What Happens If A Community Association Fails?

Published in the ECHO Journal, May 2009

Does The Experience In Florida Presage The Future For California?

We have written many times about the difficult future of the housing industry and that of common interest developments in particular.[1] Underfunded reserves have given way to underfunded operating budgets as the economic crisis deepens and community associations are finding layoffs and foreclosures beginning to impact their ability to pay for even daily operations as assessment payments dry up. What we once predicted as a future problem has been escalated to the present by the economic downturn.

This problem is not confined to California. Other states are experiencing the effects of the economy on community associations. In Florida, the problem is epidemic. In a recent article, Jim Loney, writing for Reuters.com, tells the story like this:

“Florida’s condominium and homeowners’ associations are facing what experts call a trickle-down disaster from the property crisis. Dozens and perhaps hundreds of condo buildings have budget shortfalls as thousands of owners, under water on their mortgages or in foreclosure, stop paying monthly fees.

“I call it a death spiral,” Miami Beach city commissioner Jerry Libbin said. “It’s a catastrophe in the making.” [2]

Community associations rely on the monthly cash flow from assessments to pay virtually all of their expenses. In most cases, they have no other source of income. When that income is seriously curtailed, the ability of the board of directors to protect and maintain the project is in jeopardy. Borrowing from reserves works for a while, assuming there are reserves in the first place. But that lasts only as long as does the available cash, and then what? We’ve written about this situation recently, and it leaves boards in the position of making some very tough decisions.[3] Landscape or pool maintenance? Painting or insurance premiums? Management or the water bill? When we get down to life-safety issues, like paying for electricity, security guards or the sewer bill, its time to re-evaluate the very survival of the association. Loney shows us that the problems in Florida are similar: “Rust pokes through the peeling paint on the railings, pest control has been curtailed and the palm trees are no longer being fertilized at the 1940s-era Miami Modern condominium building in Miami Beach.”

But it’s not just the owners who have lost their homes or who have lost their jobs and can no longer pay their assessments who are impacted. The remaining owners are hit hard too:

 “When a unit owner stops paying monthly fees, which can range from $150 in a small building to over $1,000 in a luxury tower, a condo board must collect money from other owners to make up the shortfall. Rising fees or special assessments, or levies, can drive other vulnerable owners into insolvency.”[4]

How Did Things Get So Bad?

The same way it happened in California—a super-heated housing boom that allowed anyone with a pulse to become a homeowner. When the bubble burst, all of those people who could never have kept their loans current even while employed abandon those properties when the debt catches up or their income is cut off. The Florida problem sounds very much like many California projects:

“The apartments were converted to condos at the height of a boom that saw prices — inflated by speculation and fraud — double within four years, then tumble in the last three. A one-bedroom, 560-square-foot (52-square-meter) unit that topped out near $200,000 might now get $70,000, leaving owners drowning in debt. Still… it could be worse. The board president pointed to a nearby tower where she said more than 200 of the 244 units have liens or lawsuits pending. She said an upscale building not far away — where units that once sold for over $1 million and are now priced below $500,000 — has 16 troubled apartments of 44 in the building. The crisis could mean serious pain for Miami Beach, a resort town with 88,000 residents and 42,000 condos. If debtors walk away from their units, buildings could become derelict. “I haven’t seen it yet, but I think we’re going to see it…”[5]

Foreclosures 

Foreclosures by lenders could actually be a blessing in disguise—if they were to actually occur. Banks and other lenders would foreclose and then pick up the assessments. The only problem is that in many cases banks have refused to do that and the properties are languishing. Whether it’s the payments themselves that the banks don’t want to make, or whether the act of foreclosing would force them to re-value these assets to the detriment of their balance sheets—the cause of this inaction varies from lender to lender–its effect can be devastating as well as unjust to the remaining owners in the project. The Florida examples are similar to what we have seen in California:

           Condo advocates say banks are partly responsible for hobbling condo boards by being slow to foreclose on owners who have fallen behind…Lenders don’t become responsible for an apartment’s costs until they foreclose and under current law, a bank is liable to pay only six months worth of fees in arrears, or 1 percent of the mortgage value, when it takes back a property…Condo advocates say banks are deliberately stalling…”There’s no doubt in my mind it’s done so they don’t have to pay the fees,” says Rosa de la Camara, a lawyer with Becker & Poliakoff, a Florida firm that does condo legal work.[6]

Many states are looking to their legislatures to fashion a way out. Bills aimed at forcing lenders to pay past assessments are being introduced (although nothing in California at the moment.) “Proposed legislation would make banks pay up to 12 months of fees. Advocates also want the Florida legislature to allow associations to collect rent directly from tenants when owners are taking in rent but not paying condo fees, and said other states are considering similar legislation.”

But even that might not be enough to save Florida projects in the most financial distress. There, the Miami Beach city commissioner is looking at a state takeover as a real possibility, stating “… the state might end up taking over bankrupt condo associations. Imagine what it will be like if you have to call the governor’s office to get a plumber…” [7]

A State Takeover Of Community Associations?

Actually that has certain symmetry to it. As a condition of approval, many community associations were required by cities and counties to maintain the very same infrastructure—streets, utilities, open space—that in other neighborhoods are maintained by the local public entity using property and sales tax dollars—income denied to community associations. So if the state or local government were to take over a community association and its various maintenance responsibilities, perhaps public instead of private revenues might finally finance some of that responsibility. Nothing like that would come without a price, however, and if the project were to remain in private hands, the price would probably be a re-payment lien placed by the government as a condition to taking over, but at least help would arrive.

Government takeover has already happened in California. We wrote about just such an action in Sacramento several years ago, when a community association that could not pay its bills and had deteriorated badly, it was condemned by the City of Sacramento and redeveloped into subsidized housing.[8] The future of other common interest developments may also lie in the hands of local or state government as well before we know it.

The current financial crisis has rapidly accelerated trends that otherwise might have taken decades to occur. The Florida examples, and our own experience in California give us reason to be concerned that the “Uncertain Future” may be here sooner than we think. The Berding|Weil website (http://www.berding-weil.net) and the ECHO Journal have many useful articles written to help community associations weather these tough economic times. Readers are encouraged to take advantage of these resources.

Tyler Berding is a founding partner of Berding & Weil, LLC, a community association law firm located in Alamo, CA. He has taught real estate and community association law at California State University East Bay and is the immediate past president of ECHO. Questions or comments can be directed to Dr. Berding at www.berding-weil.com or www.condoissues.com.