share that concern.

People who text or talk on a mobile device are more likely to be involved in an automobile crash and women are more likely than men to engage in those risky behaviors, according to a recent study.

Despite flooding that devastated Houston last year, Texas officials have not been aggressively enforcing federal flood insurance requirements aimed at reducing flood risks.

Many housing market statistics have rebounded to pre-recession levels, but the volume of adjustable rate mortgages isn’t among them. Lenders are wondering if rising interest rates will rekindle borrowers’ appetite for these loans.

Get married, have children, buy a house. That used to be the expected progression, but it isn’t any longer.

LEGAL BRIEFS

DEFINING ‘RESIDENTIAL’ PURPOSES

Many courts in many jurisdictions have considered and reached different conclusions about whether the residential use restrictions in condominium documents prohibit short-term rentals. The reasoning the Texas Supreme Court applied in this decision (Kenneth H. Tarr v. Timberwood Park Owners Association, Inc.) makes it particularly interesting and possibly influential.

Two years after purchasing a single-family home in the Timberwood Park subdivision, Kenneth Tarr began advertising it on short-term rental web sites and leasing it to guests for periods ranging from one to seven days. The homeowners’ association ordered him to cease the rental activity, which it said violated the residential use restriction in the community’s governing documents. When the association began levying fines, Tarrr sued.

The trial court and appeals court both granted summary judgment in favor of the association, finding that Tarr was operating a business in his residential property, in violation of an “unambiguous” deed restriction prohibiting it. The Supreme Court reviewed those decisions within the framework of a broader question: Whether the covenant restriction should be construed narrowly, under Common Law, or “liberally,” as dictated by a 1987 Texas statute directing that restrictive covenants “shall be liberally construed to give effect to [their] purposes and intent.”

“Unfortunately,” the court noted, “the legislature provided no explanation as to the motivations or necessity
for . . . change” and Texas courts, as a result “have been unable to determine any uniform standard for interpreting ambiguous restrictive covenants.”

Unambiguous – but Disputed

It was not necessary to resolve that question in this case, the court said, because both sides in the dispute agreed that the covenant language was “unambiguous.” They differed on what its unambiguous meaning was.

The association cited language in two covenants establishing a residential use restriction: The first said “all tracts shall be used solely for residential purposes;” The second: “No building, other than a single-family residence…shall be erected or constructed any residential tract.” The court said the two provisions address different issues and “must be read as separate and distinct.” The second deals with physical structures allowed on tracts in the community; the first focuses on how those structures can be used.

“The parties do not dispute that Tarr’s tract contains a single-family residence, so he has not violated the single-family-residence [requirement,] the court said.

The more complicated question for the court was interpreting how the covenant defined residential purposes.

“A paramount concern when construing covenants,” the court said, “is giving effect to the objective intent of
the drafters of the restrictive covenant as it is reflected in the language chosen. Equally important is the “well-settled rule” requiring that courts “strictly construe” restrictive covenants against limitations on use and resolve doubts “in favor of the unrestricted use of property.”

If you suspect this reasoning will not bode well for the association, you suspect correctly. The association argued and the lower courts agreed, that “transient” uses of the property did not meet the definition of a residential purpose, which connotes a “physical presence and an intention to remain.” The association also argued the LLC Tarr had created to manage the rentals, listing of the properties on rental sites, and his payment of the Texas state hotel tax on short-term rentals all provided evidence of “business” rather than “residential” use of the property.

Tarr argued that the duration of the tenancy did not affect the nature of the property’s use. So the appropriate distinction, he contended, was not between residential and transient use, but between residential and business use. And that distinction, he said, should be based not on whether he earned income from leasing the property, but on whether the activities in which renters engaged could be characterized as residential- or business-related.

That argument resonated with the court, which cited previous decisions in which it has held that “the terms ‘residential purposes,’ and ‘residences’ require the use of property for living purposes as distinguished from uses for business or commercial purposes.” The court also noted, favorably, the commentary provided by American Jurisprudence: “A ‘residential use’ is one that involves activities generally associated with a personal dwelling. Similarly, a ‘residential building’ is a building which is used for residential purposes or in which people reside, dwell, or make their homes, as distinguished from one which is used for commercial or business purposes…. The phrase “residential purposes” does not mean only the occupying of a premises for the purpose of making it one’s ‘usual’ place of abode; a building is a residence if it is “a” place of abode.”

Words Matter

All words in a restrictive covenant “general or not,” the court said “are to be accorded their full and fair scope. They are not to be arbitrarily limited. For this reason, we disapprove of the cases that impose an intent or physical-presence requirement when the covenant’s language includes no such specification and remains otherwise silent as to durational requirements.”

Timberland’s covenants, the court noted, “fail to address leasing, use as a vacation home, short-term rentals, minimum-occupancy durations, or the like. They do not require owner occupancy or occupancy by a tenant who uses the home as his domicile. Instead, the covenants merely require that the activities on the property comport with a “residential purpose” and not a “business purpose.” We decline to add restrictions to the Timberwood covenants by adopting an overly narrow reading of “residential.”

The failure to state a restriction, the court said, is itself unambiguous: “No construction, no matter how liberal, can construe a property restriction into existence when the covenant is silent as to that limitation.”

The court acknowledged that a covenant that was worded differently, specifying the “prohibited conduct,” might produce a different conclusion from a different court. “[But] affording these phrases their general meanings and interpreting the restrictions as a whole, we hold that so long as the occupants to whom Tarr rents his single-family residence use the home for a “] ‘residential purpose,’ no matter how short-lived, neither their on-property use nor Tarr’s off-property use violates the restrictive covenants in the Timberwood deeds,” the court concluded.

Finding no evidence that Tarr’s rental of his property constituted “commercial use” or that his tenants “have used the property in any manner inconsistent with a residential purpose,” the court ruled, “summary judgment for the association was improper.”

WORTH QUOTING

The unemployment rate for black workers…has consistently hovered well above the rate for white worker – If the numbers were reversed, “the country would be up in arms.”─ Andre Perry, a fellow at the Brookings Institution, quoted in the New York Times.


Marcus, Errico, Emmer & Brooks specializes in condo law, representing clients in Massachusetts, Rhode Island and New Hampshire.