Guidelines threaten to derail housing recovery

(MO) Author says under new guidelines, homeowners with defectively built homes might have to assess HOA fees to make repairs, or if they sue the builder could find new buyers can't get loans for that development, effectively making the homes un-sellable.

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Guidelines threaten to derail housing recovery
By Ryan Poliakoff

08/18/2009

Two little-known exclusions in the Fannie Mae and Freddie Mac lending guidelines are endangering many of America's newest neighborhoods, preventing homeowners from recovering damages for construction defects and threatening to derail the housing recovery before it gets off the ground.

According to the Community Associations Institute, nearly 60 million people in the United States live in Shared Ownership Communities — condominiums, co-ops and planned developments governed by a homeowners' association (HOAs). When these "new neighborhoods" are first built, there are often various construction defects. Such flaws are commonplace, given the complexities of the structures being designed and built. In an ideal world, every developer would stand by his product, either repairing the defects or giving homeowners enough money to fix the defects themselves.

But when this doesn't happen, community associations are forced to file lawsuits against developers to convince them to repair construction flaws. In fact, it is a legal duty of a board of directors to protect owners' interests in the property, and if negotiations with a developer fail, a lawsuit may be the only available option. According to a leading community association attorney, nearly 100 percent of new developments have warranty issues with their developer, and almost a quarter of those are forced to file litigation.

In January 2008, after the housing crash decimated the market for thousands of recently constructed homes, Freddie Mac quietly added the following regulation to its lending guidelines, stating that a project is ineligible for financing if "the homeowners' association is a party to current litigation, arbitration, mediation or other dispute resolution process and the reason for the dispute involves the safety, structural soundness or habitability of the project." Of course, this language is so broad that it encompasses almost every lawsuit ever filed against a developer, for almost any construction defect.
Fannie Mae, in an even broader exclusion, declares as ineligible "any project for which the homeowners' association or co-op corporation is named as a party to current litigation." As written, this rule is a gross restriction of the basic right of any corporation to protect its interests through the legal system. And, because many banks use the Fannie Mae/Freddie Mac guidelines as the basis for their own lending policies, loans in newly constructed neighborhoods have become extremely difficult to secure.

For example, assume that a developer has built a 100-unit condominium worth tens of millions of dollars, and that the roof was improperly waterproofed. When he refuses to repair the roof, the board of the association chooses to sue the developer, hoping to recover enough money to make repairs. But under the Fannie Mae/Freddie Mac guidelines, that lawsuit means that very few banks will lend money to new buyers in the building, bringing unit sales to a halt. This causes the property values in the condominium to crash (if you can't sell your home, it's not worth anything).

So owners, who may have spent hundreds of thousands of dollars on their homes, are now left with a property worth a fraction of its actual value, and only two options: drop the lawsuit and accept that the developer has sold them damaged goods (and try to collect enough money from assessments to make the repairs), or continue the lawsuit while their development stagnates and shrivels. Both options are unacceptable. The long-term health of shared ownership communities, and by extension all American neighborhoods, depends on a robust market for home sales, and the current lending guidelines are stagnating that market.

It is critical that federal legislators press Fannie Mae and Freddie Mac to revise their guidelines to allow community association boards, tasked with the legal obligation to protect owners' interests, to file legitimate lawsuits against developers for construction defects without restricting the ability of banks to lend money to new owners. Otherwise our housing recovery, reliant on clearing overstock from these new developments, will falter.

Ryan Poliakoff is the co-author of "New Neighborhoods: The Consumer's Guide to Condominium, Co-Op and HOA Living" and vice president of The Ocean Palms Association Inc., in Florida.

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