Explanation of the dangers of condominiums
Condominiums have grown to become an important habitat in North America’s urban centers. Touted as a carefree lifestyle housing alternative, they have become very popular, especially over the last 10 years or so. Single people, childless couples, and retirees seem to be particularly drawn to them, mainly because of the convenient amenities in and around them.
However, for many buyers and unit owners, condominium ownership can still be ambiguous and convoluted. Since condos are not based on the same ownership structure as traditional (freehold) houses at street level, comparing condos to traditional houses is like comparing apples to oranges. Condo ownership is based on a two-tier ownership system. One level pertains to the individual unit itself, and the second, to the prorated and undivided interest of all common items in the condominium complex, including the land below the complex. Although the owner of the unit receives an individual deed to the unit from him, this is at all times contingent and subordinate to the master deed of ownership of the second floor, represented by the common elements of the condominium complex. On the contrary, a traditional house, structured by its freehold, grants its owner absolute and exclusive ownership of both the land and the house that is built on it.
The main distinction here is that the individual unit owner is not the absolute owner of the condominium property. Sharing a common roof and the rest of the condominium complex with the other unit owners makes them an intrinsic part of the joint ownership community. Therefore, the value and fate of any individual unit depends on all unit owners electing competent leaders (board members) to diligently govern their condominium complex, and on their timely payments of real estate tax. , monthly maintenance fee, and special assessment, as they come due. .
These are two critically important prerequisites for any condominium complex to be professionally managed and fiscally healthy to preserve the value of its units well into the future.
One important thing to keep in mind is that the homeowner’s property loss does not adversely affect any of his neighbors. Conversely, the condo owner’s loss of the unit automatically affects all of his neighbors, the other unit owners in the same condo complex, by increasing their financial obligations to maintain the entire complex. The more units losses, the financial burden on the remaining unit owners to maintain the complex.
Condominium complexes are made up of unit owners with varying financial strengths. Some buy their units with cash and others with a hefty down payment. Many others can only afford to buy their units with very small down payments, facilitated through insured high-index mortgages, also known as Monster mortgages, mostly guaranteed by taxpayers. Economic policymakers, through quasi-government formed insurance agencies like 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 condominium scene, provided it is not overpriced, can be a viable alternative to the traditional home for which it was originally designed since its inception in 1965. Its volatility comes into play in times of overinflated prices, excess supply, unemployment and interest spikes.
As a rule, the financially weakest unit owners are the first to succumb during economic adversity. Their units are pooled and depleted through forced sales. If adverse conditions persist, over time, the pressure on the remaining unit owners to shoulder the financial burden of maintaining the entire complex can start a domino effect. More unit owners may then succumb to financial pressures, especially when there are no new unit buyers available on the market.
To realize what can happen to extreme condominiums, one has to look at what happened to cooperatives or “Co-ops,” a concept very similar to condominium ownership. The Great Depression of the 1930s caused dozens of cooperative owners, unable to cope with their financial problems, to default on their maintenance fees and regular cooperative mortgages. That precipitated the catastrophic failure of large-scale cooperatives. If the economy tanks again, condominiums, many of them fully funded, may end up meeting their demise just as cooperatives did some eighty years ago.
To avoid such scary scenarios, the public needs to be aware that buying a condominium complex is not a worry-free ownership deal, as many believe. In fact, it is fraught with danger. The popular assumption that buying a condominium unit frees one from complex ownership concerns is dead wrong. The public needs a cautionary tale about condo ownership.
Government regulators and policy makers should keep in mind that condominiums are the most volatile real estate product due to the financial diversity of its inhabitants. Financially weak unit owners with little or no equity in their units need to realize that defaulting on a condo’s mortgage and maintenance fees will cause them to lose their units, resulting in financial liabilities that could plague them for years. Policymakers and regulators in charge need to realize that in the next big market correction, the trade-off of stimulating the economy by inducing financially weak buyers to buy condos with little or no down payment may backfire, resulting in for taxpayers to pay the bill for defaulting insureds. Foreclosures Worse still, vacancies due to the consequences of unit owners without capital, could have disastrous consequences for the remaining unit owners and their complexes.
To prevent such possibilities and to ensure that condominiums remain a viable and sustainable form of housing, certain safeguards must be restored, one of which was previously used by financial institutions, to benefit the future of the condominium industry.
A required minimum down payment of at least 35%
Before government insurers stepped in to insure high-index mortgages on condo units, financial institutions insisted on a 35% minimum down payment. Knowing that the condominiums were exceptionally risky, they would not provide mortgages for more than 65% of their unit value. Their risk was later minimized—indeed, almost eliminated—once the insured government agencies began providing them with guarantees against eventual defaults.
In doing so, a vehicle was formed by which a traditional renter with very little cash on hand could purchase a condominium unit without putting up much of their own money (equity). This government-subsidized policy had induced dozens of traditional tenants, many of them turned speculators, to buy as many condominiums as possible so that the housing sector remained a strong contributor to the country’s economy.
The imperfection of a socialist-like system was put to the test during the real estate crisis of the early 1990s, where, due to oversupply, the pool of legitimately available buyers dried up, leading to a drastic reduction in property values. condominium units and mass defaults. by unit owners with no capital. Hardest hit were taxpayers, who paid banks billions of dollars for defaulted mortgages through government insurance agencies.
A second test of the imperfection of the system occurred in the US in 2008, where again, house prices, and particularly condominiums, experienced a devaluation of up to 50% in many major urban areas. Once again, it was taxpayers who had to foot the bill for delinquent mortgages.
It seems that not much was learned from such failures. A recent MarketWatch article titled “Opinion: Home Buying Will Be Easier Soon, But Don’t” on October 24, 2014, quoted the FHFA director as saying that Fannie Mae and Freddie Mac plan to guarantee some down payment loans. payments as small as 3%.
Given that most economists agree that we currently live in a bubble economy with overly inflated home prices, we must ask ourselves if we can afford to sit back and wait for the next market crash that would lead to another big condo devaluation. The next such collapse could not only affect taxpayers, but also the number of homeowners who would lose their condo units. Condominium complexes left with many vacant units are likely to end up liquidated through insolvency proceedings, eventually being transformed into ordinary apartment buildings. The damage to the economy – indeed, to the whole of society – could be very telling.
In the interest of preserving the condominium industry and minimizing the risk of taxpayer liability in the event of potential mass defaults, condominiums should be excluded from high-ratio insured mortgages. Condo buyers should again be required to make a down payment of at least 35% of their own money if they want to buy a condo. Since they no longer qualify for government-guaranteed insurance on their mortgages, and condos remain overpriced, banks could insist on even higher down payments. Scary as it sounds, this would actually take us back to the free market politics on which our society was founded. Condominium complexes that are well governed, understood as unit owners able to afford their distinctive lifestyle, would be in a much better financial position as their individual owners would put their own (substantial) equity into the units, leaving them in a position better. to cope with future increases in maintenance costs. Your individual and collective financial strength would ensure the preservation, even improvement, of your units and complexes for the ages to come.
Disqualifying condominiums for high-index insured 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 who can’t afford real estate, and it would relieve taxpayers of paying high-index insured mortgages on delinquent condo units.