UPDATE: See also our October 2023 update on Lending Questionnaires.
It has been just over a year since tragedy struck Surfside, Florida, when ninety-eight individuals perished in when a 12-story beachfront condominium partially collapsed. The national response following this catastrophic loss was multifaceted, from State-driven reforms aimed at condo safety to changes in lending and insurance standards.
On October 13, 2021, the Federal National Mortgage Association (“Fannie Mae”) issued Lender Letter LL-2021-14 (“Lender Letter”), that took effect January 1, 2022. The Lender Letter temporarily revises the eligibility requirements for lenders issuing loans that may be purchased by Fannie Mae for properties located in condominiums containing five or more attached units. These temporary revisions are aimed at mitigating the risks lenders and other industry stakeholders take when purchasing loans in the secondary mortgage market where the loan may be securing a unit in a building with structural defects that endanger the safety and security of the residents.
While Fannie Mae was the first to issue new directives aimed at deferred maintenance and the safety and habitability of a project, other players in the secondary mortgage market were quick to adopt similar standards. For instance, the Federal Home Loan Mortgage Corporation (“Freddie Mac”) subsequently issued Bulletin 2021-38 (“Bulletin”) adopting similar standards for mortgages with settlement dates on or after February 28, 2022.
The overall effect of these new directives has been significant and has been felt not only by Michigan condo sellers and purchasers, but also by Michigan condominium associations, their boards and property managers. Uncertainty regarding new condominium questionnaires and mounting pressure for information that an association may not necessarily have at its disposal has created confusion regarding how these questionnaires should be answered. This article will examine the provisions of both the Lender Letter and the Bulletin, how those changes have been implemented in these revised condominium questionnaires and recommendations for boards in addressing these requests from lenders.
I. “Deferred Maintenance” Under the Lender Letter
Under the Lender Letter, conditions that render a loan ineligible for purchase by Fannie Mae include evidence of significant deferred maintenance, as well as repair directives from a local regulatory authority or inspection agency directed towards repairs needed to resolve unsafe conditions. The Lender Letter does not define “deferred maintenance” but it does include examples of what Fannie Mae’s criteria are for finding that a project has had significant deferred maintenance. These criteria include:
- Full or partial evacuation of the building to complete repairs for more than 7 days or an unknown period of time;
- (a) The project has deficiencies, defects, substantial damage or deferred maintenance that: are severe enough to affect the safety, soundness, structural integrity, or habitability of the improvements; (b) the improvements need substantial repairs and rehabilitation, including many major components; or (c) the project’s deficiencies, defects, substantial damage or deferred maintenance impede the safe and sound functioning of one or more of the building’s major structural or mechanical elements (including foundation, roof, load bearing structures, electrical system, HVAC, or plumbing)
The Lender Letter mentions that its definition of “deferred maintenance” does not apply to routine maintenance, nor does it apply to situations where there is an isolated incident that affects one or a few units. It includes examples, such as a leaking pipe that is isolated or damage from a small fire that only affects the interior of a specific unit. The intent of Fannie Mae’s inquiry is aimed at the project as a whole and its overall safety, soundness, structural integrity and habitability.
II. Critical Repairs” Under the Bulletin
Similar to the Lender Letter, the Bulletin temporarily revises the eligibility requirements for Freddie Mac for projects that are in need of “critical repairs.” The Bulletin defines “critical repairs” as:
Repairs and replacements that significantly impact the safety, soundness, structural integrity or habitability of the project’s building(s) and/or that impact unit values, financial viability or marketability of the project. These repairs and replacements include:
- All life safety hazards
- Violations of any federal, State or local law, ordinance or code relating to zoning, subdivision and use, building, housing accessibility, health matters or fire safety
- Material Deficiencies
- Significant Deferred Maintenance
As used in the Bulletin, “Material Deficiencies” refer to unresolved problems that cannot be reasonably addressed by normal operation or routine maintenance. By way of examples, the Bulletin advises that material deficiencies are those that: (i) will lead to critical element or system failures within one year; (ii) likely result in a significant escalation of remedial costs to material building components that are approaching, have reached or exceeded their typical expected useful life, or whose remaining useful life should not be relied upon due to other factors like excessive wear and tear, poor maintenance or exposure to the elements; and (iii) result in mold, water intrusions or potentially damaging leaks in building(s). Additionally, “Significant Deferred Maintenance” is defined as the postponement of normal maintenance, which cannot be reasonably resolved by normal operations, which may result in advanced physical deterioration, a lack of full operation or efficiency, increased operating costs or a decline in property values.
While the definition of “Significant Deferred Maintenance” is broad and may encompass instances where the safety, structural integrity and habitability of a condominium are not at risk, the Bulletin also includes a definition for “Routine Repairs and Maintenance.” As defined in the Bulletin, “Routine Repairs and Maintenance” are those that are expected to be completed by the association in its normal course of business and are nominal in cost. As examples, the Bulletin advises that the following repairs are not considered to be critical: (i) that is preventative in nature; (ii) that is accomplished within the normal operating budget; (iii) that is completed by on-site staff; (iv) that is focused on keeping the condominium fully functioning and serviceable; (v) minor deficiencies that are $3,000.00 or less per repair, that do not require immediate attention but should be repaired within the next 12 months; and (vi) scheduled repairs that are fully funded, even if the cost is greater than $3,000.00, that will be undertaken within the next 12 months. Similar to the Lender Letter, the Bulletin does not consider damage or deferred maintenance that affects one or a few units to be a “Critical Repair.” Instead, the intent of the Bulletin is to examine the project as a whole for its overall safety, soundness, structural integrity and habitability prior to backing an investment in the same.
III. Additional Scrutiny Of Special Or Additional Assessments & Loans
Along with these considerations, the Lender Letter and Bulletin impose stricter eligibility standards if an association has levied special or additional assessments, or obtained a loan, to address deferred maintenance. The basis for this inquiry is that these loans or assessments may be indicative of significant deferred maintenance or critical repairs. The reason for the assessment or loan, the repayment amount and terms, along with a demonstration that there is no negative impact to the financial stability of the condominium are to be considered when a prospective homeowner’s loan is reviewed. To the extent assessments were levied or loans obtained for these purposes, additional information and documentation will be sought to determine whether the loan is eligible for purchase by Fannie Mae or Freddie Mac.
In comparison, Freddie Mac’s review is aimed at special or additional assessments, and the lender will be required to collect information regarding the reason for the assessment and the total amount assessed. For current assessments, the lender will also need to determine the total amount that is an appropriate allocation and the total amount budgeted to be collected by year-to-date has in fact been collected, whereas for planned special assessments, lenders will need to confirm there is adequate cash flow to fund the reason for the assessment.
IV. Changes To Reserve Requirements
Regarding reserve funds and reserve studies, the Lender Letter provides that Fannie Mae is suspending its practice of permitting an association’s reserve study to serve in place of its minimum budget reserve requirement and is instead strictly adhering to requiring 10% annual contribution. While it is possible to apply for an exception in established projects that have a reserve study that shows sufficient reserves, any requests for exceptions for new projects will not be considered by Fannie Mae. Consequently, not adequately funding reserves could restrict access to financing for new purchasers as well as existing owners who wish to refinance. Prior to the Lender Letter, 10% of the association’s assessment income was to be committed each year to the reserve account, unless the association has a reserve study not older than two (2) years showing that the association’s funding level equals or exceeds what is shown in the plan.
In comparison, the Bulletin still permits an association’s reserve study to stand in place of its budget reserve requirements. Similar to Fannie Mae, Freddie Mac also requires a 10% annual contribution to an association’s reserve fund. However, the Bulletin allows a reserve study to be relied upon instead of the 10% requirement, provided the reserve study is not older than thirty-six (36) months. If not already done and for purposes in addition to proper planning for repairs and replacements, a board may want to consider obtaining a reserve study in the near future, as that may be provided to both satisfy the requirements under the Bulletin, but to also serve as evidence from a third-party that there are no issues concerning the structural integrity of the buildings.
V. New Addendums to Condominium Project Questionnaires
Together, Fannie Mae and Freddie Mac developed Form 1076 and Form 476 (“Addendum”), respectively, which is an addendum to their Condominium Project Questionnaire. These Addendums address the criteria raised in the Lender Letter and the Bulletin. The 12 questions included in the Addendums seek information that speaks to the building’s safety, soundness, structural integrity and habitability. The initial inquiry asks about the last building inspection by a licensed architect, licensed engineer or any other building inspector and, if one was performed, whether that inspection yielded any findings related to the safety and habitability of the building. If the answer is “yes,” additional explanations must be given, along with copies of the inspection, the board meeting minutes relating to the inspection, the action plan and anticipated timeframe for completing the work. The Addendums also ask whether there has been a reserve study in the last three (3) years and whether there are: (1) any known deficiencies related to the safety and habitability of the buildings; (2) any outstanding violations of jurisdictional requirements; (3) any deferred maintenance, and if so, the schedule of when those components will be repaired or replaced; (4) any special assessments, and if so, the term and purpose of those assessments; or (6) any outstanding loans to finance improvements or deferred maintenance.
With the changes incorporated in these Addendums, an in-depth analysis of deferred maintenance in the condominium will be at the forefront for reviewing whether a loan will be eligible for purchase on the secondary mortgage market. This can put a lot of pressure on a board, as the questions may focus on events that may precede the historical knowledge of the current board. All an association can do is answer the questions as truthfully as possible and not try to guess at what answer the lender may be looking for. If dates of inspections are known or if there have been citations by the municipality, provide that information. If the dates are unknown, indicate the same and if there are no known issues or citations from the municipality, the association should indicate “no.” The Addendums want to know what the board may know already, and if it is unknown, then the board should simply respond as such.
Ultimately, however, it is the lender, not managers, associations or boards, that are required to perform their own due diligence to determine whether a project is safe. It is the lender that needs to show Fannie Mae or Freddie Mac that it is an acceptable loan to insure and it is their burden to show that the investment is sound.
VI. Key Takeaways
The time to start evaluating these Addendums is now and Michigan condominium associations should review these questions to see if they highlight any areas of the association’s administration of the condominium that could benefit from additional review or planning. Boards will need to carefully review their budgets and consult with necessary professionals, including property managers, attorneys, building engineers or building inspectors, to confirm whether the project has “deferred maintenance” or “critical repairs” and to the extent it does, work to formulate a plan and timetable for addressing the same.
Boards may also want to consider obtaining reserve studies, as they are strongly encouraged in the Lender Letter, Bulletin and Addendums, and will assist the association in both completing the Condominium Questionnaire and addressing additional inquiries from lenders gathering their evidence for Fannie Mae and Freddie Mac.
