Magazine article Journal of Commercial Lending

Lending to Condo Associations

Magazine article Journal of Commercial Lending

Lending to Condo Associations

Article excerpt

Typically, loans to condominium associations are for repairs, renovations, or improvements to existing facilities located in the common elements of the development. Given that the association borrower rarely owns any hard assets in its own name, these real estate loans are unique in that it is difficult to fully secure them. Each unit owner maintains title to his or her respective unit, and the association does not own any real property. Therefore, a lender is denied the chance to perfect an effective first lien position on any assets of the condominium development.

Condo Operations

The condominium declarations and bylaws provide that all areas of the property not part of the units themselves (including, in most cases, the roofs) are common elements. These declarations and bylaws are the legal governing documents of the association and empower the duly elected officials to act on behalf of the association. In the absence of fraudulent activity, these elected officials assume no personal liability for actions taken on behalf of the association or for debts incurred by the association.

Fees and Assessments

When the common elements need to be improved, the association's officers are charged with procuring the necessary funds to finance the needed work. The association can use existing funds from an operating (cash) account or funds in a reserve replacement account. Reserve replacement account balances typically are derived from a portion of regular unit owner assessments, are transfers of cash from an operating surplus, or are the result of a special assessment whose proceeds are deposited directly in a reserve replacement account and earmarked for capital expenditures.

However, these funds may be insufficient to finance the total cost of larger repairs. At this point, outside financing is usually required. To offset the expense associated with the debt, the association's board often requests an increase in the operating assessment or a special assessment from the unit owners.

Previous majority approval from the members is not always required to obtain an increase in condo fees or to enact a special assessment. Some boards of directors have the power to levy reasonable annual assessments, say 4%, without additional approval of the members. However, increases in operating fees in an amount significantly greater than a nominal percentage usually require membership approval, and special assessments almost always require approval by a special vote of the members.

Once approved and enacted, the payment of these fees is a near certainty: Failure of an individual unit owner to pay results in a lien being placed against that unit. Unfortunately for the bank, the lien does not necessarily generate cash immediately. It simply states that the property has a lien against it and, before any sale, that lien would have to be satisfied. The options available to an association are set forth in its declarations and bylaws, as amended.

Underwriting

For the lender to receive the necessary comfort level that these fees are lawfully enacted and that the membership is supportive of the increase, he or she should review the declarations and bylaws and any amendments thereto, the minutes from the meetings during which these fees were approved, as well as receive an opinion letter from outside legal counsel stating that these fees were lawfully approved and properly levied against the unit owners.(*)

From an underwriting standpoint, the lender should review what percentage of the membership voted for the fee increase and inquire about any "nuisance" owners who are attempting to mount an organized challenge. An approval margin significantly greater than the minimum required approval percentage should give the lender added comfort that there is strong support among the unit owners.

Problems may arise when a large group of unit owners decides to object to the increased assessments. …

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