The Federal Housing Administration (FHA) has issued new guidelines for condominium loans, tightening its already tight 2009 standards and including new changes for apartment to condo conversions which will hit developers square in the pocketbook.

FHA-underwritten condo loans are different than more standard single-family home loans. Before a loan is underwritten for a unit at a particular condo building or development, the property itself – and not just the borrower – must meet a slew of FHA guidelines.

Previously, before the FHA would underwrite a mortgage loan for a condo in a particular building, condo homeowner associations had to certify they were keeping a fund equivalent to 10 percent of the association’s annual budget set aside for major capital repairs.

The new rules require that in addition to the 10 percent rainy day fund, developers attempting to convert apartments into condos must conduct a “reserve study” – an examination of the building’s structural soundness and operating expenses – to determine the likely capital needs for its operation. Enough funds must now be included in the reserve fund to cover any repairs likely to be needed within the first five years, post-conversion, before a loan is approved to be underwritten for a purchase in the newly converted building.

‘A Lot Of Cash’

“The reserve study requirement is going to hit this marketplace like a bomb,” said Orest Tomaselli, CEO of National Condo Advisors LLC, a national consulting firm based in White Plains, N.Y., which advises building managers, developers and condo associations. “If you look at developments that are conversions, five years of repairs could be $50,000, $60,000, $80,000 [even] $100,000, depending upon what the repairs are.”

“That’s a lot of cash,” for some development to come up with, “since [condo associations are] run in such a lean fashion,” said Tomaselli. Additionally, completing the reserve study itself can cost from $5,000 to $25,000 depending on the size of the building, he said.

Stephen Marcus, a partner and condo law specialist at Braintree-based law firm Marcus, Errico, Emmer & Brooks, said he was “very concerned” that the reserve requirements “will have a substantial adverse effect on condo converters,” he said. By forcing developers to put a lot of money up front, the study “will very likely substantially increase the amount of condo fees,” associated with many projects.

And in today’s market, where FHA-underwritten loans have been such a dominant force – particularly for first-time buyers – even high-end developments may not be in a position to forego obtaining FHA approval.

“I don’t think it’s a far-sighted view,” said Clive Martin, an attorney with law firm Robinson & Cole, which has an office in Boston. “You’re narrowing the options of the current owners and would-be buyers if you take that option. I know at some of the high-end places that I represent, [buyers] very much resent if it’s not FHA-approved.”

Without sufficient funds in the reserve to cover major repairs, homeowners can be subject to special assessments amounting to thousands of dollars, which could potentially cause some borrowers into defaulting on their mortgage.

Silver Linings?

The new reserve requirements “are part of our risk control,” said HUD spokesperson Brian Sullivan. “We want to make sure that [the condos] have sufficient reserves on hand to meet the types of expected capital needs that any condo development might experience over the course of five years.”

The move is part of an overall tightening in the FHA’s underwriting standards for condos undertaken over the past several years in response to the housing crisis. In addition to the 10 percent reserve requirement, in 2009 the agency introduced several other new rules which presented stumbling blocks to smaller associations. These rules include stipulations that no more than 10 percent of the units be investor-owned, and that no more than 15 percent of units in a building could be delinquent on mortgage payments.

So, for example, in a building with five units or fewer, if one owner were to get behind on their mortgage, the rest of the units in the entire building would not qualify for any FHA-underwritten loans. Current residents could find it near-impossible to sell their condo even to qualified buyers, since in recent years FHA loans have dominated the market for first-time buyers especially – exactly the kind of buyers apt to buy condos in smaller buildings..

But there are a few changes which may gladden the hearts of building mangers: Owners can now apply for an exemption to allow up to 35 percent of a building’s space to be commercial, allowing many more of the kinds of mixed-use developments popular with urban planners to be approved for FHA loans. Previous requirements capped that ratio at 25 percent.

Additionally, new condo buildings will become eligible for FHA underwriting more quickly. “Prior to new guidelines, FHA required that 90 percent of the units be sold prior to FHA insuring [the] loan,” said Marcus. New guidelines reduce that figure to 51 percent.

In addition, units in converted buildings which are rent-stabilized or rent controlled will no longer be considered “investor owned.”