Hypothesis: A buyer’s access to mortgage financing in a specific building, (condo or co-op), has a direct impact on the value of every single unit in that building. 

We’re confident in that assessment, even though we can’t necessarily quantify the impact. Maybe nobody can. In fact, it’s quite possible that no one has ever even tried.

Over the years we’ve seen enough appraisals to understand the basic concepts of how residential property values are determined. Seemingly, little or nothing has to do with the availability of mortgage finance, at least on paper. 

Here is the super-distilled method of completing a residential appraisal:

An appraiser looks at recently sold properties that they consider comparable to the subject property. Then they make adjustments to values based on the differences between the property they’re appraising and the properties they’re comparing it to. The adjustments are made for things like square footage, amenities, bedroom count, and the floor the unit is on (higher floors are typically more valuable than lower floors).

In spite of our assertion that unfettered access to mortgage finance has a significant impact on property value, we can’t remember ever seeing an adjustment made in an appraisal report because financing was limited or unavailable in that building. 

Jonathan Miller of Miller Samuel Inc. and author of the Douglas Elliman Market Reports is perhaps the most qualified appraiser in all of New York City. We asked him what he thought of our hypothesis and he provided us with this: 

“Your hypothesis is true. The amenities of a building, whether physical or financial apply to all apartments in the building. This is why a similar sale in the same building as your apartment is more relevant than a similar apartment in a different building across the street. The appraiser wants to compare apples to apples, because after all, the “comparable sale” selected reflects what a potential buyer of your apartment would consider as an alternative. For example, if a bank would issue a mortgage with more favorable terms to your listing than a similar apartment in a similar looking building across the street, then the financial condition of your building is a more favorable amenity and would likely more favorably impact your value.  Selecting a similar sale has, by definition, fewer variables to consider, as fewer variables means it is more comparable.”

Making Our Case

Really, this has a lot to do with the basic laws of supply and demand. If access to finance options becomes more limited, it shrinks the pool of potential buyers.

For example, in the last month, an overwhelming majority of mortgage lenders have reduced their maximum Loan-to-Value thresholds for jumbo loans from as high as 90% down to as low as 70% for all NYC residential properties. In other words, buyers have to come up with bigger down payments, up to 30% if they want to buy a condo or co-op in New York City, and not every buyer has the means to do that. So, there are fewer qualified buyers today than there were just last month. Clearly, that has a direct impact on overall demand.

Let’s think about this through the lens of a real estate developer who may have just opened the doors at a 200-unit luxury condo building in a market where there was already an oversupply of condo units. These sweeping restrictive changes represent another obstacle to overcome during a time when total transactions in Manhattan has dropped upwards of 40% or more in each of the last 3 quarters compared to typical quarterly transaction figures.

COVID already dealt a critical blow to developers in this market, but the implementation of stricter mortgage guidelines shifts the balance of power even further in favor of the dwindling pool of New York City buyers. When sales velocity target numbers seem completely out of reach, developers are often left with little choice but to drop prices to drum up demand. Many can’t afford to let go of even one buyer.

Orest Tomaselli is the CEO and Founder of National Condo Advisors, a company that provides developers a clear path to mortgage guideline compliance as part of an overall effort to link these developers with mortgage lenders who will comfortably offer financing in their buildings.

“The apocalypse scenario is that few lenders, if any, will be willing to lend to condominium purchasers based upon the velocity of recent sales in the building, the number of owner occupant purchasers and most importantly, the delinquency percentage (Typically, no more than 15% of unit owners can be delinquent on HOA payments for more than 60 days),” Tomaselli said, stressing that we’re not at that point yet and there are a host of options for developers who want to bring more liquidity to their buildings. 

Bringing This Scenario to Life

Just last week, the Espinal Adler Team at Douglas Elliman reengaged with a client who put their search for a condo on hold in April. The client knew that prices had dropped, and mortgage rates were even lower than before, so it felt like the right time to start looking again.

Back in April, their buyer had a pre-approval in hand for 90% financing. After a divorce and a career change, moving forward without a 10% down payment scenario wasn’t an option the client was completely comfortable with. 

“Unfortunately, the first five mortgage lenders we called last week said something like, ‘No… Not in the city on a jumbo loan,’” said Marie Espinal of the Espinal Adler Team at Douglas Elliman. “A few loan officers thought it was possible through an exception request, but there was nothing solid. It’s frustrating for the client and it’s frustrating for our team.”

Espinal and her partner Jeff Adler are more in-tune with mortgage finance guidelines than most teams in New York City. Two years ago, they were the first team to hire a Mortgage Finance Director (Matthew Jablonski, 15 year veteran of the mortgage industry). During the pandemic, the team also closely aligned with Tomaselli and National Condo Advisors.

“Most of these deals have mortgage financing,” Adler said. “What’s happening now with the banks is a lot like what we saw back in 2008 and 2009. Rates are amazing, but it’s getting more difficult to get a mortgage. We need to be in position to provide solutions for our clients, and aligning ourselves with the right people allows us to do that better than anybody.”

Compliance is the Key to Mortgage Liquidity

It’s a small gathering of people who have devoted the time to fully understand COMPLIANCE, which in this instance is the adherence to lending guidelines. Whether or not a building is compliant is the single biggest factor in determining the availability of competitive mortgage finance options there.

We already covered what happens when sweeping industry-wide changes impact an entire marketplace. But it’s extremely important to point out that every single building is judged individually too. Each time a buyer applies for a loan to buy a condo or co-op unit, an underwriter for their lender analyzes the building and its finances to see if it’s compliant with their guidelines. The more compliant a building is, the more willing lenders will be to offer financing there.

There are many common reasons for a lender or an agency like Fannie Mae to categorize a building as out of compliance or “non-warrantable.” For example:

  • The budget doesn’t have a 10% line item for reserves (With little or no reserves, an HOA would have to implement special assessments to pay for repairs or necessary upgrades, which makes living in the building less affordable)
  • More than 15% of unit owners are over 60 days late on their HOA fees
  • Low owner occupancy levels (there are more renters than owners in the building)
  • Too much commercial space (A building could become reliant on revenue generated by a commercial tenant. Losing that tenant could have a major impact on the financial health of the building)
  • Ongoing litigation

While it is possible to find mortgage financing for buildings categorized as non-warrantable, lenders often tighten guidelines or adjust pricing in those situations by way of a higher interest rate or higher fees for that loan. 

Just like in the example provided by Jonathan Miller, a buyer might be considering two different properties. One of the options is in a building that’s compliant, and one is in a building that is not. 

Let’s put that buyer’s decision in perspective using real numbers:

Assume the purchase price for both apartments is $1,333,333. If the buyer’s bank reduced its LTV threshold from 80% to 75% for non-warrantable buildings, instead of making a down payment of $266,666, they’d have to come up with $333,333 instead, a difference of $66,666.

Taking the example a step further, if we assumed the buyer planned to put down 25% anyway, they might still be faced with a higher mortgage rate if they choose the non-warrantable building. If the buyer borrowed $1 Million at 2.75% in the warrantable building, they’re monthly principal and interest payment would be $4,082.41. If the buyer borrowed $1 Million at 3%, the payment would be $4,216.04, an additional $133.63 per month.

In the warrantable building scenario, the buyer would pay $469,668 in total interest payments over the life of the loan. In the non-warrantable building scenario, the buyer would pay $517,775 in total interest over the life of the loan, a difference of $48,107. 

Being compliant and having the most flexible and attractive finance options in place helps to attract new buyers, but that’s not the only benefit. If mortgage rates improve even more in the future, people who already live in the building will want the ability to refinance. There are examples of buildings in New York City that have fallen out of compliance, to the point where unit owners weren’t permitted to refinance. In fact, Adler said he lived in a Manhattan condo in a situation just like that. For a couple of years, there were no banks willing to lend in his building, until a legal dispute was finally resolved. Property values noticeably improved after the litigation was resolved and finance options opened up. 

Aside from attracting new buyers and allowing unit owners to take advantage of low refinance rates, a potential buyer has to think about their future re-sale options. If it’s difficult to find optimal financing today, it’s easy to surmise that it could be just as difficult when the time comes to sell, another strike against purchasing in a building that is less than compliant.

In an ultra-competitive market with a massive amount of inventory, you’d think developers and condo and co-op boards would go out of their way to give their buildings every advantage possible over their competitors. 

Many lenders seek guidance from National Condo Advisors when formulating new guidelines designed to eliminate undue risk. It uniquely positions the company to provide invaluable expertise to developers who could benefit by implementing their suggestions. Still, Tomaselli said pitching his company’s services hasn’t always been easy, especially when guidelines are relaxed and it’s more difficult to quantify the value of compliance.

“It has become a lot easier (to quantify) since the Covid-19 Pandemic hit,” Tomaselli said, perhaps because developers are seeing lending guidelines change in real time before their eyes. “For years, few lenders paid much attention to whether a building was Fannie Mae warrantable or not. They were comfortable providing jumbo mortgages to condominium purchasers or owners either way.”

But when developers call upon him today, Tomaselli said, the first question they ask is whether a building can be “Fannie Mae approved.”

“Ensuring that a building is Fannie Mae warrantable reduces lender risk dramatically and therefore allows an abundance of available loan options for purchasers. In the end, unit values will be secured by condo building warrantability.”