Reserve studies, in which one can demonstrate there are sufficient reserves set aside for potential condominium maintenance without necessarily meeting the traditional guideline of 10%, are being described as a way to increase FHA and Fannie Mae financing for condo units.
In order to offer FHA and Fannie financing options to buyers, an entire condo development project must be approved, according to Orest Tomaselli, CEO of National Condo Advisors, White Plains, N.Y.
This complex process requires a number of physical and environmental studies and inspections to be performed before or during submission. These include reserve studies, environmental site assessments, property construction assessments, noise studies and flood zone solutions such as a FEMA Letter of Map Amendment.
The 10% reserve option is not only a requirement of Fannie Mae/Freddie Mac but many portfolio products also follow this guideline, regardless of a project's Fannie/Freddie eligibility.
This guideline requires a specific line item in the budget for replacement reserves.
"It is one of many guidelines that can create a problem obtaining a FNMA approval," he tells Origination News.
"The reserve study has proven to be a way around the traditional guideline of 10%. Having a reserve study done will increase financing."
Some developments have a large amount of capital that they are holding in reserve already, he said. "They just don't have a line item in the budget. Some have just done $5 million or $10 million in repairs to the building and it is not necessary for them to have the full 10%."
His company recently launched a new subsidiary, National Condo Inspections LLC, which assists developers through the project approval status.
"We send out a professional engineer to the site who inspects every single aspect of the mechanicals, the roof and every other ongoing repair. They come up with a formula to which they decide what a reserve amount should be."
In some cases, his company has submitted reserve studies with as little as a 2% reserve.
"On average on new construction developments, it runs between 3% to 5%."
The reserve study is not necessarily a tool to reduce the amount of the reserve, Tomaselli points out.
"It's a tool to provide an accurate number. If our engineers go into a site and see all the roofs need to be replaced over the next three years, they are going to increase that reserve so it can cover those repairs. That fits into the risk management piece that Fannie Mae and FHA are so concerned about."
Mark Flicker is director of end loan financing for Related, a real estate development firm in New York, where he acts as a liaison between the buyer and lending source. Flicker prequalifies buyers who are interested in a specific unit prior to contract execution, refers them to the appropriate lender, and stays in the process by working with underwriters, appraisers, bank reps and legal to ensure a smooth transaction.
"In today's lending environment, the project itself plays as significant a role in the underwriting process as the buyer's financial situation and credit history," Flicker told ON. "A reserve study, performed by a licensed engineer familiar with FNMA guidelines, can significantly reduce the requirement for newly constructed projects. Once a project has obtained FNMA or FHA approval, virtually all of the project related hurdles are eliminated."
In the past, Flicker said developers weren't concerned with Fannie guidelines. A project was sold out and buyers would show up at the closing table.
Now, he says, Fannie and FHA project approvals are a sales tool and many developers are going through the application process and considering the guidelines when creating their offering plan.
"It's an integral part of the process. Although there are many portfolio lenders, lenders who do not intend to sell to FNMA and therefore do not follow the guidelines, the vast majority of buyers, especially with rates as low as they are, are seeking out FNMA or FHA loans." Flicker believes the current guidelines will add stability and long-term appreciation to the projects.
According to Joshua Erskine, president of CalCon Mutual Mortgage Corp., San Diego, regardless of price of units and the percentage of the project which will be Fannie/Freddie eligible, it is very important to have the conditional approval so investors see that the basic parameters of the project fit.
"The reserve study will prove to open up additional financing product for projects, which in the current financing environment will prove to be very important. It is also a practical tool in the management of the HOA and guidance over the first few years before there are historical numbers," he told ON. Erskine said CalCon has taken a different approach than most lenders do on building exposure. "Other lenders in the market have gone from careless to the opposite end of the spectrum with increased lending parameters, backing off projects after making many loans and buildings, cherry picking borrowers within projects and the overall tightening of lending parameters across the country."
The company feels that many of these guidelines are actually increasing risk within a project because the average buyer is having a very difficult time getting loans within projects. "Without solving for a complete solution including foreign national financing in many markets, as this is an important sector of the market in many locations throughout the U.S., lenders are actually increasing their risk."
Much of the success of projects is based on momentum and when lenders come in and lend on 15% of the units and walk away, they have done nothing in securing their investment in the project, according to Erskine. "If a project then has no solution for additional financing, the project typically has had to drop prices, which increases the original loan-to-value of the first set of loans that were made, increasing the risk profile on those notes."
