September 22, 2023

Epic Law

The Law Folks

Condo Perils Explained

Condos have grown to become a major habitat of urban centers across North America. Touted as a housing alternative with a care-free lifestyle, they have become very popular, especially during the last 10 years or so. Single people, childless couples and retirees seem to be particularly attracted to them, mainly because of convenient amenities in and around them.

Yet, to many buyers and unit owners, condominium ownership may still be ambiguous and convoluted. Since condos are not based on the same ownership structure as street-level traditional (freehold) homes, comparing condos to traditional homes is like comparing apples with oranges. Condo ownership is based on a two-tiered ownership system. One tier pertains to the individual unit itself, and the second, to the pro-rated and undivided interest of all the common elements in the condo complex, including the land underneath the complex. Even though the unit owner receives an individual deed to their unit, it is at all times contingent and subordinate to the master deed of the second tier ownership, represented by the common elements of the condo complex. Conversely, a traditional home, structured by its fee simple title ownership, gives its owner an absolute and exclusive ownership of both the land and the dwelling erected on it.

The major distinction here is that the individual unit owner is not the absolute master of the condo property. Sharing a common roof and the rest of the condo complex with the other unit owners makes them an intrinsic part of the joint ownership commune. Therefore, the value and destiny of any individual unit depends on all the unit owners electing competent leaders (board members) to govern their condo complex diligently, and on their prompt payments of realty tax, monthly maintenance fee and special assessment, as they become due.

These are two pivotally important pre-requisites for any condo complex to be run professionally, and remain fiscally healthy to preserve the value of its units in the future.

An important thing to note is that the home owner’s loss of property does not adversely affect any of their neighbours. Conversely, the condo owner’s loss of their unit automatically affects all of their neighbours, the other fellow unit owners in the same condo complex, by increasing their financial obligations to maintain the whole complex. The more losses of the units, the heavier financial burden on remaining unit owners to maintain the complex.

Condo complexes are comprised of unit owners with varying financial strengths. Some buy their units all in cash, and some with a sizable down payment. Many others can only afford to buy their units with very small down payments, facilitated through insured high-ratio, a.k.a. Monster mortgages, mostly guaranteed by tax payers. Economic policy makers, through quasi-government formed insurance agencies such as Fannie May, Freddy Mac and CMHC in Canada, have been approving and encouraging such (subsidized) purchases to stimulate the economy for quite some time.

During times of a healthy economy and vibrant real estate markets, the condo scene – providing it is not overvalued – may be a viable alternative to traditional housing for which it was originally designed from its inception in 1965. Its volatility comes into play in times of over-inflated prices, oversupply, unemployment and interest spikes.

As a rule, the financially weakest unit owners are the first to succumb during economic adversity. Their units get liened and sold out by forced sales. If adverse conditions persist, over time, the strain on the remaining unit owners to shoulder the financial burden of maintaining the whole complex may start a domino effect. More unit owners may then succumb to financial pressures, especially when there are no readily available new unit buyers on the market.

To realize what may happen to condos in the extreme, one has to look at what happened to cooperatives or “Co-ops,” a very similar concept to condominium-like ownership. The Great Depression of the 1930s caused scores of co-op owners, unable to cope with their financial woes, to default on their maintenance fees and common co-op mortgages. That precipitated the catastrophic failure of co-ops on a massive scale. Should the economy tank again, condos, many of them financed to the hilt, may end up meeting their demise just as co-ops did some eighty years ago.

To prevent such scary scenarios, the public should be aware that buying into a condo complex is not a worry free ownership arrangement, as many are led to believe. In fact, it is fraught with peril. The popular assumption that by buying a condo unit, one becomes free of its complex ownership worries is dead wrong. The public needs a cautionary tale about condo ownership.

Government regulators and policy makers should take note that condominiums are the most volatile of real estate products due to the financial diversity of its inhabitants. Financially weak unit owners with little or no equity in their units must realize that defaulting on a condo’s maintenance fees and mortgages will make them lose their units, resulting in financial liabilities that could haunt them for years. Politicians and regulators in charge should realize that at the next major market correction, the trade-off of stimulating the economy by inducing financially weak buyers to buy condos with little or no down payments may backfire badly, resulting in taxpayers footing the bill for defaulted insured mortgages. Worse yet, vacancies due to fall-outs by no-equity unit owners, could cause disastrous consequences to the remaining unit owners and their complexes.

To prevent such possibilities and assure that condos remain a viable and sustainable form of housing, certain safeguards, one of which was formerly used by financial institutions, should be reinstated for the benefit of the condo industry’s future.

A Mandatory Minimum Down Payment of at least 35%

Before government insurers stepped in to insure high-ratio mortgages on condo units, financial institutions were insisting on a minimum 35% down payment. Knowing that condos were exceptionally risky, they would not provide mortgages for more than 65% of their unit value. Their risk was later minimized – in fact, almost eliminated – once government insured agencies started to provide them with guarantees in case of eventual defaults.

By doing so, a vehicle was formed by which a traditional renter with very low cash on hand could buy a condo unit without putting down much of their own money (equity). This government-subsidized policy had induced scores of traditional renters, many of them turned-speculators, to buy as many condos as possible for the sake of keeping the housing sector a strong contributor to the country’s economy.

The imperfection of such a socialist-like system was tested during the real estate crash of the early 90s, where, due to oversupply, the pool of legitimately available buyers dried out, leading to a dramatic lowering of condominium unit values and massive defaults by no-equity unit owners. Worst hit were taxpayers, who paid banks billions of dollars for defaulted mortgages through government insurance agencies.

A second test of the system’s imperfection occurred in the US in 2008, where again, the prices of housing, and particularly condominiums, experienced devaluation of up to 50% in many major urban areas. Again, it was taxpayers that had to foot the bill for the defaulted mortgages.

It seems as if not much was learned from such failures. A recent MarketWatch piece titled “Opinion: It will soon get easier to buy a home-but don’t do it” of October 24, 2014, quotes the FHFA director saying that Fannie Mae and Freddie Mac are planning to guarantee some loans with down payments as little as 3%.

Given that most economists agree we presently live in an economic bubble with overinflated real estate prices, we must ask ourselves if we can afford to sit and wait for the next market crash that would lead to another major condo devaluation. The next such crash could not only affect taxpayers but also the score of owners that would lose their condo units. Condo complexes left with many empty units could very possibly end up wound down through insolvency proceedings, eventually transforming themselves into ordinary apartment buildings. Damage to the economy – in fact, to the whole society – could be very dire.

For the sake of preserving the condominium industry and to minimize the risk of taxpayers’ liability in case of potential massive defaults, condos should be excluded from high-ratio insured mortgages. Condo buyers should again be required to put at least a 35% down payment of their own money if they wish to buy a condo. With no longer qualifying for government guaranteed insurance on their mortgages, and condos remaining to be overpriced, banks might insist for even higher down payments. Although sounding scary, this would actually lead us back to the free-market policy, on which our society was founded. Condo complexes that are well governed, comprised of unit owners able to afford its distinct life-style, would be in much better financial shape as its individual owners would put down their own (substantial) equity into the units, leaving them in much better position to cope with future increased maintenance costs. Their individual and collective financial strength would assure the preservation, even enhancement, of their units and complexes in times to come.

Disqualifying condos for insured high ratio mortgages would not weaken the real estate industry. In fact, it would entice developers to build more affordable apartment buildings to house members of the public that cannot afford to buy real estate, and alleviate tax payers of paying for high-ratio insured mortgages on defaulted condo units.