What to Do When a Condo Project Goes South

By Hallem, Timi Anyon | American Banker, April 28, 2009 | Go to article overview

What to Do When a Condo Project Goes South


Hallem, Timi Anyon, American Banker


Byline: Timi Anyon Hallem

In determining whether to make a loan for the construction of a condominium development, a lender will typically look at pro formas, market studies and developer track records. But if a loan goes into default, a lender must quickly become familiar with everything from internal condo rules and regulations and association by-laws to state and federal regulations governing the sale or reuse of failed projects.

The good news is that the collateral security is a real asset: real estate, which, for the right price, can be used by someone for something. The bad news is that those documents can present many hurdles that may limit the value of that collateral.

Before evaluating their options, lenders need to understand that condo rules can vary from state to state. The Department of Housing and Urban Development, the Federal Housing Administration, Fannie Mae and Freddie Mac each have their own rules governing whether they will buy or insure condominium mortgages and, in the case of HUD, whether a separate filing is required.

In addition to all the statutory requirements, every condo project is governed by documents covering how the project is managed and what the owners, occupants, association and developer can do in or to their units and in common areas. These documents may create a lender's biggest headaches.

Consider Project X, a high-rise building that was completed and partially sold out when the lender foreclosed. Since the lender did not control the homeowners association (because too many units had been sold), it could not amend the documents to give itself needed rights. Therefore, it had no extraordinary voting rights, no control of the association, no right to a model unit, no right to use a unit as a sales office and no right to amend the condo documents.

Since the project could not be marketed without an on-site office and model, the lender had to pay the homeowners association to "purchase" the rights to an on-site office, model unit and big signs in front of the project.

Moreover, the lender ended up having to fund obligations that belonged to the developer, such as a new HVAC system that cost hundreds of thousands of dollars. Without the new system, units were not saleable.

In Project Y, another foreclosed property, the lender spent hundred of thousands of dollars trying to repair a water problem before concluding the problem could not be totally fixed. The lender finally made the repairs it could make and then sold the units at a discount. The sale terms required every buyer to sign a disclosure acknowledgment and a waiver of liability and promise not to sue the lender.

In Project Z, a condo hotel project that was partially built (for over $100 million), the lender hired a consultant who concluded that the project did not work as a hotel, could not be used for residential housing, needed $30 million of work, and would have a value of $40 million once it was completed.

So far the lender has not foreclosed, but every day the partially completed project deteriorates a little more. …

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