In the current difficult financial market, every single shared ownership community is facing a common problem–owners who fail to pay their maintenance. Maintenance in SOCs is largely a fixed cost, and when one owner doesn’t pay, that cost is passed on to the other owners in the form of even more maintenance. It’s a constant, vicious cycle.
To combat this, state governments have generally given associations an extremely powerful “stick” to use to encourage payment–the risk of foreclosure. If a unit owner does not pay their maintenance, an association may generally place a lien on the unit (a notice to potential buyers that there is a debt due that must be made whole before the unit can be sold), and then after time has passed the association may foreclose on that lien–force a sale of the property, sometimes to the association itself.
However, the decision of whether or not to foreclose on a recalcitrant unit owner is not a simple one, especially in the past 5 years. When an association forecloses on a lien, that foreclosure is subject to any superior liens–ie, a first mortgage. That is, even if a condo or HOA forecloses on a unit, if the bank that provided the primary mortgage calls in their loan the association must turn over the property, or the value of the loan. Now, in a good market, when first mortgages are only for 70% or 80% of the value of the property, that decision is fairly simple–the association can resell the property for market value, pay off the bank, and even make a small profit. But today, that procedure has gotten turned on its head. Because of bad lending practices many loans were made on properties for nearly 100% of their then-market value, and after the crash those properties have become leveraged for far more than they are worth. Not only does this affect borrowers and banks, it affects shared ownership communities. Boards can no longer simply vote to foreclose on every unit where maintenance is unpaid. For example, let’s assume a unit in a property is worth $500,000 in the current market. However, that unit was bought for $750,000, and mortgaged for $700,000. Now assume that the owner has stopped paying maintenance (they may also not be paying their mortgage payments, which we’ll get to in a moment). If the board were to foreclose on the unit to collect, they would eventually own a property worth $500,000 at market, but they would never be able to repay the bank loan! As a result, when the bank comes calling, the association would lose the property, having paid the costs of foreclosure for nothing. Certainly, not a sustainable situation for any SOC, and not a good way to collect on debt.
Complicating this issue is the fact that recalcitrant owners are often not paying their mortgages, either, and the primary banks may file their own foreclosure proceedings. Now, if the banks were actually foreclosing, that would be fine–the bank would eventually own the property, and they would be responsible for maintenance payments just like any other owner. But what is currently happening, all around the country, is that banks are sitting on foreclosures, even foreclosure judgments, simply so that they do not have to pay maintenance to condo and HOA associations. If the bank has a judgment of foreclosure, and the association files their own foreclosure, the bank would simply effect the judgment and force the association to pay off the mortgage or turn over the property. It’s a no-win situation for SOC boards throughout the United States.
So what’s an association to do? Some difficult choices must be made. One strategy is to foreclose on every unit that is not paying maintenance, no matter the lending situation, to establish a precedent that encourages owners not to ignore their maintenance. This strategy, however, can get quite costly if foreclosures are high and if a large percentage of units have been improperly leveraged. Another strategy is to foreclose as early as possible, whenever possible, and try to rent out the units to recover as much maintenance as possible before the bank has a chance to file their own foreclosure. This strategy sometimes works well, as banks typically can take up to 2 years to push a foreclosure through the court system (mostly due to universal bank disinterest). A third strategy is to decide every foreclosure on a case-by-case basis, depending on the loan amounts owed to the primary mortgagee (as an aside, how do you remember that a mortgaGEE is the person who owes the money in a loan? Because the bank thinks “Gee, I hope they make their payments!”) The risk of this strategy is that any owner who is over-leveraged knows that the association will never foreclose on their unit, and it is essentially a free pass for them not to pay their maintenance.
The current economic times have presented very difficult issues for all association boards, and SOCs will have to make due the best they can until the crisis passes. Encourage your legislators to pass laws that force banks to pursue foreclosures aggressively, or that require banks, after filing a foreclosure, to pay maintenance to the association, whether or not they have effected the judgement. There is no simple solution to this problem, and every SOC board will have difficult choices to make in the months, and perhaps years, to come.