Changes to lending rules from Fannie Mae and Freddie Mac alarm NYC condo buildings

New York City condo buildings where buyers tend to rely on conventional financing face a looming deadline. New, stricter lending guidelines are going into effect with the potential to limit mortgage eligibility, shaking up many condo buildings across the city.

The new guidance from Fannie Mae and Freddie Mac issued in March applies to condo buildings only and has several significant changes, including the end of the limited review process by lenders, a shortcut to the underwriting procedure that requires less documentation. After August 3rd, most condo transactions will require the full review process, meaning lengthy documentation via condo questionnaires, which has the potential to slow down deals.

Another major shift involves how much buildings set aside to pay for major capital repairs. Effective January 4th, 2027, Fannie Mae and Freddie Mac, the U.S.-backed entities that buy loans from banks, will increase the minimum reserve funding requirement from 10 percent to 15 percent of the annual budget—a number that many buildings will find astronomical or antithetical to how they operate. Many NYC buildings raise assessments to fund major work, for example, when a new roof or façade repair is needed; a major façade project can run as high as $1 million.

Some changes are likely to welcomed by buildings, for example, buildings with up to 10 units may be eligible for a streamlined review process, since they are often self-managed. The long-standing limit on investors owning no more than 50 percent of units is also being eliminated, which could boost sales. And multiple changes to property insurance rules, including ending the requirement to insure roofs at full replacement cost, will lower costs significantly.

In recent years, higher conforming loan limits set by Fannie Mae and Freddie Mac meant more NYC buyers gained access to conventional loans with better rates. Becoming unwarrantable, or ineligible for government-backed lending, could dramatically hurt deals in buildings where units sell for under $2 million, sources told Brick.

Echoes of Surfside

The latest changes build on the response to the June 2021 deadly collapse of a condo tower in Surfside, Florida, caused by a severe lack of structural maintenance. In a move that had a major impact on condo lending and managing, Fannie Mae implemented tougher rules to prevent buyers from purchasing in buildings with low reserve funds, part of an effort to prevent buildings from putting off costly repairs. Many lenders fell in line with Fannie Mae's guidance.

New laws were passed in Florida, mandating inspections, and New Jersey, mandating reserve studies and inspections, but similar laws did not materialize in New York as many in the real estate industry expected. However, as a result of NYC’s numerous local laws, buildings already undergo an array of stringent façade, parapet, and building garage inspections

‘Seismic change’ for buildings

After August 3rd, roughly 40 percent of condo transactions will get harder overnight, according to a post on the website of the Community Associations Institute (CAI), a nonprofit representing condominiums and other homeowner associations. 

That’s because when lenders perform limited reviews, they are looking at the building’s overall finances and not the building’s annual budget or whether it has deferred maintenance built into the annual budget, said Marc Kotler, president of the New York office of property manager FirstService Residential, who said the shift to full review is a “seismic change in the review process.”

In the past, many loans would go through with a limited review if the building was financially stable and the individual was high net worth. After August 3rd, many lenders will align with Fannie Mae's and Freddie Mac’s guidance and require the full review.

“Banks are going to be looking for financial stability, budgeted reserves or reserve studies to ensure that the board is planning for the long-term maintenance of the property,” he said. However, the result will be a more onerous condo questionnaire and review process, with more “back and forth” as some responses will raise additional questions, Kotler said.

About 65 percent of condo loans in the U.S. go through the limited review process, according to Orest Tomaselli, president and CEO of the reserve study firm Strategic Inspections, so the move to a full review is “pretty impactful,” he said. Any red flags, like a building that needs critical repairs, will show up here.

Similarly, the increased reserve requirement from 10 to 15 percent is a massive lift for buildings. Some don’t maintain reserve funds at all. Are buildings that previously scoffed at reserve fund line items freaking out? Tomaselli mused. “Hell yes.”

“What everyone is starting to figure out is that not being compliant correlates directly to unit value,” Tomaselli said. For buildings that are considered “non-warrantable,” financing will come with higher interest rates and less favorable terms.

Some sources said that at ultra-luxury buildings, where buyers pay all cash or use private lenders, it will be business as usual and they won’t see the need to come into compliance. But that’s not a recommended strategy for a building “where 90 percent of buyers pay cash—that still leaves 10 percent who need financing,” Tomaselli said.

"While there will always be an exception to the rule for well-capitalized borrowers in these luxury properties, many will become non-warrantable without complying with the new guidelines,” he said. Plus, “not every owner is liquid” and can handle paying a sudden special assessment.

Often buyers who paid cash to purchase will seek to refinance later, but when the new rules take effect, this strategy could be eliminated in some buildings that don't meet new lending guidelines.

When buildings are not in compliance with lending guidelines, both agencies reach out and let them know, and the information is also available on Fannie Mae’s portal. But often buildings find out the bad news when an owner tries to refinance and a lender checks to see if they are eligible.  

The reserve study workaround

There is a workaround that can reduce the amount a building needs to set aside in a reserve fund. Current Fannie Mae and Freddie Mac guidelines allow buildings to commission a reserve study to demonstrate a project has sufficient reserves to handle capital projects.

This assessment of a building’s physical components, including the elevator, boiler, sprinkler system, façade, and roof, determines how much will be needed for necessary upgrades to avoid imposing large special assessments.

Co-op buildings aren’t specifically mandated to comply with 15 percent reserve requirements under these new guideline changes. However, they are required to have adequate reserves based on agency lending guidelines and adequate often means alignment with condo reserve requirements as outlined by the agencies, Tomaselli explained.  

There is one change regarding reserve studies: Buildings need to set aside the highest recommended reserve allocation recommended by the reserve study to adequately cover the costs identified.

For a building that has done a lot of maintenance, spent money to comply with NYC’s local laws on façade inspections and electrification, a reserve study—which can run $8,500 to $9,500 for a 100-unit building—could ultimately save hundreds of thousands of dollars.

For example, Tomaselli is working with an 89-unit building that has $4 million in its reserve fund and found through a reserve study that it can reduce its reserve fund contribution down to 3 percent of the operating budget.

But buildings that intend to undertake a reserve study need to get cracking, since budget planning begins in the fall. Expect a 90-day turn around for reserve studies, Tomaselli said.

Advice for buyers, sellers, and owners

The long-term goal of the changes to lending guidance is to create healthy buildings, said Michael Rossi, executive vice president of real estate firm Howard Hanna NYC. But he characterized the short-term impact as a “tsunami.”

And the move comes as the real estate market is getting slammed from several angles, he said, notably Governor Kathy Hochul’s proposal for a new pied-à-terre tax on luxury second homes in NYC worth more than $5 million. While that tax is aimed at the high end of the market, the latest changes coming from Fannie Mae and Freddie Mac will reduce the number of listings in the lower part of the market.

Rossi and the other sources Brick spoke to said that any buildings where units sell for $2 million or under will be most impacted. These buyers tend to rely on conventional financing.

“The impact is that the buyer pool is going to be reduced because these units are not going to be able to be financed in the traditional way,” he said.

His advice was to work with a broker who has been paying close attention to changes in lending guidelines—don’t be shy in asking them what they know about Fannie and Freddie's new rules.

If you’re a seller or owner, you will want to make sure your building is being maintained and has an adequate reserve fund. “The numbers are going to be scrutinized in a way they weren’t before. It’s like a 70 year old going to the doctor for the first time,” he said.

From the horse’s mouth

Another savvy move is to find out what type of lending occurs in your building. Drew Donovan, co-CEO of Choice Property Management, which manages 120 condo and co-op buildings in NYC, recommended speaking to a mortgage broker to find this out.

“Talk to those who are lending in your building. Get their advice,” Donovan said. Pay attention to whether lenders are doing “agency loans” (sold to Fannie Mae and Freddie Mac and must meet their strict criteria) or “portfolio loans,” which the lender keeps in their portfolio but can have higher interest rates.

Buyers (or their lawyers) will want to keep the new lending requirements in mind when evaluating a prospective building’s finances and consider, for example, the implications of buying in a building with no reserve fund.

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