December 30, 2020

Suggested Legal Structure for Owner/Occupied Affordable Housing Developments Using Blanket Mortgage Financing

Today, most newly constructed owner/occupant housing developments are governed by a condominium and/or non-condominium homeowners association (“HOA”) made up of the owners of the homes in the development. The housing crash and the great recession which followed (the “Crash”) exposed many flaws and weaknesses in the HOA model. See, Time to Rehab the Aging Condominium Concept: Fixing Problems Uncovered by the Great Recession, The Practical Real Estate Lawyer, September, 2017.

This paper identifies those weaknesses in the HOA model which undermine owner/occupied “affordable/workforce” developments and suggests a legal structure which would address those weaknesses and effectively govern sustainable, viable, self-governed, equity building, primarily owner/occupied affordable housing developments in the South and West Sides of Chicago.

The Issues
Following is a list of several of the most daunting issues which must be effectively dealt with for a Community of affordable owner/occupied homes to be successful:

Availability of Financing – After the Crash, home loans became hard to come by for moderate income households.

Budgeting, Cash Management and Reserve Build-ups – Due to the financial stress which confronted owners and HOAs in the aftermath of the Crash, many moderate income HOAs were not able to, or did not, budget adequately for their needs, did not properly manage the funds which they had, and were unwilling or unable to build up sufficient reserves to pay for major repairs or replacements when they became necessary.

Affordability – When the market recovered from the Crash, in many areas, especially those where there was “gentrification” occurring, the monthly cost (mortgage service, real estate taxes and assessments) of owning homes in those areas rose to be beyond the affordability of working households (i.e. in excess of 50% of the income of a household earning 80%-120% of median family income).

Lack of Consistent, Knowledgeable Leadership – The boards of directors of struggling HOAs were often inexperienced and incapable of identifying and dealing with the issues facing HOAs, a problem which was exasperated by frequent turnover of membership on the board and incompetent and/or inattentive professional management.

The cost of acquiring land, preparing the land for construction and constructing affordable homes is a threshold issue. Today, the cost to construct a home far exceeds the price that the home can be sold for in order to be “affordable”, i.e. monthly cost of ownership less than 30% of 100% of MFI (about $2,000/month for a family of 4 in Chicago earning about $79,000/year). For purposes of this paper, we will assume that sufficient land on which to build a “Community” consisting of several “Neighborhoods” of homes on the South or West Side of Chicago will be supplied by the City of Chicago, the Cook County Land Bank or another source, the land will be “cleaned up” and made ready for construction using available TIF funds, and sold to an approved developer for $1 per lot. Funds to pay the cost of the construction and for end loan financing of the homes could be furnished by a Blanket Mortgage (defined below).

Suggested Legal Structure
Each Neighborhood would be made subject to a condominium or non-condominium declaration (“Neighborhood Declaration”) which would provide for the administration of the Neighborhood by a “Neighborhood HOA” whose members are the owners of the homes in the Neighborhood.

The entire Community, and each Neighborhood, would be made subject to a declaration (“Community Declaration”). The Community Declaration would reserve to an entity named in the Community Declaration (which could be a not-for-profit corporation with experience in administering affordable communities, such as United Power or a CNI affiliate) (“Administrative Entity”) rights and powers with respect to the management and operation of the Community and the Neighborhoods. The Administrative Entity would act in place of a Community HOA which, under applicable Illinois law, would be required to be turned over to the owners after the first to occur of 75% sell out of the homes in the Community or 3 years from recording of the Community Declaration. Among other things, the Administrative Entity would have the right and power to (i) provide designated maintenance and other services to portions, or all, of the Community and charge to cost thereof to the HOAs whose members benefit from the services and (ii) to establish, modify and enforce rules and regulations designed to promote and maintain the viability and sustainability of the Community and each Neighborhood HOA. Each Neighborhood HOA would be governed by its owners, subject to the guidance of the Administrative Entity whose mission and purpose would be to help the Community to effectively deal with issues, including the issues discussed above, and flourish.

In a deviation from the typical condominium or HOA setup, each Neighborhood Declaration would provide that each owner will be required to pay monthly to the Neighborhood HOA the following with respect to the owner’s home: (a) the monthly assessment, (b) monthly deposits of real estate taxes, and (c) the monthly mortgage service applicable to the home. The Neighborhood HOA would then administer the Neighborhood and pay necessary expenses and would also make mortgage service and real estate tax payments as they become due on behalf of each owner. The payment of mortgage service and real estate taxes is something that housing co-operatives ordinarily do, but condominiums and HOAs have not historically done. By centralizing this function in the Neighborhood HOA, the Neighborhood HOA will get an early warning when an owner may be experiencing financial difficulties so the HOA can effectively deal with the issue.

Each Neighborhood HOA’s budget would include line items for reserves to cover delinquencies as well as to build up sinking funds to pay the cost of the inevitable major repairs and replacements to the improvements maintained by the Neighborhood HOA. If properly funded, the reserves could help cover the hopefully brief periods when assessments with respect to a home are disrupted, avoid delinquencies on mortgages or real estate taxes, and permit the Neighborhood HOA to avoid borrowing or levying special assessments to pay for major repairs or replacements.

The Administrative Entity would oversee and regulate each Neighborhood HOA to make sure that it is adequately administering its Neighborhood and complying with its Neighborhood Declaration. The Administrative Entity would be a resource and guide to, and regulator of, the boards of the Neighborhood HOAs.

The Blanket Mortgage Approach
As mentioned above, a major issue that faces moderate income homebuyers is obtaining a mortgage loan. One possible approach which may help a development of newly constructed affordable homes would be for the Developer of each Neighborhood to have the option of providing financing by way of a non-recourse (i.e. no personal liability to a homeowner), long term, fixed rate, self-amortizing mortgage loan on the entire Neighborhood (“Blanket Mortgage”). Blanket Mortgages are commonly found in housing co-operatives. The Blanket Mortgage could initially be set up as a construction loan secured by a mortgage on the lots which will make up the Neighborhood. After all construction has been completed and paid for (hopefully with subsidies from the City or Federal grants) the construction loan would be converted to a permanent Blanket Mortgage loan on the homes in the Neighborhood.

Each buyer/owner of a home which is subject to the Blanket Mortgage would be obligated to pay to the Neighborhood HOA its proportionate share of the mortgage service under the Blanket Mortgage based on the ratio of (i) the monthly assessment payable by the owner to (ii) the monthly assessments payable by all owners of homes subject to the Blanket Mortgage. In a Neighborhood of similarly priced homes, each owner of a home would pay an equal amount of the mortgage service each month. An owner’s equity in the owner’s home will increase over time as a function of (a) the rising market value of the home and (b) the reduction of the portion of the Blanket Mortgage attributable to the home as periodic payments of principal are made.

In a Neighborhood where the market values of homes may not be increasing and where a buyer is able to pay cash for the portion of the sale price which is above the portion of the Blanket Mortgage attributable to the home, the fact that the Blanket Mortgage is non-recourse to the individual owners will make it much easier to transfer ownership of a home subject to the Blanket Mortgage. [This is a feature of a limited equity housing cooperative.] If the buyer’s credit rating and income permits the buyer to carry a greater monthly ownership cost than what is being paid by the seller, the holder of the Blanket Mortgage may permit a second or junior mortgage to be placed on the home by the buyer to facilitate the sale. [A feature not available in a limited equity housing cooperative.]

The Developer will make a home subject to the Neighborhood Declaration when the home is sold and conveyed to the first buyer. When all of the homes in the Neighborhood have been built, sold and conveyed and the Neighborhood is stabilized, the then holder of the Blanket Mortgage should be able to sell the Blanket Mortgage to a bank which wants to promote affordable housing and could use CRA credit or another investor, such as Fannie Mae or Freddie Mac, or made part of a mortgage backed security insured by FHA.

Until a significant percentage of the homes have been refinanced and released from the Blanket Mortgage, the holder of the Blanket Mortgage and the Administrative Entity should have a significant role in the administration of the Neighborhood HOA. In particular, the mortgage holder and the Administrative Entity will want a system in place that screens each potential owner to maximize the likelihood that the owner will meet his or her financial obligations to the Neighborhood HOA.

If the Blanket Mortgage model is used, hopefully, at some point, the difference between the portion of the Blanket Mortgage attributable to a home and the resale value of the home will become high enough that paying cash for the difference or financing the difference with a second mortgage may not be feasible for a moderate income buyer. At that point, the then holder of the Blanket Mortgage should be willing to permit home by home releases (“partial releases”) from the Blanket Mortgage. The ability to either refinance a home or to sell the home to a buyer who can finance the purchase with a first mortgage on the home, where the proceeds are used to obtain a partial release from the Blanket Mortgage, will greatly enhance the marketability of homes in the Neighborhood. .

The Blanket Mortgage would permit and provide for the release of a home from the lien of the Blanket Mortgage upon payment to the holder of the Blanket Mortgage of a sum equal to the portion of the mortgage debt which is attributable to the home. This amount, commonly referred to as the “release price”, would be determined by multiplying the outstanding principal balance of the Blanket Mortgage loan by a fraction, the numerator of which is the home’s share of assessment payments to the HOA and the denominator of which is the share of assessments payable to the HOA by all homes then subject to the lien of the Blanket Mortgage. Release prices will decline as amortizing payments under the Blanket Mortgage are made and the principal outstanding under the Blanket Mortgage decreases.

The legal and financing structure suggested above is designed to facilitate the construction of affordable owner/occupant communities in areas of the City which need it most and provide the communities with a very good chance to be a sustainable source of generational wealth and avoid the pitfalls which have hampered such communities in the past.

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