Published on: March 26, 2012
Condominium associations have dodged another bullet fired in their direction by federal regulators. This one, from the Federal Housing Finance Agency (FHFA), would have prohibited Fannie Mae, Freddie Mac and the Federal Home Loan Banks from purchasing mortgages on properties encumbered by “deed transfer fees” charged every time the properties are sold.
The FHFA’s primary target was fees charged by private developers, but as proposed initially, the regulation would have barred all deed transfer fees, including those charged by condominium associations.
Associations fare much better under the final rule, which applies prospectively to transfer fee covenants adopted after February 8, 2011, and carves out an exception for condominium association fees that “directly benefit” the underlying property. The Community Associations Institute (CAI), which lobbied intensely against the FHFA’s initial proposal, says the substantially revised language represents a major victory for condominium associations, preserving their ability to impose transfer fees, while ensuring that all funds they generate are used exclusively “to benefit their associations and [association] property.”
Housing Industry Complaints
CAI’s successful lobbying effort is at the center of the regulation’s back story. Housing industry trade groups, led by the National Association of Realtors (NAR), had been complaining for some time about transfer fees imposed by private developers, and those complaints had grown louder as the fees became more widespread.
Representing as much as 3 percent of the purchase price and running for as long as 99 years, the fees existed solely to generate income for developers and investors (through the creation of securities collateralized by the fee income), critics said, while providing no benefits for the properties or property owners. In addition to being what the NAR termed a “stealthy way to milk real estate transactions,” the fees, critics said, were not clearly disclosed to homebuyers, needlessly complicated real estate closings and artificially inflated home prices.
CAI agreed with those arguments as they applied to private developers, but insisted that they should not apply to the fees condominium associations have used “for decades to help fund reserve accounts or community improvement projects.”
The FHFA wasn’t persuaded at first. “Even if the fees are dedicated to homeowners associations,” the agency concluded in the policy statement accompanying its initial proposal, “they are not proportional or related to the purposes for which the fees were to be collected.” In any event, the agency decided, “the risks and uncertainties for the housing market that come with the use of private transfer fee covenants do not appear to be counterbalanced by sufficient positive effects.”
But CAI persisted, mustering statistics to support its contention that barring the transfer fees would have a “devastating” impact on condominium associations and condominium owners, essentially precluding mortgage financing for the 11 million homes CAI estimated to be in condominium associations that currently have transfer fees and rely on then to finance operating expenses and fund essential, long-term maintenance and capital improvement projects.
Citing the results of an industry survey, CAI reported that nearly half of the 1,254 communities responding, representing about 500,000 residences, had transfer covenants in place that had been in place for a decade or more; most described their fees as “nominal” – less than $500 or less than 1 percent of the purchase price ― and virtually all (99.2 percent) said the fees directly support their communities. More than half (60 percent) said they would have to increase association assessments to compensate for lost revenue if they were no longer able to rely on transfer fees.
The FHFA apparently listened to those arguments and ultimately agreed that condominium associations should be treated differently. The final rule creates an exception for a private transfer fee covenant “that requires payment of a private transfer fee to a covered association and limits the use of such transfer fees exclusively to purposes which provide a direct benefit to the real property encumbered by the transfer fee covenants.” To meet the definition of a direct benefit, a transfer fee must “be used exclusively to support maintenance and improvements to encumbered properties and acquisition, improvement, administration, and maintenance of property owned by the covered association of which the owners of the burdened property are members and used primarily for their benefit.”
Good Result for Condominiums
Most condominium associations will have no trouble meeting that test. In a memo analyzing the regulation, CAI notes that he FHFA’s direct benefit definition reflects the “burden v. benefit test ― a “well-established, broadly accepted legal standard” that CAI said, “[condominium associations have used over the past several decades when adopting transfer fees….Only [condominium] associations that choose to deviate from this generally accepted industry and legal standard by adopting transfer fees that do not directly benefit properties will be impacted by the final regulation,” the CAI analysis notes
The FHFA’s final rule incorporates several other changes CAI had sought, the most significant among them, broadening the definition of “direct benefit.” Under the initial proposal, only “maintenance and improvements to common property” would have qualified. The final rule adds to that list “acquisition, improvement, administration, and maintenance” of property owned by the association and used primarily for the benefit of owners. It also includes cultural, educational, charitable, recreational, environmental, conservation and similar activities that are:
- Conducted in or protect the burdened community or adjacent or contiguous property, or
- Conducted on other property that is used primarily by residents of the burdened community.
That definition should cover virtually all association activities. This revised wording also eliminates language in the original proposal that defined “adjacent or contiguous properties” as those located within 1000 yards of the association’s main property line. CAI argued successfully that this would exclude association-owned property in some communities, and it did not consider the master association/sub-association structure that exists in many associations. The revised language makes it clear that transfer fees can be used “to support all land that is owned by the associations,” the CAI analysis notes. But it also emphasizes that “these association properties (like all other association properties) must be primarily used by association residents. CAI does not interpret the final regulation to permit transfer fees to be used to support property that is generally open and available for public use or use by another entity, private or public.”
The final rule also eliminates proposed language that would have required condominium associations to charge a fee for public access to common area property supported by association transfer fees, accepting CAI’s argument that “an association is free to allow access to common property as long as such access provides a direct benefit to the encumbered properties.”
No Harmful Impact
Unlike the FHFA’s initial proposal, the final rule, which takes effect July 16th, does no harm to condominium associations. It has no effect on transfer fees charged before February 8, 2011, but it does require boards that have charged transfer fees since that date in connection with the sale or lease of properties, or are planning to begin charging those fees, to make sure they are using that revenue for the “direct benefit” of their communities, as the regulation requires. Failure to do so could make it impossible for owners (or prospective buyers to whom they might want to sell their units) to obtain mortgage financing. Boards should also consult their association attorneys to make sure the language in their existing covenants, or in covenants the association is adopting, reflects the ‘direct benefit’ restrictions on the use of transfer fees. We are suggesting the following language for our clients:
“In order to maintain sufficient reserves for the condominium, whenever a unit is sold, conveyed or transferred to a bona fide purchaser for value, the Board of Trustees shall collect from each unit purchaser, and such unit purchaser shall pay to the Board of Trustees upon the closing of his or her purchase of the unit, an amount equal to two- months of the estimated annual common charges attributable to said unit. Such sum is to be for the use and benefit of the Trust and shall not be considered advance payment of any other assessments, including, but not limited to, any regular, monthly, quarterly, supplemental and/or special assessment.”