Throwing a Lifeline to Drowning Condos: A Plan to Recycle At Risk Condos That Would Avoid Blight

I. The Problem

          1. For purposes of this proposal an “At Risk Condo” is a condominium project in which a substantial number of the units are owned by owner/occupants and the balance of the units are owned by lenders (REO), the developer, a successor developer, and/or investors. 

          2. There is very limited unit loan financing or refinancing available for an owner/occupant or an investor who desires to purchase units in the At Risk Condo.

          3. All of the units in the At Risk Condo are worth substantially less than they were valued at prior to the housing crash. The owner/occupied units with mortgages are “under water”; many of them are delinquent on mortgage payments, assessments and real estate taxes; and some of them are in various stages of foreclosure. 

          4. Unless something is done to deal with the At Risk Condo, it may deteriorate and fail.

Following is a proposal that could save “under water” unit owners from financial disaster, provide quality affordable housing to those who need it, and pay for itself.  The proposal is based on current Illinois law. 

II. Illinois Proposal

          1. A municipality or other governmental entity with eminent domain powers, would use its powers to obtain title to all units in the At Risk Condo by paying an amount equal to the current fair market value of each unit, as determined by the court.  The amount paid for each unit would go first go to pay off the liens on the unit, with the balance, if any, going to the former owner of the unit. This process would be essentially a forced short sale (“Forced Short Sale”) of each unit in the At Risk Condo.[1]

          2. The cost of acquiring the units in the At Risk Condo would be paid by way of a loan from a financial institution or an investor in an amount necessary to pay the cost of the Forced Short Sale and any additional costs necessary to make repairs or improvements to the common area and carry out the balance of the plan to reposition and return the At Risk Condo to the community as a viable source of housing (“Recycled Condo”).   The repayment of the loan would be secured by a mortgage which would initially be placed on all of the units in the Recycled Condo (“Blanket Mortgage”).  

          3. Units in the Recycled Condo could then be conveyed to those owner/occupants who desire to continue to own their unit, subject to the Blanket Mortgage. Other units could be rented to former owner/occupants and/or current tenants. To comply with the requirements of the Equity in Eminent Domain Act, 20% of the units (“Affordable Units”) would be sold or conveyed (subject to the Blanket Mortgage) to an investor (which may be a not for profit entity) to be rented to tenants (“Income Qualified Tenants”) who satisfy the income criteria set forth in the Equity in Eminent Domain Act.[2] If the recycling is successful, the investor which owns the units that are not sold or conveyed to owner/occupants could begin selling and conveying units to buyers who will become owner/occupants.  Initially such sales, like the conveyances to the former owner/occupants and investors would be made subject to the Blanket Mortgage.

          4. Under the Condo Act, the percentage interests assigned to each of the units may be allocated or reallocated based on “value”.  If necessary, a restricted Affordable Unit can be assigned a lower “value” and thus a relatively lower percentage interest (based on use and resale restrictions) than a similar, but unrestricted unit. This would result in the owners of the Affordable Units paying lower assessments, lower real estate taxes, and a lower portion of the Blanket Mortgage attributable to the unit than that which would be payable by, or attributable to, other similar, but unrestricted, units. Note, however, that depending on the cost per unit of the recycling, it may not be necessary to skew the percentage interests in order to make it economical for the Affordable Units to be leased at rents that an Income Qualified Tenant can afford.

          5. Using this approach, the Recycled Condo would start out with a mix of (i) owner/occupants, (ii) market rate tenants and (iii) Income Qualified Tenants. The Blanket Mortgage would be a first mortgage on each unit. The units could be could be sold and/or refinanced as the market permits.

          6.  To demonstrate how the plan could work, assume the following:

                    (a)  The units in the At Risk Condo are acquired in a Forced Short Sale for an average price of $30,000 per unit. 

                    (b) The cost of implementing the Forced Short Sale and recycling the At Risk Condo into a viable Recycled Condo is an additional $10,000 per unit, for a total cost to recycle of $40,000 per unit.

                    (c) Because many of the factors that caused the values of the units in the At Risk Condo to be depressed will be addressed and dealt with in the course of the recycling, the values of the units in the Recycled Condo will average $50,000 per unit.

Based on these assumptions, the Blanket Mortgage would be $40,000 per unit and the loan to value ratio of the Blanket Mortgage to an average unit valued at $50,000 would be 80%.  Some units in the Recycled Condo could, and should, be simply deeded back to those owner/occupants who desire to continue in ownership subject to the Blanket Mortgage debt attributable to the unit and no more.  The Blanket Mortgage should be non-recourse to the owners (i.e., no personal liability beyond the lien of the Blanket Mortgage) and should contain partial release provisions which would permit a unit to be released from the lien of the Blanket Mortgage upon payment of a release amount equal to the portion of the Blanket Mortgage attributable to the unit.[3]  Thus an owner/buyer of a unit in the Recycled Condo could replace the Blanket Mortgage lien on his unit with a first mortgage that hopefully will qualify for conventional or FHA financing.  Alternatively, since the Blanket Mortgage will be non-recourse to the unit owner, the unit could be conveyed subject to the Blanket Mortgage (with the mortgagee’s approval), thus obviating the need to refinance the unit.  Hopefully, over time the Recycled Condo would become a conventionally financed condominium with mixed income occupants, many of whom would be owner/occupants, 20% of whom would be Income Qualified Tenants, and the balance of whom would be market rate renters.

          7. There are benefits from the fact that there will continue to be a condominium association to govern the Recycled Condo.  In Illinois the condo association is generally a not for profit corporation which is governed by and subject to the condominium declaration, the association’s bylaws, the Condo Act and the Illinois Not for Profit Corporation Act.  These laws and documents encourage and require democratic governance.  The board of directors is generally made up of unit owners or persons designated by unit owners (which could include renters) and there is a great amount of flexibility in setting up committees, as well as allocating costs.  Since after the Forced Short Sale the municipality will own 100% of the units, if only for an instant, it would have the power to amend the declaration to address anticipated issues.  For example, the declaration could contain provisions designed to insure proper screening of potential owners and tenants, to involve the tenants in the governance of the condo and to allow the municipality to approve or consent to certain actions, such as proposed amendments, that could adversely affect the rights or interests of certain categories of occupants.

          8. Delinquencies can also be more easily dealt with under this approach.  The condominium association could be required to collect assessments, real estate tax deposits and each unit’s share of the Blanket Mortgage’s principal and interest payment.  Failure to pay these amounts would give the condominium association the right to evict the non paying owner and rent out the unit to cover the required payments under the Forcible Detainer Act.  In Illinois this remedy is easier and quicker to enforce than a mortgage foreclosure. Another tool that can be used to deal with potential delinquencies would involve selling the units to former owner/occupants, new owner/occupants and investors under what is commonly referred to as an “Installment Sale Contract”.  Under Illinois law, the seller of property under and installment sale contract not need to go through the cumbersome foreclosure procedures to terminate a defaulting buyer who owes more than 80% of the purchase price when the buyer defaults under the contract. 735 ILCS 5/15-1106.  

I believe that this proposal can work.  I believe that it could be a way to recycle and reposition At Risk Condos in Illinois.   Under the requirement that 20% of the units be made available for occupancy by Income Qualified Tenants, it will provide housing for people who need affordable housing much more quickly and at a cost far below what it would cost to plan and build an affordable income housing project from scratch.  It would also result in a mixing of people from different social, ethnic and economic backgrounds, which, if properly handled, would promote diversity in housing and, hopefully, serve at least to begin a process of breaking down long standing social barriers that have been  perpetuated by outdated, but entrenched, federal housing policies and practices. 

III. Challenges

          1. The above proposal is based on Illinois law and practice.  I believe it can work in Illinois without any change in the law if municipalities are willing to use their eminent domain powers and financial institutions or investors are willing to make Blanket Mortgages and unit loans.

          2. I expect that there will be political resistance to this proposal, especially in certain suburbs where the suggestion of low income or affordable housing is generally met with significant opposition.[4] It is my hope that the potential benefit of getting under water condominium unit owners/voters out from under a mortgage that they can’t repay, paired with the ability to put those owners back into ownership of their unit subject to a non-recourse Blanket Mortgage lien (with unit release provisions) which is less than the market value of the unit in the Recycled Condo, will motivate the municipality to sign on to this proposal. I expect that before a municipality agrees to initiate the Forced Short Sale of an At Risk Condo, it will want the concept and the process to be fully explained to the occupants of the At Risk Condo.  The municipality would want the occupants to support the proposed recycling of their At Risk Condo.  As mentioned above, the municipality will have the opportunity to modify the condo declaration to address concerns of the occupants as well as those of residents in the surrounding community.     

          3.  I expect that some mortgage holders or servicers will resist this proposal. Consensual short sales are often difficult, if not impossible, to effectuate.  This is partly due to the fact that many under water mortgages are in mortgage backed securities where the servicers have very limited flexibility to agree to short sales. It is also partly due to the fact that the individuals who are employed by the servicers and who are often motivated by a fear of losing their jobs, are inclined to refuse to agree to a short sale unless they are given a specific direction to do so.  However, I believe that the use of a Forced Short Sale will work because it is judicially imposed and the employees of the mortgagee or servicer can say they had no choice but to accept the Forced Short Sale and therefore cannot be blamed or criticized by their superiors or the regulators.                       

          4. One potential issue in Illinois is that the lender would still be able to pursue the owner occupant for the deficiency between the amount owed on the mortgage and the amount paid to the lender out of the Forced Short Sale proceeds. One possible way to deal with this issue would be to work with the lenders after the eminent domain action is filed and the lenders are before the court to increase the amount of the Forced Short Sale proceeds payable to the lender in return for the lender’s agreement to waive any deficiency. 

          5. It is important that the first recycling effort is successfully implemented with minimal controversy.  For that to happen, several things need to occur:

                        (a) A municipality needs to be willing to exercise their eminent domain powers to effectuate a Forced Short Sale and partner up with a developer which can help implement the recycling effort;

                        (b) An appropriate At Risk Condo needs to be identified in the municipality;

                        (c) A source of financing for the Forced Short Sale and recycling effort needs to be secured; and

                        (d) The current occupants of the At Risk Condo, particularly the owner/occupants, need to support the proposed Forced Short Sale and recycling.

          6. I believe that an At Risk Condo that would have the best chance to being successfully recycled under this proposal will have the following characteristics:

                        (a) At least 20% of the units are owned by owner/occupants, all of whom have mortgages that are under water;

                        (b) The current value of the units and the amount likely to be paid for the units in a Forced Short Sale is in the area of $30,000-60,000 average per unit; and

                        (c) The community in which the At Risk Condo is located already has affordable housing. 

IV.  Scalability

          1. Housing is basically a local issue, depending to a great extent on local ordinances and state laws.   However, federal policies, programs, laws, and regulations have had a significant impact on housing.[5]    Unfortunately the FHA, Fannie Mae and Freddie Mac (government sponsored entities or “GSEs”) programs for condominium unit loans have not changed much since the early 1980s.  They are based on the long standing federal policy to promote the “American Dream” of homeownership. The GSE condominium programs did not then, and do not now, envision or support condominiums with a mix of owner/occupants and renters, especially lower income renters. 

          2. To help this proposal gain traction and be scalable, the GSE programs will need to be modified to permit and encourage the GSEs to insure or purchase Blanket Mortgages as well as loans to owner/occupants and investors who own units in Recycled Condos.

          3. Another example of federal action that impacted housing was the founding of the National Cooperative Bank (“NCB”) in the late 1970s.  The NCB is a federally chartered savings bank that makes loans to all different types of cooperatives, including housing cooperatives.  Either NCB or a new federally chartered savings bank should be authorized and encouraged to make Blanket Mortgages, as well as unit loans to owner/occupants and investors on units in Recycled Condos.

          4. Although the proposal put forth above focuses on condominiums, with a few adjustments it could apply as well to distressed non-condominium developments with townhome style and/or single family tract homes.

Conclusion.

The current situation, with numerous At Risk Condos throughout the nation, particularly in urban areas, is akin to an urban cancer.  If not treated quickly and aggressively, it may ravage entire communities.  However, I believe that a program along the lines suggested above which is quickly and effectively implemented can accomplish the following:

 

  1. Save At Risk Condos from deteriorating;
  2. Provide immediately available affordable housing;
  3. Allow under water owner/occupants to continue in ownership of their unit subject to a mortgage that is no longer under water;
  4. Allow units to be sold, financed and refinanced, thus permitting owners to be able to build equity;
  5. Allow people to either rent or own in the same condominium;
  6. Promote a mix of occupants from different socio-economic backgrounds and means living in the same building; and
  7. Pay for itself.

December 24, 2012       

Brian Meltzer

 

   

 


[1] Following are excerpts from relevant Illinois laws that form the legal basis for the use of eminent domain in this situation

 

  1. Eminent Domain.  735 ILCS 30/5 (Illinois Equity in Eminent Domain Act) (2006) deals with the power of eminent domain.  Section 5-5-5 (e), which deals with the use of eminent domain to acquire property for private ownership, reads, in part, as follows:

 

“(e) If the exercise of eminent domain authority is to acquire property for private ownership or control and if the primary purpose of the acquisition is one of the purposes specified in item (iii) of this subsection and the condemning authority elects to proceed under this subsection, then the condemning authority must prove by a preponderance of the evidence that: (i) the acquisition of the property is necessary for a public purpose; (ii) an enforceable written agreement, deed restriction, or similar encumbrance has been or will be executed and recorded against the acquired property to assure that the project and the use of the property remain consistent with the applicable purpose specified in item (iii) of this subsection for a period of at least 40 years, which execution and recording shall be included as a requirement in any final order entered in the condemnation proceeding; and (iii) the acquired property will be one of the following:


        (1) included in the project site for a residential project, or a mixed-use project including residential units, where not less than 20% of the residential units in the project are made available, for at least 15 years, by deed restriction, long-term lease, regulatory agreement, extended use agreement, or a comparable recorded encumbrance, to low-income households and very low-income households, as defined in Section 3 of the Illinois Affordable Housing Act…”

                       

B. Low Income Households and Very Low Income Households.  Section 3 of the Illinois Affordable Housing Act (310 ILCS 65) defines Low Income Household, Very Low Income Household, and Affordable Housing as follows:

 

“(c) "Low-income household" means a single person, family or unrelated persons living together whose adjusted income is more than 50%, but less than 80%, of the median income of the area of residence, adjusted for family size, as such adjusted income and median income for the area are determined from time to time by the United States Department of Housing and Urban Development for purposes of Section 8 of the United States Housing Act of 1937.


(d) "Very low-income household" means a single person, family or unrelated persons living together whose adjusted income is not more than 50% of the median income of the area of residence, adjusted for family size, as such adjusted income and median income for the area are determined from time to time by the United States Department of Housing and Urban Development for purposes of Section 8 of the United States Housing Act of 1937.


(e) "Affordable housing" means residential housing that, so long as the same is occupied by low-income households or very low-income households, requires payment of monthly housing costs, including utilities other than telephone, of no more than 30% of the maximum allowable income as stated for such households as defined in this Section.”

 

[2] The Equity in Eminent Domain Act was passed in Illinois in 2006 in response to the U.S. Supreme Court opinion in the case of Kelo v City of New London, 545 U.S. 469 (2005).  The court in Kelo dealt with the constitutionality of the use of eminent domain to take private land (homes) to convey to another private owner in order to facilitate a redevelopment project. The court upheld the taking in Kelo as a legitimate exercise of eminent domain for a “public purpose”.  In Kelo the justification for the taking was that the redevelopment project would generate more tax revenue and, thus, would serve a public purpose.  The Kelo decision was met with a public outcry from private property owners who feared that their homes or businesses would be taken without their consent for a different private use that would generate more tax revenue.  Many states quickly passed legislation to limit the power of local governments to make such takings.  Illinois passed the Equity in Eminent Domain Act in 2006.  The Act allows the taking of private property for private use as housing or mixed use as long as 20% of the units are made available for at least 15 years for occupancy by low income households. The legislature may have had in mind the demolition of existing improvements and the construction of new residential or mixed use buildings.  However, the law, as written, does not preclude the recycling of an At Risk Condo without demolition and construction.  Thus, I believe that the recycling of an At Risk Condo as suggested in this proposal falls within the ambit of the Equity in Eminent Domain Act in Illinois and would likely be permitted in other states whether or not they have passed legislation similar to the Equity in Eminent Domain Act.

 

[3] The release amount would be equal to the current principal outstanding on the Blanket Mortgage multiplied by a fraction (i) the numerator of which is the percentage interest of the unit and (ii) the denominator of which is the total percentage interests of all units then still subject to the Blanket Mortgage.

 

[4] Low income housing has different connotations and meanings to different people.  I believe that there are various options for satisfying the low income requirement in a Recycled Condo which will be acceptable to the municipality, the occupants of the Recycled Condo and the community. For example, the low income units could be master leased to a NFP which serves a specific category of low income people and needs to provide then with safe housing where the NFP will actively monitor and supervise the tenants.

 

[5] For instance, the condominium concept was introduced in the United States by the addition of Section 234(c) to the National Housing Act in 1961.  Section 234(c) authorized FHA to insure loans on individually owned units (condominium units) in multi-unit buildings.  As a practical matter, condominiums could not exist without enabling legislation at the state level.  All of the states wanted to allow developers and buyers to utilize this new program, even though they may not have fully understood the concept.  Thus, within a couple of years after the adoption of Section 234 (c), every state had adopted some form of condominium enabling act.  By the mid 1970s, the concept had caught on and condominiums were a significant housing option in urban areas.  In the mid 1970s condominium ownership got a big boost when Fannie Mae and Freddie Mac started to buy condominium unit loans in condominiums that met their published standards.

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