By: Jane C. Kotake
For the past few years, new apartment construction has been the only development game in town. However, many industry experts have suggested that the Atlanta market is ready and gearing up for the next condominium development cycle. Apartments are plentiful in the Atlanta intown market and even more are being constructed and planned for development. On the flip side, the supply of new condominium units in Atlanta is reported to be at its lowest in more than a decade and unable to meet an increased demand for for-sale product. In the last condominium development cycle, a large proportion of condominiums in Atlanta were apartment to condominium “conversions.” Will conversion condominiums kick-start a new development wave in Atlanta?
Financing constraints is one of the primary reasons why condominium development remains tricky. The availability of financing for new construction condominium developments is still limited. Moreover, the seemingly endless supply of end loan financing options for condominium units in the last real estate boom is now limited. Unless a purchaser has funds tucked away to buy a condominium unit for cash, the condominium project (and not just the condominium unit) must have project approval by either the Federal Housing Administration (“FHA”) or the Federal National Mortgage Association (“Fannie Mae”) in order for that purchaser to obtain end-loan financing for the condominium unit. Unfortunately, such project approval requirements are much more stringent and regulated than in past years. If an apartment to conversion condominium is being considered as a possible exit strategy, apartment owners, developers and would-be condominium converters should understand project approval requirements as they currently exist with respect to a newly converted condominium.
General Eligibility Requirements
The current FHA Guide defines a “newly converted condominium” as any condominium for which an application is submitted to the FHA for project approval within two years from the date of conversion. A newly converted condominium can be either a “converted, non-gut rehabilitation condominium” or a “converted, gut rehabilitation condominium”.
The current Fannie Mae Guidelines also identify certain types of condominium projects as being ineligible for project approval, such as projects that represent a legal, but non-conforming use of the land, if zoning regulations prohibit rebuilding the improvements to current density in the event of their partial or full destruction. Fannie Mae also will not accept a condominium project that has any unit measuring less than 400 square feet, which probably is not an issue since Atlanta has not yet embraced the “Micro-Unit” housing concept, but should be considered if an apartment is in its planning stages. Similar to the FHA Guide, the Fannie Mae guidelines also requires that all “gut” rehabilitation work involved in a conversion condominium must been completed in a professional manner, and that the project, or the subject legal phase, must be substantially complete as evidenced by a certificate of occupancy or other substantially similar document issued by the applicable governmental agency for the project or subject legal phase.
Cap on non-residential or commercial space
As the population continues to favor pedestrian-friendly “live, work, play” communities, it is no surprise that many apartments are nestled in mixed-use developments or contain commercial space within the apartment building. However, the amount of commercial space may be an important factor in determining whether a condominium is eligible for project approval. For example, a project that has more than 20% of the total space used for non-residential purposes is treated as “ineligible” for Fannie Mae project approval; however, an exception to the 20% cap may be considered by Fannie Mae if the project is submitted for approval through the Project Eligibility Review Service (PERS) process. The cap under the FHA Guide is slightly higher at 25%, and also provides that the non-residential or commercial space must be of a nature that is homogeneous with residential use, which is free of adverse conditions to the occupants of the individual condominium units. In addition, for condominium projects that exceed the 25% cap, but have commercial space that is equal to or less than 35%, FHA will consider exemption requests on a case-by-case basis. However, in order to submit a request for consideration of such exemption, the condominium project must be complete for at least one (1) year, and control of the condominium association must have been transferred to the condominium unit owners. The FHA Guide also provides that for mixed-use developments that are unable to satisfy the 25% and/or the 35% commercial space cap, an exemption request may be made for a cap not exceeding 50% commercial space, unless specifically approved by the FHA Commissioner or his/her designee.
EXCLUSIVE PARKING AND OTHER CONSIDERATIONS PERTAINING TO MIXED-USE DEVELOPMENTS
For most stand-alone apartment communities in the Atlanta area, parking areas are exclusive to the apartment and its residents. However, that may not be the case for an apartment community that is situated in a mixed-use development where there may be residential, office, commercial and retail users sharing a common parking area. The parking area may be governed by a declaration of covenants, a reciprocal easement agreement or other legal instrument that provides for the shared use of the parking spaces in hopes of maximizing the full potential of the parking spaces. However, when it comes to project approval of a conversion condominium, both the FHA Guide and Fannie Mae Guidelines require that the conversion condominium have dedicated parking, particularly in cities, like Atlanta, where mass-transit is not widely used for transportation in the area. A project without dedicated parking is deemed to be less competitive than those projects with dedicated parking. Although there is MARTA, we all recognize that the car is king in Atlanta for the immediate future.
In addition, the developer of the conversion condominium is prohibited from retaining any ownership interest in any of the facilities related to the conversion condominium. Both the FHA Guide and Fannie Mae Guidelines also provide that such facilities may not be subject to a lease or contract between the unit owners or the homeowners association and a third party. Most importantly, however, is Fannie Mae’s position regarding ownership of the facilities related to the conversion condominium – the Fannie Mae Guidelines specifically provides that facilities related to the conversion condominium (such as parking and recreational amenities) must be owned by the unit owners or by the homeowners association.
Developers of mixed-use projects that include an apartment component may think that a conversion condominium is not in their future. However, to preserve maximum flexibility either for a future purchaser of the mixed-use project (or possibly just the apartment component of the mixed-use project) or the developer, it should ensure that the legal structure for the mixed-use project will allow for the apartment component and its related facilities to be converted to the condominium form of ownership or sold off to a third party or financed as a separate parcel.
 Lately, there’s been much discussion about eliminating Fannie Mae (and Freddie Mac) and beefing up FHA’s insurance fund and mortgage operations, so it is very possible that the FHA Guide and Fannie Mae Guidelines will change with respect to conversion condominiums.
 The Condominium Project Approval and Processing Guide, dated June 30, 2011, as modified by Mortgagee Letter 2012-18 (dated September 13, 2012) and Mortgagee Letter 2013-18 (dated May 31, 2013).
 Section 1.5.1 of the FHA Guide provides that conversion occurs as of the date on which all the documents, specifically, the condominium declaration, necessary to create a condominium regime have been recorded in accordance with state and/or local laws. If the project application is submitted after the two-year period, then the conversion is considered existing and subject to all applicable requirements for approval of an “existing project.”
 Section 1.5.1 of the FHA Guide refers to a “converted, non-gut rehabilitation condominium” as any project that involves primarily cosmetic improvements such as, but not limited to, painting, new carpet, and the replacement of fixtures, cabinets, doors and windows.
 Section 1.5.1 of the FHA Guide refers to a “converted, gut rehabilitation condominium” as any project that involves work such as, but not limited to, renovation down to the shell of the structure, replacement/installation of the HVAC systems and/or electrical components, and structural modifications.
 Fannie Mae Selling Guide (January 17, 2013).
 The FHA Guide defines mixed-use developments as developments with a combination of any of the following: commercial, residential retail, office or parking space.
Special thanks to Council Premier Member Weissman, Nowack, Curry & Wilco for this article.