12/03/08

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Associations face crunch

Ellen Levy is concerned about her investment at Carriage Pointe in Boynton Beach.

When Ellen Levy plunked down $363,530 two years ago to purchase a three-bedroom, three-and-one-half-bath townhouse at Carriage Pointe in Boynton Beach, she envisioned living in a vibrant, stable community filled with children and young professionals who would exhibit pride of ownership.

Today, however, tenants occupy many of the units and nearly 15 percent of the unit owners are in arrears or foreclosure. The homeowners' association is feeling the impact of losing close to $5,000 per month in assessment income that it desperately needs to balance its operating budget and properly maintain the association property.

"We have people in survival mode who are fighting to keep their houses and food on their table," says Levy. "They don't want to do anything to the community, but to keep this a living, viable community that attracts potential new buyers, we've got to maintain it."

Carriage Pointe is just one of the associations reeling from the effects of the housing slump and subprime mortgage crisis. But with foreclosures and bankruptcies on the rise — and some 58.8 million Americans living in association-governed communities in 2007 — a potential crisis for community associations is looming. And that crisis also affects potential purchasers, many of whom may not be able to obtain financing for a unit in a community with a substantial number of unit owners in arrears.

"This is the largest problem I've ever seen of this type," says Leslie Kaminoff, chief executive officer of Akam Living Services Inc., a Boca Raton-based property management firm.

Kaminoff, who manages about 45 associations in South Florida and has 25 years of experience in the industry, says that the majority of his clients are having problems with unit owners in arrears. Even when just a few owners fall behind in their payments, major headaches ensue.

"These associations are nonprofits and basically run to break even," he says. "So if you get five or 10 percent of the people paying two or three months late, that kills your cash flow as far as paying for fixed services, real estate taxes, security and so forth. Even before you get to foreclosure, just the late payments really hinder the operations and make a manager's job more difficult."

The result: Association boards are cutting back, putting off special projects or improvements. Some are reducing the number of days landscapers work or cutting back on concierge hours, Kaminoff says. Other associations, such as Carriage Pointe, are levying special assessments on unit owners to raise additional operating funds, in essence forcing those who do pay to subsidize owners in arrears. And some desperate associations are seeking out lines of credit to cover gaps in their budgets until things improve.

"Lenders look to see if the association has been well run, has a good operating history and that a board knows what it's doing," says Mark Grant, an attorney with Ruden McClosky in Fort Lauderdale who focuses on real estate, including condominium and homeowner association documentation and commercial lending. "But it would be a red flag for a bank if there are a lot of foreclosures in a community."

The associations hardest hit by declining revenues due to delinquencies are those in which speculators bought a large number of units. Many investors either abandon those units or stop paying assessments because they can't afford the carrying costs.

Additionally, buyers who paid top dollar for units at the height of the real estate boom are now stretched thin due to adjustments in their exotic mortgages, which is leaving many associations struggling.

Compounding the issue in Florida, the foreclosure process can take up to a year. In many cases, owners are not paying assessments during the foreclosure, and are often reluctant to pay outstanding assessments afterward.

"The banks are not stepping up and taking over their responsibility to pay their share when they own the house," says Norman Silverstein, president of A&N Management Inc. in Boca Raton, who represents 30 associations in South Florida. "Over the next six months, associations are going to be in serious condition unless they have provided for bad debt or have a tremendous amount of excess money in their reserve accounts."

Under Florida law, a lender foreclosing on a unit in an association-governed community is responsible for monthly assessments when it takes title to that unit (whether by foreclosure sale or deed in lieu of foreclosure), just like any other unit owner.

But what about the assessments accruing during a foreclosure action? The law differs depending on whether the unit is located in a condominium or homeowners' association.

For units in a condominium, a foreclosing lender is responsible for the lesser of six months of assessments or 1 percent of the original mortgage amount, says attorney Grant. For units in a homeowners' association-governed community, law dictates that when a lender forecloses or takes a deed in lieu, it is responsible for all past due assessments. But payment is not required until the bank has title to the unit, thereby adding to the cash flow problems faced by the association.

Rising arrearages and foreclosures are also wreaking havoc on community associations in another way. Once delinquencies in an association reach a certain threshold — typically 15 percent — a buyer might have difficulty obtaining a mortgage to purchase a unit there.

"If more than 15 percent of the units are delinquent, it creates a call to action," says Gus Pasquale, executive vice president of Element Funding, an Atlanta-based mortgage company with operations in South Florida. "The mortgage investors — Fannie Mae and Freddie Mac — will require the buyer to put down more money. Or the loan could become what's called a 'non-agency product,' purchased by an investor other than Fannie Mae or Freddie Mac — at a higher interest rate because the risk is real."

Pasquale said he's seeing a "heightened pattern" of problems with mortgages in troubled associations.

Grant doesn't think that courts will allow associations to file for bankruptcy. "An association has the ability to assess the owners for the monies that are owed," he says. "And it has the obligation to keep assessing and assessing and assessing until it pays off its obligations."

If homeowners cannot afford to pay the additional fees, the result of repeated assessing could worsen the problem in the long run.

Peter Zalewski, founder of Condo Vultures LLC, a market analysis firm in Bal Harbour, predicts that banks will hesitate to extend emergency loans to associations, thereby creating an opportunity for hard-money lenders to provide private financing. "You hit them at hard equity pricing, so there would be origination fees, higher-than-normal interest rates and prepayment penalties," he says, quoting rates of 10 to 15 percent and three to five points up front. He says he has already discussed these opportunities with some funds he's working with.

Kaminoff believes that opportunities are now being created as well, but he has a more optimistic view.

"One man's disaster is another man's opportunity," he says. "A lot of investors are trying to buy up bulks of apartments here because of the opportunity." That would bring an infusion of capital to the associations.

And that's what Jorge Perez, chairman and CEO of the Related Group in Miami, wants to do with his well-publicized $1 billion opportunity fund, which he plans to use to purchase unsold blocks of condominium units, among other product.

"If a building has 100 units and 50 are unsold, either somebody like us comes in or that association goes broke because there are 50 units that are not paying," he says. "It's a win-win situation."