Factors to Consider in Maintaining and Maximizing the Value of Your Condominium
Developers in the City of Detroit recently announced a plan to open an eleven (11) story 83 unit luxury condominium complex in Detroit known as The Ashton Detroit. Construction is expected to start in 2017 and it is to be ready for occupancy by 2018. The $35 million project is significant because it is the first free-standing condominium complex in downtown Detroit in the past twenty (20) years. Renderings of the intended complex portray expansive living spaces, units flooded with bright, natural lighting, and modern common areas including an indoor pool. Units are expected to be large, between 1,500 and 2,200 square feet, and in addition to a pool and fitness area, the developers have indicated that the complex will have unspecified ground-floor retail space.
The announcement of The Ashton Detroit brings excitement, and were it to be built its presence would add significantly to the downtown area in which it is intended to be located. Regardless of the actual prices of the units that are eventually sold, the purchasers (and, to a certain extent, the developers), are most likely going to be concerned about the very same things that other condominium owners are concerned with – namely, how to maximize the value of their investment by maintaining the value of their condominium.
Target prices for the units to be sold at The Ashton Detroit have not yet been announced. However, assuming that its intended market is millennials and Gen-Xers seeking to live in an urban community, (whatever you do, don’t use the term young, urban, professionals), the developers will most likely need to keep costs at least at the upper ranges of affordability for a median-income family, which would put the lowest potential cost of a unit (excluding regular assessments), around $350,000. Assuming this to be the low end of the purchaser’s investment, each owner will have a significant stake in ensuring that the condominium thrives and that they can recover their investment (and more) when they decide to sell. This article discusses different factors that can affect the long-term value of a condominium unit.
One of the most important aspects in determining the value of a condominium complex to a prospective purchaser is the upkeep of its common elements. A well run condominium will make capital improvements as they become necessary, address maintenance issues immediately, and keep the grounds neat and orderly. In order to be able to afford the costs associated with these expenses, an association must make sure that its budget is adequate, and that its reserve funds are sufficient to address any necessary capital improvements. This requires a board of directors to be involved and to ensure that co-owners are timely paying their assessments. On the other hand, if an association fails to maintain its common elements, or fails to increase assessments sufficiently to maintain the project, then not only will the board of directors have contributed to the potential devaluation of the project as a whole, but the board may have also exposed themselves to potential liability for a breach of fiduciary duty, as the New Jersey Court of Appeals found in Ebert v. Briar Knoll Condominium Association.
At the time units are initially sold, a condominium’s assessments are most likely as low as they will ever be. In an effort not to scare away potential purchasers, a developer has an incentive to portray the recurring costs associated with owning a unit as minimally as possible. These initial assessments may reflect the maintenance costs of a brand-new condominium complex, but may not reflect the true costs associated with a condominium complex that requires capital improvements or significant maintenance over time. In addition, these initial low assessments do not alter the fundamental principle that the value of the condominium units within the condominium are maximized by adequately maintaining the common elements and portraying the condominium as an attractive place to live. Accordingly, it is important that purchasers of new condominium units engage in adequate long-term planning which takes into account the true cost of maintaining the complex, and, if necessary, adjust their assessments to take into account those costs not considered by the developer but vital for the condominium project’s long-term success.
Another potential factor in maintaining the long-term value of an investment in a condominium project is whether potential purchasers of units within the condominium project qualify for government insured mortgages, an important resource for many first time home-buyers. This is significant because the national share of first time home-buyers with either a Fannie Mae, Freddie Mac, or Federal Housing Association (“FHA”) mortgage was 54% of all purchase mortgages in 2014. Especially with respect to FHA financing, however, there is a concern that a restrictive regulatory environment has forced a number of potential purchasers out of the marketplace. While the FHA helped finance roughly 80,000 to 90,000 condominium mortgages a year over the past decade and a half, this number has more recently been reduced to a quarter of that volume. In addition, the FHA requires condominium projects to go through a certification process every two years, but according to the Community Associations Institute less than 14,000 of the 152,000 condominium associations eligible for FHA loans actually attain FHA certification. Undoubtedly, removing 60,000 potential purchasers from the condominium market will have an effect on value. To a certain extent, the FHA’s restrictive policies arise out of lessons learned from the collapse in housing values in the late 2000s, when the typical U.S. condominium lost 33.2 percent of its value. Further, there is an argument to be made that these restrictive policies do not have a materially adverse effect on values since, at least as of late 2015, condominium value appreciation was still outpacing single-family homes.
Nonetheless, steps are being made to make condominiums available to more potential purchasers within the current regulatory framework. A major issue in this area tends to revolve around rentals. For several years the FHA has required a non-owner occupancy percentage of no more than fifty (50%) percent in order for a potential buyer to be approved for an FHA-approved mortgage. Fannie Mae and Freddie Mac have similar requirements. In late 2015 the FHA rules interpreting its requirements were temporarily relaxed to allow non-investor owner second homes to be considered “owner occupied.” In addition, in July 2016 Congress passed legislation (H.R. 3700) which reduces the maximum non-owner occupancy percentage from 50% to 35%, unless the FHA can provide justification for a higher percentage, and also requires the FHA to streamline its certification process. If a project does not allow for an FHA mortgage, or a Fannie Mae or Freddie Mac mortgage, then an entire market of potential purchasers is excluded, potentially decreasing the value of the units within the project as less purchasers are available to compete with one another. Accordingly, these changes may assist in maintaining condominium values by increasing the pool of potential purchasers.
In addition to meeting FHA eligibility, there are additional reasons why a condominium may want to limit the number of rental units within the condominium. More anecdotal concerns regarding rentals relate to the incentive (or lack of incentive) for a non-owner occupant to adhere to and comply with condominium rules and regulations pertaining to usage of the common elements and maintenance requirements, and to work on building a long-term relationship between the unit occupant and the project. This rationale presumes that an owner occupant has more of a personal stake in the ownership of his or her unit than a non-owner occupant, and in the long-term success of the condominium project as a whole. This is part of the thinking behind the FHA’s requirement that a minimum percentage of units be owner-occupied. To this argument, however, there is a counter-argument, at least as to value. If a condominium prohibits sales to non-occupant owners due to a maximum rental threshold having already been reached, then such prohibition will also exclude a market of potential purchasers (i.e., investors), who might otherwise be interested in purchasing a unit. In theory, this too could have a potential adverse effect on the value of a unit, though the effect would most likely only be felt if the price-point for a condominium unit were already at a price-point that an investor were willing to pay. In other words, the adverse effect of a rental limitation may, as a practical matter, only be felt when prices are trending downwards and investors are seeking to purchase units at discounted prices. Further, this could potentially actually have a positive effect, as it could prevent disillusioned owners from “dumping” their units at bargain-basement prices when the market turns south, thus preventing an influx of comparable sales with low sale prices. In stock market parlance, a rental cap could act as a “trading curb” or a “circuit breaker” to help prevent crashing prices (by preventing owners from being able to sell to investors who will only purchase at low prices).
Finally, because of its location, The Ashton Detroit may be able to tap into what has been called a “pent-up demand” for walkable housing in metropolitan Detroit which is believed to correlate to a 50% premium for residential housing. If retail shops are opened and the project becomes a true “mixed use” development, then this may also assist in keeping values high. These comparative advantages over similar projects in other areas may help maintain the values of the units sold in the project even in economic instability. Undoubtedly, this concept was attractive to the developers as they embarked on their development project, and similar factors can be considered by condominium boards as they observe the development that takes place in their particular areas.
Whether to attain FHA certification and whether to impose a rental cap are issues that may affect condominium value. Location is a factor in value, but is mostly fixed and difficult to change internally. Ultimately, as with every condominium project, it will be incumbent on the condominium association to fulfill its responsibilities in maintaining the condominium in order to preserve property values over time. This involves an adequate reserve fund, a realistic budget, timely collection of assessments, adherence to the condominium documents, and an involved board of directors. So long as these core principles are followed, then a condominium project should thrive indefinitely.
Matthew W. Heron is a Member of Hirzel Law, PLC where he focuses his practice on dispute avoidance, condominium law, commercial litigation, commercial real estate, land use, large contractual disputes and title litigation. He has extensive litigation and trial experience in state and federal courts involving commercial litigation issues and real estate matters. Mr. Heron concentrates his practice on drafting, revising, amending, restating and interpreting governing documents of condominium and homeowner’s associations in Michigan. He can be reached at (248) 480-8758 or [email protected]. You can also follow him on Twitter at @mwheron75.