Killing Condos

If you think the market for houses is rough, you should see the condo market. The Wall Street Journal today says that Fannie Mae and Freddie Mac aren't helping matters: they've recently tightened their requirements to guarantee condo mortgages. As might be expected, some in Congress, including House Financial Services Chairman Barney Frank (D- MA), aren't happy. But it's a little unclear to me why Fannie and Freddie should listen to Congress, since guaranteeing condos poses greater risk to taxpayers' wallets than single-family home mortgages.

The WSJ article explains these strict requirements:

In March, Fannie Mae said it would no longer guarantee mortgages on condos in buildings where fewer than 70% of the units have been sold, up from 51%. Fannie Mae also won't purchase mortgages in buildings where 15% of owners are delinquent on condo association dues or where one owner has more than 10% of units, which the firm sees as signals that a building could run into financial trouble. Freddie Mac will implement similar policies next month.

On the face of it, you might be able to see why Frank thinks these requirements are "too onerous." When you think of new condo developments, it's pretty likely that they haven't reached the 70% occupancy threshold, and won't for some time in this market. Given the high number of mortgage delinquencies out there today, the latter requirement also could be difficult to achieve.

This has got to be a serious blow for some of the places hardest hit by the housing collapse. Florida comes to mind. There were hundreds of condominiums that were put up during the housing boom, many of which had poor enough timing to be completed in or after 2007. Without federal guarantees, their hopes of filling those condos anytime soon might be dashed.

But I'm a little wary about Frank's assumption that Fannie and Freddie should go easier on condos. If a developer that manages condos is having great trouble selling them or collecting mortgage payments, it could default on the building's commercial mortgage or other obligations. That could get ugly, as Benny Kass explained a while back in the Washington Post. He's talking specifically about being the very first buyer in condo association, but theoretically this should apply to any buyer prior to 100% occupancy:

If you are the first buyer in a multi-unit project, and the developer files for Chapter 11 bankruptcy protection, there is some protection. Whoever ultimately will own the rest of the units will be obligated to pay the assessments for those units.

While this sounds good in theory, as a practical matter it can be disastrous. The bankruptcy court may take a long time before deciding on the disposition of the unsold units, and there will be no money in the association to pay monthly expenses such as insurance, utility bills and maintenance.

I'm not sure how that would shake out, but I am sure that this poses a substantial risk on the health of the mortgages associated with those condos. This is unique to the condo market when compared single-family homes. While helping the condo market seems like a good intention, I'm a little worried that Frank and others haven't fully realized the risk that lax requirements for guaranteeing condo mortgages pose to U.S. taxpayers.