I Challenge the Assertion the Condo is Not Approvable by FHA

gstockstudio_2This week, I had to pass along news to a property manager that her condominium client was not eligible for FHA approval due to leasing restrictions.  Upon receiving the news, she fired back an email stating that she challenged the assertion because the condominium has “always been FHA approved” and the legal documents have always contained that language.

She went on to say that most condominiums in the area have similar leasing restriction language because it is associations’ only recourse against a problem tenant.

We can certainly understand her frustration.  The condominium was approved with FHA two years ago and the legal documents have not been amended.  Here is my response email:

I can understand your position and had already inquired with HUD before sending the email, below.  However, because the condominium was approved two years ago does not mean that it was reviewed properly at that time nor does it take into account that there have been further clarifications to FHA’s guidance.  I also agree with you that other condominiums have similar language; however, those with identical language would also not be eligible.

Unfortunately, the fact that it “has always been FHA approved” has no relevance to the current situation.  We have had several condominiums that have been rejected by HUD that were approved just two years ago for leasing restriction violations.  HUD changed the qualifications for condominium project approval in written form in 2009 and then again in 2011 and 2012.  It provided written updates and clarifications to the guidance in 2011 and 2013.  It provided verbal clarifications during the Roundtable Sessions that I attended in 2014 and 2015.

However, the underlying law behind all of it is the National Housing Act which is in the Code of Federal Regulations.  In this Section of the Code, it creates the rules for FHA-insured loans.  The Section pertaining to leasing restrictions is 24CFR203.41, which speaks to “free assumability”.  HUD does not have to issue written policy on leasing restrictions because it is already there in the Code.

24CFR203.41(b) states: “Policy of free assumability with no restrictions. A mortgage shall not be eligible for insurance if the mortgaged property is subject to legal restrictions on conveyance, except as permitted by this part.”  You can read the Section of the Regs if you like; I linked to it above.  The exceptions “permitted by this part” are subsections c-g and include:

  • Eligible government or nonprofit programs and specific policies
  • Tax-exempt bond financing
  • 55+ communities
  • Specific jurisdictions (Indian lands, certain Hawaiian home lands, etc)

24CFR203.41(a)(3)(i) states: “Legal restrictions on conveyance means any provision in any legal instrument, law or regulation applicable to the mortgagor or the mortgaged property, including but not limited to a lease, deed, sales contract, declaration of covenants, declaration of condominium, option, right of first refusal, will, or trust agreement, that attempts to cause a conveyance (including a lease) made by the mortgagor to:

(i) Be void or voidable by a third party;” [Emphasis added]

Section 14.1(k) of the Declaration of [name removed] condominium states: “if any Residential Unit Owner/lessor or lessee is in violation of any of the provisions of the lease, this Declaration or the condominium Rules and Regulations, the Association may bring an action in its own name or in the name of the residential Unit Owner/lessor, lessee or both, to have the lessee evicted or to recover damages, or both.

Section 14.3 states: “The Association…shall have the rights of enforcement of any lease4 of a Residential Unit directly against the lessee(s) including, without limitation, the right to terminate any lease by reason of violation…

Because the Association has the authority to terminate leases, it violates 24CFR203.41(b) “free assumability” which renders the condominium ineligible for FHA-insured loans.  This also means that it is not eligible for project approval.

wanamakerFurthermore, I inquired about the language in Sections 14.1(i) and (k) to verify compliance.  In an email from the Philadelphia Homeownership Center:

“Eric:

14.1 (i) is acceptable.

14.1 (k) is unacceptable.

Thanks.”

Beyond that, it would be escalated to HUD in Washington, DC.  I verified this very information at the Roundtable on August 27, 2015.  The Association cannot have the power to void leases; it can only levy fines for leasing violations.

Therefore, the condominium will have to remove Sections 14.1(k) and 14.3 in order to be eligible for project approval.”

More About FHA’s Stance on Condominium Leasing Restrictions

HUD_bldgTwo weeks ago, we published an article about some recent clarifications by FHA regarding condominium leasing restrictions.  The article created quite a buzz and generated many calls and email inquiries regarding its content.  This is a follow-up article addressing some of those questions.

The section of the National Housing Act, 24CFR203.41, states that properties encumbered with FHA-insured loans must have free assumability with no restrictions except as stated in the section.  This includes leasing and conveyance restrictions which impact a unit owner’s ability to sell or lease the unit or reduce the unit owner’s proceeds upon sale of the unit.

Is there an FHA document that states these restrictions?  The document by which the leasing restrictions are governed is 24CFR203.41.  Section 1.8.9 of FHA’s Mortgagee Letter 11-22 notes the acceptable leasing restrictions.  Beyond these sources, the list that we provided in the previous article have been compiled by submitting condominium approval packages to HUD and speaking to HUD directly about specific scenarios.

Why can’t the association require that the unit owner own the unit for a period of time prior to leasing it?  This is a direct violation of 24CFR203.41 because it disallows the unit owner the ability to lease the unit during the initial time period, violating free assumability.

Why can’t the association restrict a unit owner’s ability to lease a unit if the owner is delinquent in the payment of common charges?  This obviously prevents the unit owner from leasing the unit same as above.  However, the documents CAN require assignment of the lease payments to the HOA if the unit owner is delinquent but it cannot forbid leasing of the unit.

Why can’t the association require background checks or credit references or checks?  The exception to this is the requirement to check the Registered Sex Offender List.  Other than that, the unit owner cannot be required by the HOA/Board to gather information about the tenant.  The Board cannot request this information or require that the potential tenant (or buyer) sit or interview with the Board.  This constitutes third party approval which is forbidden by 24CFR203.41.

Can the association restrict pets?  From FHA’s standpoint, a condominium can outright restrict pets.  However, it would be wise to check with your association’s attorney in the cases of service animals and those which are therapy animals.  Not exactly sure what this question has to do with leasing but there you go.

On a related note:

The association CAN require Board approval of leases if only to verify that the subject lease does not exceed the maximum leasing percentage or rental cap as stated in the legal governing documents.  Because this would be the sole authority of the Board to approve or reject leases, it is allowed by FHA.

 

FHA Condo Approvals – Transient Leasing

Salvatore VuonoFHA only allows a handful of leasing restrictions; one of them is that units cannot be used for transient leasing.  FHA also does not allow unit owners to provide hotel-like accommodations for the tenants.  If either of these are allowed in the condominium project, it is not eligible for FHA condominium project approval.

The term transient or hotel purposes is defined to mean:

1.     any rental for a period of less than 30 days, or

2.     any rental if the occupants of the housing accommodations are provided customary hotel services such as room service for food and beverages, maid service, furnishing and laundering of linen and bellboy service.

Prior to the 2013 bulletin, the only way for a project to get approved with HUD if the legal governing documents allowed for transient leasing was to amend the legal documents to remove or revise this language.  This can sometimes be difficult to accomplish as the legal documents often require a 2/3 majority vote in order to amend the documents.

HUD allows for another option.

If the Association is not willing to amend their legal documents, an executed written statement may be provided by the Board that affirms that there are no units within the project currently rented for less than 30 days and/or pursuant to the lessor for providing any services normally associated with a hotel.

On the loan-level, the FHA Originating Lender will also be required to provide an executed written statement that affirms  in the event of a conveyance action to the lender that they will not rent the associated unit for less than 30 days an/or provide any services normally associated with a hotel.

Borrowers will now be required to execute form HUD-92561, Borrower’s contract with Respect to Hotel and Transient Use of Property for all condominium loans using FHA insured financing.  This is the same form required by HUD for loans for 2-4 unit properties.

Image courtsey of Salvatore Vuono/freedigitalphotos.net

FHA Clarifies its Position on Leasing Restrictions in Condominiums

HUDsignTallFHA-allowed leasing restrictions in condominiums has been a hot topic as of late.  As we all know, a condominium’s legal governing documents may place restrictions on the leasing of units in the condominium.  These restrictions can vary greatly and recently HUD clarified what is and is not allowable.

[For information on the background of why certain restrictions are not allowed, you can follow THIS LINK to an article about 24CFR203.41.]

During the roundtable session that Eric attended in late August, the facilitator offered this broad statement:

“If the homeowners association has approval authority of a unit owner’s ability to lease his/her unit either directly or indirectly, the condominium is ineligible for project approval with FHA.”

During the ensuing discussion, the following clarifications were offered.

Allowable Leasing Restrictions

The association can

  • Restrict total number of units that can be rented at any given time
  • Restrict the total percentage of units that may be leased at any given time
  • Create a hardship clause for exception to the first two above
  • Require that the Board be provided with a copy of the lease
  • Require that the lease must be in writing
  • Request the names of the tenants
  • Require that the lease conforms to the legal governing documents of the association
  • Set minimum and maximum lease periods
  • Require unit owner to check the Registered Sex Offenders list
  • Require rent to be assigned to association if the unit owner is delinquent in the payment of his/her common charges
  • Provide corporate leasing restrictions
  • Require Board review of lease [May not require approval of lease]
  • Require that the lease be on a specific form

Non-allowable Leasing Restrictions

The association cannot

  • Outright restrict leasing of all units (at least one unit in the condominium must be allowed to be leased) [**See Note below]
  • Require that the unit owner own the unit for a period of time prior to being allowed to lease the unit
  • Require Board/HOA approval of lease
  • Require Board/HOA approval of modifications to, alterations of, amendments to or extensions of lease
  • Be granted automatic power of attorney by the unit owner upon purchase of a unit
  • Restrict a unit owner’s ability to lease his/her unit if he/she is delinquent in the payment of common charges
  • Require potential tenants to sit with the Board
  • Require credit references
  • Require criminal background checks (except for Registered Sex Offenders list)
  • Require Board/HOA approval of tenant
  • Have the power to void leases (leases cannot be voidable by a third party)
  • Allow transient leasing
  • Allow accommodations typically associated with a hotel, such as maid or front desk service.

**NOTE: There are two exceptions where an association can outright restrict leasing: age-restricted communities and condominiums where 100% of the units are under Affordable Housing restriction.

If you have specific leasing restriction questions, please contact us.  We would be happy to answer any of your questions on this matter.  approvals@readysetloan.com

The VA is Definitely Tougher on Condo Leasing Restrictions

small__2832610326In the past month, three of our condominium submissions have been approved by FHA and rejected by the VA – all for leasing restriction language.  Through at least the end of the year, when hired for FHA Condominium Project Approval, we are submitting for VA project approval if requested at no additional charge.  The VA submission package is similar to the FHA submission so we offer to do both.

[For those who don’t know, the VA requires condominium project approval prior to allowing VA financing to encumber any of the units in the project.]

The VA is tougher on leasing restrictions than is FHA, if you can believe that.  The rationale behind it makes sense though: the VA doesn’t want leasing restrictions to impede a Veteran’s** ability to lease his/her unit in the case of deployment.  Therefore, maximum leasing restrictions are reviewed more closely.

Maximum number of leases cannot be established because once this number or percentage is met, no other units may be leased.  It’s not difficult to see that this could impede a Veteran from leasing his/her unit.

Must use a Board-approved lease form or the Board must approve the form on which the lease is written.  This is not allowed because the Board could require a form that is not in compliance with other VA requirements or the Board could reject the form the Veteran has used.

Third-party approval of tenants is also not allowed by FHA.  If the association/Board has the authority to approve or reject potential tenants, most of the time the condominium is not approvable by either the VA or FHA.

Third-party approval of modifications to leases poses a potential restriction for the Veteran.  What if the Veteran wishes to extend or shorten the lease according to changes in his/her deployment period and the Board doesn’t allow it?

Maximum lease period can be an issue for a Veteran if the deployment extends beyond the maximum established lease period.  Fortunately, though, we don’t see this very often.

Often, developers and Boards place the above provisions in place in an attempt to protect the community.  However, in doing so, Veterans are prevented from using their VA benefits to purchase units in the community.

One way to potentially circumvent the above and still obtain a project approval is to include an exception for units that are encumbered with VA financing.  From what we have been told by the VA, this should be allowable in most cases.

**NOTE: the term “Veteran” is being used to conserve space and is meant to represent Veterans, active service members and anyone who qualifies for VA home loan financing.

What Types of Condominium Projects are Approvable by FHA?

stuartmiles (6)This is one of the most commonly-asked question that we receive.  The better question to answer is Which types of condominiums are NOT approvable by FHA?   Then we can deduce that all other types of condominiums are eligible for FHA condominium project approval.

These projects are ineligible for FHA condominium project approval:

  • Projects where more than 25% of the total floor area is non-residential.  That is the basic guideline although there may be exceptions granted that will allow up to 50% in certain circumstances.
  • Timeshares and Condohotels (Condotels).  Segmented unit ownership or condominiums that also operate as a hotel.  Condominiums cannot offer hotel-type services such as a front desk, room service or maid/cleaning service or offer leases or rentals for less than 30 days (aka “transient leasing”).
  • Multi-dwelling unit condominiums are fairly rare but this means that the condo units are multi-family dwellings and the project consists of a grouping of these whether they are attached or detached.  These are not allowed.
  • Mandatory rental pooling of the units is not allowed.
  • Condominiums converted from hotels or motels.
  • Mandatory membership to a country club or the like.  Condominiums can be required to be a part of a Master Association but it cannot require unit owners to be members of any type of club, such as a golf or racket club.
  • Houseboat condominiums is not something that we have seen but there must be enough of them out there – somewhere – for FHA to mention them on this list.arvind balaraman
  • Projects in designated coastal barriers according to FEMA such as sections of the Atlantic Coast, Great Lakes and Gulf of Mexico.
  • Occupancy restrictions which is an entire topic by itself.  Basically, a third party, such as an HOA, cannot prevent or restrict the leasing or sale of a unit except under certain circumstances nor can the HOA screen a potential buyer or lessee (except the Registered Sex Offenders list).  A right of first refusal is acceptable provided that it is written in the proper manner.
  • Projects that outright restrict leasing.  A project has to allow leasing of at least one unit.  Exceptions include age-restricted communities and projects that consist entirely of Affordable Housing units or the like.
  • Conveyance/deed restrictions that require 3rd party transfer fees which are not administrative in nature or benefit the association directly.  For example, a transfer fee of $300 paid to the HOA for providing resale packages is acceptable as is one which contributes to the association’s reserve account.  Unacceptable transfer fees include those tied to a percentage of the sales price or those paid to a “nonprofit organization” for any reason.

The above list represents the major categories of condominiums that are not eligible for FHA project approval.  Most of them are also not eligible for Fannie Mae (conventional) financing options as well.  Age-restricted and Affordable Housing communities may be eligible for FHA project approval if they meet other FHA criteria for approval.

 

Top Photo Credit: Freedigitalphotos.net / stuartmiles

Houseboat Photo Credit: Freedigitalphotos.net / arvind balaraman

Can We Not Send that Document to FHA?

elensthewise_300pxWe are currently processing a 2-year FHA recertification for a small 6-unit condominium.  It was approved with FHA in June of 2013 so it should be a piece of cake, right?  Well, maybe not…

Our contact with the association hired us after reading a few of our blogs.  He called when he had some questions regarding FHA loan concentration limits.  Satisfied with our level of understanding of the FHA guidelines and process, he hired us to help him.

During our process of collecting the documents, we uncovered an Amendment to the Declaration filed in 2012, which was prior to the project’s previous approval (nice alliteration).  The Amendment stated that as of the date of filing, all units must now only be owner-occupied and gave powers to the Board to evict tenants and levy penalties against the unit owners if they leased their units.

Because leasing is not allowed in the project at all, FHA will not recertify this project.  FHA states that at least one unit in any condominium project must be allowed to be leased; the outright restriction of leasing if forbidden.

I brought this to the attention of our client.  He was baffled because they were approved in 2013.  I said that the rules hadn’t changed since then so the only potential reason was that the Amendment wasn’t provided to FHA during the original approval process.

He asked the next logical question: “Can we not supply that document to FHA?

I replied: “Part of the submission package is a document that we sign certifying that the information provided is true, accurate and complete and that the project meets FHA’s guidelines.  With knowledge of the Amendment, signing this form constitutes fraud and the penalty can be 20 years imprisonment and/or $1,000,000 fine.  This is something that we simply won’t do.”

He agreed and retracted his question and posed a second asking what can be done to correct this.  I told him that they would have to file an Amendment on the land records to remove this restriction.  Currently, he is working with the association’s attorney to draft an amendment that will allow a maximum of 3 units to be leased at any given time.  This leasing restriction does meet FHA’s guidelines.

Top Photo Credit: (c) Can Stock Photo / elenathewise

Why Do I Keep Hearing About 24CFR203.41?

sframeAfter working with FHA Condominium Project Approvals even for a short time, you will run into a condominium’s legal documents that violate 24CFR203.41.  This section of the Code of Federal Regulations relates to the exemptions of what is called “free assumability”.  That is, a third party may not infringe on the legal rights of ownership of real property.

Section 24CFR203.41(b) states: “A mortgage shall not be eligible for insurance if the mortgaged property is subject to legal restrictions on conveyance, except as permitted by this part.”  [“Insurance” means financing provided by an FHA-insured loan.]

Enough with the legal jargon, let’s stick to “normal people” talk.

Free assumability is normally threatened in the ownership of a unit in a common interest community, such as a condominium, planned community/PUD or Co-Op.  These communities typically have their own governing documents by which all unit owners are required to abide.

Some communities have restrictions on the leasing or sale of the units.  They may allow sales to be voidable by third party entities (such as a Board of Directors).  They may also require that a certain percentage of the proceeds from the sale of a unit be payable to a third party (such as the association).

24CFR203.41 describes all of the specific exceptions to free assumability.  There are four (4) distinct types of exemptions, which are:

  1. Legal restrictions imposed by eligible governmental and non-profit entities may be exempted if the restrictions meet certain criteria.  One such criteria is that the restrictions terminate upon transfer of title or the mortgage to the Secretary of HUD.
  2. Financing involving the sale of tax-exempt bonds.  The Connecticut Housing Finance Authority (CHFA) in the State of Connecticut, for example, offers mortgage loans for first-time buyers with down payment assistance and reduced interest rates.  It accomplishes this through the sale of tax-exempt bonds.  Upon sale of a home encumbered by a CHFA loan, the seller may incur a recapture tax under certain situations.  This is allowed under 24CFR203.41 because CHFA is an eligible governmental entity.
  3. Exemption for protective covenants excluding non-elderly.  This allows for FHA financing in age-restricted communities so long as this restriction does not impact marketability or violate Fair Housing or other laws against discrimination.
  4. Exemptions for special jurisdictions.  This relates to mortgages on certain Indian land, Hawaiian home land, American Samoa and the Northern Mariana Islands that meet the requirements to be deemed as eligible areas of exception (which is beyond the scope of this article).

All other legal restrictions were originally said to render units ineligible for FHA financing.

In 2011, FHA announced that certain leasing restrictions are allowed.  This was made permanent by the Condominium Project Approval and Processing Guide (page 26).  Basically, it allows associations to

  • Set minimum and maximum lease terms
  • Require copies of leases and that they be in writing
  • Request the names of the tenants
  • Require that the leases conform to the legal documents, and
  • Set a maximum number of units that may be leased at any time.

Condominiums with leasing and conveyance restrictions that do not meet the exceptions in the Section or page 26 of the Guide are not eligible for FHA condo project approval, and, therefore, FHA financing.

Top Photo Credit: (c) Can Stock Photo / sframe