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 dwelling units 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 could be used in conjunction with the off-site unit requirements of the Chicago Affordable Requirements Ordinance (“ARO”), Section 2-45-115, Municipal Code of Chicago, to support and govern sustainable, viable, self-governed, equity building, primarily owner/occupied affordable housing developments.
Following is a list of several of the most daunting issues which must be effectively dealt with for a community of affordable owner/occupied housing to be successful:
- Availability of Financing. After the Crash, home loans became hard to come by for moderate income households, especially for those who desired to acquire a unit in a condominium.
- 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 units 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 the HOA, 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 units thereon is a threshold issue. Today, the cost to construct a unit far exceeds the price that the unit 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/units 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 by a not for profit using available TIF funds, and the cost of the construction of the units will be furnished by the investment of funds by developers which are required under the ARO to provide off-site affordable units (currently, approx. $180,000 per unit). The units would then be sold to households earning not more than 120% of MFI at a price which is affordable at a monthly cost of not more than 30% of the income of a household earning not more than 100% of MFI (as high as $210,000 under current ARO rules, but realistically more likely around $130,000). Financing for the buyer would be provided by a lender approved by the City under the ARO, which most likely would receive Community Reinvestment Act (“CRA”) credit. (However, see discussion below of the Blanket Mortgage Approach.)
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 an HOA whose members are the owners of the units in the Neighborhood.
- The entire Community, and each Neighborhood Declaration, would be made subject to a declaration (“Community Declaration”). The Community Declaration would reserve to an entity named in the Community Declaration (which may be the declarant or a not for profit corporation with experience in administering affordable communities) (“Administrative Entity”) a number of 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 units 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 certain 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. Thus the several Neighborhood HOAs 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 the issues discussed above.
- 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 HOA the following with respect to the owner’s unit: (a) the monthly assessment, (b) monthly deposits of real estate taxes, and (c) the monthly mortgage service applicable to the unit. The Neighborhood HOA would then make the necessary 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-ops ordinarily do but condominiums and HOAs have not done in the past. By centralizing this function in the HOA, the HOA will get an early warning when an owner may be experiencing financial difficulties so they can effectively deal with the issue.
- Each HOA’s budget would be required to 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. If properly funded, the reserves could help cover the hopefully brief periods when payments with respect to a unit are disrupted and avoid delinquencies on mortgages or real estate taxes and permit the HOA to avoid borrowing or levying special assessments to pay for major repairs or replacements.
- The Administrative Entity would oversee and regulate the Neighborhood HOAs to make sure that they are adequately administering their Neighborhood and complying with their 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.
- Under the ARO, a Developer is required to spend funds (currently about $180,000 per required ARO unit) for the acquisition and/or construction of each required ARO off-site unit. If the Developer spends $180,000 to build an off-site unit and then sells it for net proceeds of, say, $140,000, the transaction would cost the Developer $40,000, which is preferable to paying the “in lieu” amount (currently $230,000 or $180,000) to the City with no return. As mentioned above, one of the issues that face a moderate income household is obtaining a mortgage loan. Also, the price at which an owner of an ARO off-site unit can resell the unit will be restricted for 30 years. Even if the resale price was not restricted, the prices of units in certain areas of the City would likely not increase much over time.
- One possible approach which may help a development of newly constructed ARO off-site units be more likely to fulfill its intended purpose of providing a source of affordable housing would be for the Developer of each Neighborhood to have the option of taking back “seller” financing by subjecting the units in the Neighborhood to what is commonly known as a “blanket mortgage”. The blanket mortgage would be non-recourse, i.e. no personal liability to a unit owner. It will be a long term, fixed rate, self-amortizing mortgage. This type of mortgage is common in a housing co-op structure. The amount of the blanket mortgage would be set based on what the monthly ownership cost of the units in the Neighborhood would be, i.e. assessments, insurance, real estate taxes and mortgage service so that the ownership costs are less than 30% of 100% of MFI (as of 2018, about $2,000/month of less). Using this approach would result in the portion of the blanket mortgage attributable to each unit being less than the approximately $180,000 cost of constructing the unit.
- Each buyer/owner of a unit 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 units subject to the blanket mortgage. In a Neighborhood of same size single family homes or condominium units, each owner of a unit would pay an equal amount of the mortgage service each month. An owner’s equity in the owner’s ARO off-site unit will increase over time as a function of (a) the rising market value (and increase in the permitted resale price), if any, of the unit and (b) the reduction of the portion of the blanket mortgage attributable to the unit as periodic payments of principal are made.
- In a Neighborhood of ARO off-site units where the market values of units may not be increasing (and even if they are increasing, the resale price is restricted under the ARO), 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 which is attributable to the unit, the fact that the blanket mortgage is non-recourse to the individual owners will make it much easier to transfer ownership of a unit subject to the blanket mortgage. 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 unit to permit the sale to occur.
- The Developer will make a unit subject to the Neighborhood Declaration and the blanket mortgage when the unit is sold and conveyed to the first buyer. When all of the units in the Neighborhood have been built, sold and conveyed and the Neighborhood is stabilized, the Developer should be able to sell the blanket mortgage to a bank which wants to promote affordable housing and could use CRA credit. What the Developer receives for the blanket mortgage when and if it sells it would likely be much less than the cost of construction. However, even if a Developer receives back only a portion of the funds invested, it will still be a better return than if the Developer had made the “in lieu” payment and received nothing back. In addition, the Developer would be able to be part of a commendable effort to rebuild communities which were devastated by the Crash by providing new affordable owner/occupied housing to moderate income households.
- Until a significant percentage of the units 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, at some point in time, the difference between the portion of the blanket mortgage attributable to a unit and the resale price of a unit (even with the resale price restrictions of the ARO) 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 unit by unit releases from the blanket mortgage. The ability to either refinance a unit or to sell the unit to a buyer who can finance the purchase with a first mortgage on the unit, where the proceeds are used to obtain a release from the blanket mortgage, will greatly enhance the marketability of units in the Neighborhood. The holder of the blanket mortgage likely will not permit partial releases unless and until the Neighborhood HOA satisfies the then applicable requirements of the secondary mortgage market for the insurance or purchase by the secondary mortgage market of loans on units in the HOA.
- The blanket mortgage would permit and provide for the release of a unit 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 unit. This amount, commonly referred to as the “release price”, will be determined by multiplying the outstanding principal balance of the blanket mortgage loan by a fraction, the numerator of which is the unit’s share of assessment payments to the HOA and the denominator of which is the share of assessments payable to the HOA by all units then subject to the lien of the blanket mortgage. The release price will decline as amortizing payments under the blanket mortgage are made and the principal outstanding under the blanket mortgage decreases.
The legal structure suggested above is designed to facilitate the creation of affordable owner/occupant communities in areas of the City which need it most and allow the communities to sustainable and flexible and avoid the pitfalls which have hampered such communities in the past.