Explanation of the dangers of condominiums
Condominiums have grown to become a major habitat in urban centers across North America. Touted as a carefree lifestyle housing alternative, they have become very popular, especially over the last 10 years or so. Single people, couples without children, and retirees seem to be particularly drawn to them, mainly because of the convenient amenities in and around them.
However, for many unit buyers and owners, condo ownership can still be ambiguous and convoluted. Since condominiums are not based on the same ownership structure as traditional (freehold) homes at street level, comparing condominiums to traditional homes is like comparing apples to oranges. Condominium ownership is based on a two-tier ownership system. One level pertains to the individual unit itself, and the second to the undivided, prorated interest in all common elements in the condominium complex, including the land beneath the complex. While the unit owner receives an individual unit deed from him, it 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 dwelling, structured by full ownership, grants its owner absolute and exclusive ownership of both the land and the dwelling that stands on it.
The main distinction here is that the individual unit owner is not the outright 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 govern their condominium complex diligently, and on their timely payments of property tax. , monthly maintenance fee, and special assessment, as they come due. .
These are two critically important prerequisites for any condo complex to be professionally managed and fiscally sound to preserve the value of its units well into the future.
One important thing to keep in mind is that the home owner’s loss of property does not adversely affect any of his neighbors. Rather, the condo owner’s loss of the unit automatically affects all of their neighbors, the other unit owners in the same condo complex, by increasing their financial obligations to maintain the entire complex. The more losses from the units, 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 high-rate insured mortgages, also known as Monster mortgages, mostly guaranteed by taxpayers. Economic policy makers, 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 housing markets, the condo scene, as long as it is not overvalued, can be a viable alternative to the traditional housing 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 general rule, the financially weakest unit owners are the first to succumb during economic adversity. Their units are put together and sold out through forced sales. If adverse conditions persist, pressure on remaining unit owners to shoulder the financial burden of maintaining the entire complex over time 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 with condominiums in the extreme, one has to look at what happened with cooperatives or “Co-ops”, a concept very similar to condominium property. 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 common cooperative mortgages. That precipitated the catastrophic failure of large-scale cooperatives. If the economy tanks again, condominiums, many of them max-funded, may end up meeting their demise just as co-ops did some eighty years ago.
To avoid such scary scenarios, the public needs to be aware that buying a condominium complex is not a carefree 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 policymakers need to 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 failure to pay condo mortgage and maintenance fees will cause them to lose their units, resulting in financial liabilities that could haunt them for years. Politicians 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 that taxpayers pay the bill of the defaulted policyholders. Mortgages Worse yet, vacancies due to the consequences of homeowners with no equity, could have disastrous consequences for the remaining homeowners and their complexes.
To avoid such possibilities and ensure that condominiums remain a viable and sustainable form of housing, certain safeguards must be reinstated, one of which was previously used by financial institutions, to the benefit of the future of the condominium industry.
A mandatory minimum down payment of at least 35%
Before government insurers stepped in to insure high-rate mortgages on condominium units, financial institutions insisted on a minimum 35% down payment. Knowing that condominiums were exceptionally risky, they would not provide mortgages for more than 65% of their unit value. Subsequently, their risk was minimized – in fact, almost eliminated – once the insured government agencies began to provide them with guarantees in case of possible defaults.
In doing so, a vehicle was formed whereby a traditional renter with very little cash on hand could purchase a condominium unit without putting down much of their own money (equity). This government-subsidized policy had induced dozens of traditional renters, many of them turned speculators, to buy as many condominiums as possible so that the housing sector would remain a strong contributor to the country’s economy.
The imperfection of a socialist-like system was put to the test during the housing crash 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 owners of units without 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 the taxpayers who had to foot the bill for delinquent mortgages.
Not much seems to have been learned from such failures. A recent MarketWatch article titled “Opinion: Buying a Home Will Soon Be Easier, But Don’t” on October 24, 2014, quotes the FHFA director as saying that Fannie Mae and Freddie Mac plan to guarantee some down payment loans. payments as little as 3%.
Since most economists agree that we currently live in a bubble economy with overly inflated real estate prices, we have to 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 condominium units. Condominium complexes that remain with many vacant units are likely to end up liquidated through insolvency proceedings, eventually transforming into ordinary apartment buildings. The damage to the economy – indeed, to all of society – could be said.
In the interest of preserving the condominium industry and minimizing taxpayer liability risk in the event of potential mass defaults, condominiums should be excluded from high-ratio insured mortgages. Condo buyers should again be required to put down a down payment of at least 35% of their own money if they wish to purchase a condo. Since they no longer qualify for government-guaranteed insurance on their mortgages, and condos remain overvalued, banks could insist on even higher down payments. Scary as it sounds, this would actually take us back to 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) capital into the units, leaving them in a position better. to meet future increases in maintenance costs. Their individual and collective financial strength would ensure the preservation, even improvement, of their units and complexes for times to come.
Disqualifying condominiums for high-rate 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 to buy real estate, and it would relieve taxpayers of paying high-rate insured mortgages on delinquent condo units.