Weathering Financial Storms

What’s in Your Economic Preparedness Kit?

by Kathy Danforth / Published August 2014

Many associations have suffered unprecedented financial shortfalls in recent years; others have trembled but sailed through. With the experience from this episode, communities can determine from successes and failures how they can mitigate the impact of another housing market collapse and/or recession. 

Even in a financial crisis, a board is bound to abide by the governing documents, and these can dictate terms of collections, rentals, sales, foreclosure, taking advantage of legislative changes, and other activities that have come to the forefront. “Obviously, one of the best times to make changes is before a recession happens again,” attorney Aaron Gordon with LM Funding notes. “In many cases, it requires a vote of 75 percent of the membership, and in Florida, particularly, it’s hard to have 75 percent present. It has even been hard to have 75 percent current in their assessments so they are eligible to vote without leaving the results open to a legal challenge.” Plus, in hard times, individuals are more prone to guard their personal interests than to protect the community as a whole, and it may not be the best time to add restraints to sales.

TIPS ON CUTTING EXPENSES
The first step in righting an unbalanced budget is trimming costs. “Associations have a hard time cutting expenses because they cannot simply stop providing common element services,” Bolin adds. “I am a proponent of the proposal process to compare vendor services and price, but having the cheapest vendor may do more harm than good.”

Gordon acknowledges that cutting expenses is the first step, in order to keep current owners going as long as possible. “Switch group water to individual meters, and drop bulk cable so you aren’t providing for folks who aren’t paying,” he advises. “Don’t impair the property’s appearance or defer maintenance, or you’ll drive prices down and create a bigger problem. If you’ve cut expenses and are trending down in a death spiral, you have to raise fees even if more people are forced out.”

In cutting expenses, Drimmer reminds associations to look at what is usually the largest line item: insurance. “I’ve seen associations renew their policies for years without getting comparative quotes,” he remarks. Once the budget has been pared, Drimmer advises, “If you have to decide whether to cut services or increase fees, I go for the fee increase. Boards are often reluctant to increase maintenance fees, much like politicians shy away from tax increases, as they are both unpopular. But in governance, sometimes hard choices have to be made or your association will suffer more.”

Mitch Drimmer with SNAP Collections relates, “I’ve worked with a community that had their rights to collect unpaid assessments from a first mortgage totally eviscerated. The documents, dated from 1985, state that when a bank takes title either by foreclosure sale or a deed in lieu of foreclosure, the membership has to absorb the debt. These documents were written before the Safe Harbor Laws (limiting debt to 12 months or one percent of the mortgage), and the documents also never added Kaufman Language that would allow new provisions in the governing documents as it ‘may be amended from time to time’ by changes in the statutes. So, the association received nothing because that is how their documents were crafted.”

In this case, Drimmer notes, “Over the last 22 years, the association has had four different attorneys, five management companies, and heaven knows how many board members responsible to keep the documents up to date. The lesson here is that a community association is not only a business, but in many ways functions like a government; and every year or so the laws have to be examined, reviewed, and changed if needed.”

Though Florida law limits the first mortgage debt to the lesser of 12 months of assessments or one percent of the first mortgage balance, Gordon points out, “This statute can be overruled by an 

association’s governing documents, so in some cases, the documents can be changed to make mortgagees jointly and severally liable in case of a foreclosure. The banks will tell you that associations won’t do that because then banks won’t lend in those communities, but I haven’t heard of a bank reviewing association documents to check on that. I’m almost certain they don’t.” 

Preventing a large rental population can be a goal of an association, but it is a double-edged sword. According to Gordon, “A lot of banks won’t lend into communities above a certain threshold of rental properties because they’re worried that investors will walk away again. Often, they want 70 percent of homes occupied by owners for an association loan, which can be a necessity for major repairs such as roof replacement. The threshold is different for a home resale loan—but if there’s a high concentration of renters, and a buyer can’t get an FHA or Fannie Mae loan, that drastically reduces the pool of buyers. But, you miss out on the investor boom if you limit rentals or require residency for 12 months before allowing rental. It comes down to communication and the combined goals of the community: some are investor-controlled and just want to get to the next bubble [of high housing values], while others are primarily owner-occupied and want a calm atmosphere, low assessments, good appearance, and high asset value.”

Screening new residents for financial stability can protect a community going forward, though Drimmer points out, “Everybody has a right to sell their property, and unless the governing documents have a criterion regarding a person’s financial position, it is difficult to keep them out. If an association wishes to protect itself going forward, they should consult their attorney to add such language and criteria to their documents.” Another method of protecting an association’s finances is requiring a capital contribution from new owners. Again, it can deter sales, and Drimmer comments, “It’s not a popular procedure because it just makes the house more expensive to a prospective purchase. But, I feel that it makes the community more attractive to the buyer as it does bring financial stability.”

Associations may need to revise documents to enable maintenance or inspection of abandoned properties, foreclosure and possible rental of homes, or other policies such as denial of amenities for delinquent accounts. House Bill 807, signed into law June 13, 2014, enables associations to request a rental receiver to take over abandoned units and generate cash for maintenance fees. “It is not a bad idea to change documents to reflect these changes so the association can take whatever steps the legislature allows,” Gordon advises. When homeowners become delinquent in payment of fees, the advice is unanimous: this is a business, and action must be taken promptly. “Don’t wait and see. Take action,” advises Jane Bolin, attorney with the PeytonBolin law firm. “The associations that created standards for the collection of assessments and took action quickly were able to monetize foreclosed units and decrease the consumption of common element resources by past-due owners.”

Drimmer observes, “Often I’ve seen boards reluctant to send units for collections because they want to show compassion, but in reality, they are doing a disservice to both the association and the homeowner. By allowing the homeowner to dig himself deeper into a hole, the board is making it harder for him to get back on track.” Drimmer does point out, “There is no one-size-fits-all solution that addresses all delinquencies, as they each have their own story and issues.” While some associations pursue delinquent accounts themselves, specialized collection agencies have also entered the arena and pass along their fees to the delinquent owner. Drimmer explains, “Collection agencies are usually performance based and will pursue a collection process before a legal route.” The collection process includes the initial demand letter, providing payment options, tracing the owner, phone calls, notice of intent to lien, reporting delinquencies to credit bureaus, and collection of fees when the bank forecloses. An attorney may be required if there is no payment, and a lien must be placed or the association decides to foreclose. 

Foreclosure by the association and renting the unit until the bank (mortgage holder) takes title has been quite a grab bag for associations. Drimmer states, “Sometimes that has worked well, and sometimes it has turned out to be a disaster. Once an association forecloses on a unit and has the right to rent it, they enter a world with new potential liability and the challenges of the unknown. Some boards are loath to do it because they don’t want to go into the real estate business, and it could increase their number of rentals thereby diminishing their FHA loan eligibility for new buyers.” 

Two of the main factors in whether foreclosing and renting will turn out to be a profitable move are the condition of the unit and the amount of time until the bank takes title. “I have seen associations close on units so badly damaged by previous owners that there is no economic way to rehabilitate the unit and recover their investment. Getting inside a home to see the condition can be a tricky feat but goes a long way to informing whether to proceed with foreclosure,” Drimmer points out.

Gordon notes, “Some associations think they’ve made money by renting out a unit, but in actuality they’ve lost. There’s the cost for foreclosure, preparing the unit for market, rental management, ongoing repair, and the legal cost to be represented as the owner when the mortgagee forecloses. A lot of boards don’t know or understand all the costs involved in foreclosure, and there can be spite involved, but the lawyers always come out ahead because it’s litigation. Foreclosure is very property specific—if it costs $5,000 to foreclose and rents for $4,500 per month, no problem. If it costs another $5,000 to get in shape and rents for $500 per month, you have to rent for 20 months without any repairs or the bank foreclosing to break even.”

Meanwhile, as efforts to collect overdue assessments or foreclose on units are proceeding, the hapless association has a shortage of income. On the preventive side, if reserves have been adequately funded in the past, the association has options. “Associations with reserves are better suited for handling major expenditures that normally arise in the physical component—for example, upkeep of common elements,” says Bolin. Gordon cautions associations, “Don’t get trapped in thinking of delinquencies as the new “normal.” Even though it’s been going on for years, it’s not ok, not in a community where everyone’s obligated to carry their fair share. Associations should watch out for desensitization to the problem of delinquent owners.”

What would have once seemed a far-fetched, negative extremist’s delusion became a reality for many associations, but now associations are forewarned and can prepare. Reserves, frugality, and up-to-date documents and collection procedures should all be part of an association’s economic preparedness kit.