Should FHA Relax Condo Rules?

By Deborah Goonan, Independent American Communities


In light of recent developments, I am republishing the following blog, originally appearing October 27, 2015.

See the following article. The House of Representatives has voted to relax condo rules. This is, in my opinion, a very misguided approach to improving the rate of homeownership, as well as affordability, for American home buyers. These new policies, if also approved in the Senate, will only lead to increased financial risk for US taxpayers, who ultimately pay for financial backing of distressed condominium associations by FHA.


Bipartisan vote bodes well for condo buyers

Anyone who believes that condominium projects with only 35% owner-occupancy are a good buy for first-time or downsizing homeowners is severely misguided.

In most cases, once a condominium project reaches such a high level of owner-investors and/or vacancies and/or unsold units, the association is likely to be in financial distress and with significant levels of deferred maintenance.

The chances of majority investor-owners selling to owner-occupants is slim, as this would effectively require investors to yield control of the Association Board of Directors. If investors are willing to let go of control, watch out. They are most likely dumping units they deem a non-profitable investment.

Read on for more common sense considerations, and forward it to your Senators.



Several news releases are circulating about the push from housing industry stakeholders to relax FHA certification standards for condos. This article analyzes the pros and cons, and suggests factors that should be considered in HUD’s rule revisions.

Source article:

Pressure Mounts on FHA to Relax Condo Rules

Why do FHA Condo Certification Rules need to be revised?

These are the main goals of a proposed bill entitled “Housing Opportunity Through Modernization Act,” sponsored by House Rep. Blaine Luetkemeyer, Chair of the House Financial Services subcommittee. The bill is supported by National Association of Realtors (NAR) and National Association of Home Builders (NAHB), and has garnered the signatures of 50 House members, according to the source article.

Rep. Blaine Luetkemeyer, the chairman of the House Financial Services subcommittee on housing, held a hearing Tuesday on his bill that would force the FHA to make significant changes to its condo rules. The “Housing Opportunity Through Modernization Act” would streamline FHA’s certification requirements for condo projects, allow more commercial space in agency-approved condo buildings and relax owner-occupancy requirements.

“FHA places significant restrictions on the purchase and sale of condominium, even though they are often the most affordable home ownership option for first-time buyers, small families, urban and older Americans,” said the Oct. 13 letter, whose signers included Reps. Emanuel Cleaver, D-Mo., and Mike Fitzpatrick, R-Pa.

“Current FHA regulations prevent buyers from purchasing condominiums, harms homeowners who need to sell their condominiums, and limits the ability of condominium projects to attract resident buyers,” said Chris Polychron, the chairman of the National Association of Realtors, during the hearing.

Rep. Joyce Beatty, D-Ohio… called on FHA to ease its owner-occupancy requirements. Currently, 50% of the residents in a condo building must own their unit before FHA will approve a condo loan. The Luetkemeyer bill would reduce this owner-occupancy requirement to 35%.

Will reducing owner-occupancy requirements, and allowing for more commercial space help consumers and increase homeownership?

The great paradox

On the one hand, supporters of relaxing FHA condo standards claim the need to promote affordable homeownership, and to increase the number of resales. It is a valid claim that many condo owners are holding onto their units and renting them, simply because there are not enough qualified buyers, and that’s driving down sale prices. Too many condo owners of units at affordable price levels are still underwater on their mortgages, and cannot afford to sell unless they are willing to take a loss.

But on the other hand, how would reducing owner-occupancy requirements encourage traditional homeownership, where the buyer intends to use the condo as a primary residence?

The current FHA rule states that a buyer must purchase with the intent to occupy immediately as a primary residence. But an owner can rent his or her home after just one year. Lax owner-occupancy standards for condo projects could ultimately encourage more investor-owners who have no intention of occupying the units beyond the first year.

And as for classifying condos as the “most affordable form of homeownership,” that’s debatable as well, as I have previously opined.

The unintended consequence of FHA’s Owner-Occupancy ratios

FHA tends to reinforce a blanket prejudice against tenants, by virtue of their lending policies based on an arbitrary owner-occupancy ratio. The unintended consequence of that policy perpetuates the belief that people who rent are inherently more problematic than resident owners, and that they are not interested in taking care of condo units that they do not own.

There are many reasons that responsible people choose to rent rather than purchase — they could be between career options, might have just had a major life event such as divorce or death or a family member, might have gone through a foreclosure due to predatory lending and buying at the wrong time, etc.

In reality, tenant problems can often be traced back to owner-landlord problems. Absentee owners may not always be conscientious about screening tenants or maintaining their units. When you have a condo that has a lot of tenants, you essentially end up with an apartment building consisting of multiple landlords of varying quality.

If the intent of up to 65% of “owners” is to collect maximum rent while spending the minimum amount on expenses — and that includes keeping assessments artificially low — that is the kind of dynamic that leads to a decline in pride of ownership overall. Such an environment makes it difficult for the Condo Association to keep high maintenance standards and sufficient reserve funds. No doubt, this is why HUD has been reluctant to further relax owner-occupancy standards for FHA certification.

But for owner-occupants to find fault with tenants for a decline in the health of the association is misplacing the blame.

Commercial space

From a consumer-homeowner perspective, the greater the commercial proportion of condo association ownership, the greater potential for problems affecting owners. Commercial members of condo associations almost always hold proportionately higher voting interests than owner-occupants, and therefore have more political clout in the affairs of the association.

I tend to hear complaints from owners that the commercial members do not pay their fair share of assessments, or that commercial votes usually overrule the wishes of condo owners.

Depending on the nature of the business, noise and other disturbances can be a significant disadvantage for owners and tenants, depressing resale values and market rents.

And if the commercial business fails, and the owner stops paying assessments, leaving the association with a substantial shortfall in their budget, condo owners have to pick up the slack.

Other supporters of relaxing FHA condo rules

There are plums in this bill for several special interest groups:

The NAR and National Association of Home Builders, as well as advocates for public housing programs and assisted living programs, are pushing Luetkemeyer’s bill.

The Luetkemeyer bill includes provisions regarding Section 8 rental assistance and public housing programs.

The bill also would provide a big boost for the Rural Housing Service single-family program. It would provide direct endorsement authority so that lenders can approve loans without waiting for RHS staff to approve the loan application.

Notice that the bill includes incentives for owners that will ultimately rent their condo units. Once again, how does this policy proposal support FHA’s goal of increasing homeownership for owner-occupants over the long term?

What factors should FHA consider when revising its condo certification rule?

FHA — and lenders in general — need to use different criteria for determining financial risks for issuing mortgages in condominiums.

Instead of establishing an arbitrary owner-occupancy ratio, FHA ought to be looking at the demographic composition of the owners in the Association. Any of the following could describe ownership in a condo association at the time of certification:

  • A few landlord/investors and/or a developer own more than 20%, 35%, or even 50% of the units
  • Primarily individual owners that lease their units to residential tenants
  • A significant number of individual owners that allow family members to live in their units.

Obviously, the type of ownership portfolio makes a big difference in overall commitment to longevity of the association.

What matters most is the relative risk of investor takeover or tyranny of the developer. Investors and developers tend to be in the game for short-term gain, or perhaps for additional revenue streams generated by amenities or commercial operations. And since developers can get away with exemptions to paying full assessments prior to turnover — and controlling the Board and the budget set for operations and reserves — when the developer retains too many units for too long, it generally doesn’t benefit the consumer and owner-occupants.

In addition, FHA and lenders need to be looking at the overall health of the Association:

  • Are reserves adequate, and based on a recent reserve study?
  • Is the Association performing regular maintenance?
  • Are assessments being incrementally increased to reflect true cost of ownership?
  • Are tenants properly screened (without discriminatory processes)?
  • Are evictions handled properly when necessary?
  • Is there adequate insurance in place?
  • Are there any local code violations that need to be addressed?
  • Does the Association operate openly and transparently?
  • Does the developer still control with weighted votes?
  • Is the Association showing signs of financial distress?
  • Is the Association involved in lawsuits?
  • Is the Association frequently assessing fees for covenant violations?
  • Is it difficult to find people to serve on the Board? etc.

Some of these variables are currently considered, but others are not. If condo projects are not carefully evaluated, FHA could end up insuring many thousands of units in financially risky and unstable Associations.  That outcome would be of no benefit to either taxpayers or owners repaying FHA-insured mortgages.

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