Wires and drywall were all that remained in a three-bedroom, two-and-a-half-bath Wrigleyville condominium unit that its owner abandoned in 2009. The owner wasn’t paying on his mortgage or his monthly condo association assessments, prompting his lender to foreclose and causing a budget shortfall that the other owners in the association had to absorb, reports Keith J. Hales, president of Hales Property Management, Inc. in Chicago, whose firm manages the 21-unit building.
This is just one example of the crisis impacting condo associations throughout the seven-county Chicagoland region as foreclosures continue to increase and condo and homeowners association boards must grapple with a variety of related problems.
According to the Illinois Foreclosure Listing Service, June 2012 foreclosure filings in the region totaled 6,645, up about three percent from 6,440 in May 2012 and about 10 percent from 6,032 in June 201l. Roughly twice as many other properties are in various stages of pre-foreclosure, and still others in distress could further inflate foreclosure statistics in the months ahead. “We do not see a slowdown in foreclosures,” declares Mark Pearlstein, a partner in the Chicago law firm of Levenfeld Pearlstein LLC.
Debtor in Possession
Faced with a backlog of unpaid assessments on a Chicagoland condo unit or home, a board has several alternatives. One is an Illinois law that allows the board to ask a judge for possession so it can rent out the unit for up to 13 months. After that, if the bank still holds title, the board could go back to court and ask to retain possession for another 13 months.
Marcia Caruso of Caruso Management Group in Naperville used this procedure for over 20 units in the first half of 2012. “If we get possession of a unit within six months and then rent it within one or two weeks, we can recoup the association’s loss in six to nine months,” she says. “If the homeowner walks back into the scene and says, ‘Give me my home back,’ you have to give him the excess cash. The homeowner resumes being in good standing. It’s a win-win situation. He gets it back in good condition with all new appliances.”
Because putting the Wrigleyville condo unit in rentable condition would have involved significant expense, the board there opted instead to wait for the lender to foreclose and auction off the unit. “It was worth about $500,000,” Hales says. “It went for about $100,000, and the new owner probably had to put another $200,000 or so into it to resell it.”
Leniency vs. Fiduciary Duty
Before dispossessing delinquent owners, most boards will encourage them to erase their deficit. “Boards have to consider payment plans,” Caruso says. “If you work with homeowners, you’ll get farther ahead. It doesn’t help to add more legal expense if they’re not going to pay.”
Caruso advocates “a very strong, consistent collection program. If you don’t collect your money, you’re not going to do anything else in the community. In an HOA, an abandoned home that’s not being maintained brings down the value of the community. In a condo, departing owners turn off the heat in the dead of winter and the pipes burst. The bank should come in and winterize, but often the association has to get in and turn the heat back on.”
Owners who stop paying on their mortgage but continue to pay assessments may remain in their residence for several years until the lender takes action, “but if you don’t pay assessments you’ll be out in 60 to 90 days,” Caruso says. “I assume everyone is as assertive as we are in protecting the assets of our communities.”
Not necessarily. Hales says many boards have become more lenient. “Especially in smaller buildings, owners don’t want to turn in their neighbors, but the worst thing the board can do is nothing.” He advises “a documented payment plan requiring a signature from the owner—maybe a quarter or a third [of what is owed] plus their original assessment from here on out.”
Although boards have an obligation to levy special assessments when their property needs repairs, they may offer an installment plan to ease the pain for neighbors who can’t afford a lump sum. “To spread out the payments even further, close to 80 percent of the boards borrow money for a large project,” Pearlstein says.
Coping with Absentee Owners
Owners who don’t actually live in the community pose other problems for its board. Some absentee owners leave because they lose a job and have to move away. If they haven’t abandoned their unit or home, they may rent it out. Others are investors who sought rental income and/or a profit upon an eventual sale. Either way, they tend to become disengaged from the building’s upkeep and repair needs.
“If they’re disengaged, they basically don’t care,” Hales says. “The association doesn’t get enough people to be on the board. Fewer people to manage the building results in poor maintenance and management. Things don’t get done; maintenance is reactive rather than proactive.”
Sometimes even resident owners become disengaged. Hales describes a three-unit condominium where each owner pays $60 a month—just enough to cover the utilities. “It looks like a bomb went off,” he says. “They have roof issues and mold on the ceilings. The smoke detectors were removed and their wires are hanging from the ceiling. If an inspector came in, he would shut the building down. The owners all need to sit down and have a meeting. It’s going to take some money to maintain their investment.”
The Rental Dilemma
As the percentage of renters rises, the market value of individual units can be adversely affected, and prospective purchasers may have difficulty in securing a loan. The Federal Housing Administration (FHA), Fannie Mae, and Freddie Mac won’t approve financing in a building or community where residents own fewer than 51 percent of the units or homes. Caruso says that that restriction is critically important in DuPage and Will counties, where the FHA supplies 93 percent of all residential financing.
“The more renters there are, the greater the number of investors,” Pearlstein says. “They are more resistant to supporting assessment increases, and may even be actively opposed. Boards become concerned when non-residents occupy 25 percent of the units. With 30 to 40 percent non-residents, there is concern that the property is turning into an apartment building.”
Limiting the percentage of renters in a building or community is a double-edged sword. While it helps to make the units more saleable and financeable, it limits the options of existing owners. They complain that if they can’t rent their units, they won’t be able to pay their assessments and will have to sell at a loss.
“People want to lease out their units and move home with Mom and Dad. If there are leasing restrictions, they can’t do it,” Caruso says. “They are petitioning boards for help and not getting it.”
Hales tells of a 56-unit condominium in which 18 owners—almost a third of the total—were renting out their units. “The building did not have a rental restriction,” he says. “Three board members, all residents, wanted to institute one. There was a huge uproar from the owners who were currently renting.”
Faced with a cash-flow crunch and a budget shortfall, associations look desperately for ways to make ends meet. Bankruptcy and waiving reserve contributions are commonly suggested, but few associations actually do these things because they really don’t help.
Bankruptcy is like a Band-Aid on a gaping wound. It can discharge an association’s backlog of unpaid utility bills and other debts, but doesn’t solve the underlying problems that will lead inexorably to a new backlog.
Voting to waive contributions to the reserves can reduce assessments, but could make the property ineligible for federally-guaranteed financing. Fannie Mae requires a reserve study and a minimum allocation of 10 percent of the association’s annual revenues to fund the reserves. The FHA and Freddie Mac have similar requirements, and so do many private-sector lenders.
When a Community Fails
What happens when a condo or HOA has so many units defaulting on assessments that it lacks money to operate, the manager resigns, the directors resign from the board, the property is essentially abandoned, and no one is in charge? Several alternatives exist.
• Receivership. “Under Illinois law, an interested party can petition the court to appoint a receiver,” Pearlstein says. The interested party could be someone still living in the community, a lender, or a vendor with unpaid bills.
“The receiver would collect assessments from owners, pay the bills, and report to the court on a regular basis. Receivers are entitled to compensation, and can retain an attorney whose fees are also a cost—perhaps an additional $10,000 to $20,000 a year. It’s not an inexpensive alternative, but it could be the only alternative. Sometimes the banks will contribute towards that cost.”
• Selling the property. Section 15 (a) of the Illinois Condominium Property Act sets the rules: approval by “a majority” of the unit owners in a two-unit condo, at least two-thirds in a three-unit condo, at least three-quarters in a condo with four or more units, or more if the condo documents require a higher percentage. Assuming that enough owners agree, a sale is easiest to accomplish in a mature community with all units built out and either occupied or rentable.
Pearlstein says selling a condominium is a two-part process. “First is a vote of the owners to convert from a condominium. Then comes the sale of the property to one entity—a third party, whether an individual or a company—who will then presumably operate it as a rental apartment complex.”
• Bulk sale.“We usually see a bulk sale of unsold condo units to an investor in a failed new construction project,” Pearlstein says. “The investor will rent the units out on a short-term basis. He intends to sell them when the market improves. The condominium remains unless its owners vote to terminate it.”
In one failing 40-unit condominium on Chicago’s North Side, only eight units were occupied, 12 more were complete but vacant, and the other 20 were shelled in but incomplete. The bank that financed the building wanted to turn it over to a developer who would complete it and operate it as an all-rental property. “The developer was trying to get the eight owners to sign off on that in exchange for a cash payment and a period of free rent,” Hales recounts.
“Could another developer come in, finish it, and keep it as a condo? Sure, but then he would have to deal with the other owners who are there, if they already have an association. Developers like to be in full control. They would find it more appealing to flip to a total rental.”
Ultimately of course, the aim of any community is to remain solvent and stable—and that can be challenging even when there's not a global economic crisis going on. As recessionary conditions evolve, Chicagoland boards will have their work cut out for them in navigating the legal issues, paperwork, and strategic planning necessary to help their HOAs weather the storm and come through in as good a shape as possible.
George Leposky is a freelance writer and editor living in Miami, Florida, and is a frequent contributor to The Chicagoland Cooperator.