One of our brokers approached me the other day with a question about a self-managed strata corporation in Richmond –
“I have a client with a Strata Townhouse in Richmond who wants to take a mortgage. But they have one of those 'self-managed' strata committees, ran by all of the owners themselves. Is this insane? Is it legal?? There are strata minutes available, but no financial statements. There is also no contingency reserve. Dumb question - Is this safe for a private lender to lend against a building built in 1984 that has proper insurance but no contingency fund? How can they protect themselves? “
The broker obtained a legal opinion on the deal, after verbally discussing it with me, and this is what the lawyers said,
…Self-managed stratas are more common than I would like… As for the Contingency
fund (CRF), the Strata Property Act requires them to keep one, and for good reason. Insurance covers some catastrophic situations, but a myriad of others would leave the owners (and more importantly, the lenders) high and dry - from the basic replacement of pipes, to the building envelope issues we see so much of. Add to that that some lender, or owner might get antsy that there is no CRF and petition to court to appoint an administrator to run the strata, effectively putting control in the hand of a bureaucrat.I would strongly recommend against such a loan.[i]
This got me thinking more generally about issues related to strata corporations, and the implications for lenders, investors and underwriters. A recent report by the Vancouver Island Strata Owners Association (“VISOA”) raises a number of issues arising out of current legislative deficiencies, and proposes remedies in a new Act or Acts governing various aspects of the issues.
There are a large number of issues addressed by the VISAO report, and I’m not going to attempt to address all of them, especially since a number of the issues are primarily related to deficiencies in the Acts that relate to the owners of the strata units or bare lots, not all of which directly impinge on a mortgage interest. Unfortunately most of them do, as the legal interests of a lender are derivative, that is, they are derived from the rights of an owner established under the various acts.
Strata or condominium ownership has grown to 25% of taxable properties across British Columbia, with there now being 460,000 individual strata units. In several large urban areas, strata homes now account for 50% of all taxable properties. Growth in strata homeownership is expected to continue as land prices increase and efforts are made to reduce the “environmental footprint” of new housing.[ii]
In many urban areas such as the Lower Mainland and southern Vancouver Island strata ownership is becoming the de facto standard form of housing for most new homebuyers, indeed the vast majority of home ownership in the next twenty-five years will likely be strata titled property. Increasingly, for lenders, there will be little choice but to invest mortgage dollars into strata properties, as there will be few opportunities otherwise, especially for private mortgage lenders who tend to lend in situations where banks are unwilling to do so.
The Strata Property Act (SPA), the Real Estate Development Marketing Act (REDMA) and the Real Estate Services Act (RESA) affect strata homeownership. Although the RESA and the REDMA are relatively recent (2004) creations in response to concerns of the real estate industry, no public review of strata legislation to address homeowner concerns has occurred since 1998. In the meantime, other provinces have moved ahead with legislation to address emerging concerns in strata (or condo) homeownership. In 2003 the BC government recognized there were significant issues with the SPA and committed itself to a review. This review has not occurred.
VISOA has identified many deficiencies in transparency and accountability under current legislation and has categorized them under the topics of:
A. Strata Governance,
B. Strata Management Licensees,
C. Disclosure,
D. Strata Development Approvals,
E. Property Taxation,
and
F. Strata Fee Equity.
The areas which primarily are of immediate concern to lenders are: Strata Governance, Strata Management Licensees, and Disclosure. Although there are serious issues related to Property Taxation and Strata Fee Equity are also of some concern to ownership, they are of less relevance to the vast majority of mortgage lenders as they do not directly affect the quality of the security on a mortgage loan placed on a strata title.
Strata Governance
The complexities of shared ownership and mutual obligations among individual owners and their corporate body require relevant knowledge of the Strata Property Act and simple, direct and affordable access to due process for enforcing the Act and resolving disputes. Current legislation provides for only cumbersome, intimidating and expensive judicial, arbitration or mediation processes to administer the Act. It effectively indulges irresponsible actions and leaves disputes unresolved.
The main concern for a lender here is the derivative consequence of unresolved or irresolvable conflicts related to the maintenance and/or repair of common property held by a Strata Corp. Because there are requirements that a Strata Corporation must obtain 75% approval for any significant expenditure, including substantial maintenance or repairs, a council with reluctant participant with over 25% of the votes at an annual meeting may find itself unable to make corrective investments or even to repair serious damage to a building. The owners may have a remedy, by suing the corporation, to force necessary repairs, but there is no efficient mechanism by which an owner can enforce responsible conduct by a strata council, especially one where irresponsible members form a substantial minority of the votes (ie: over 25%).
The mortgage interest in a property can be seriously damaged if the quality of a building declines through deferred maintenance or damage that is not repaired. The lender has little or no leverage on the owner to force the strata to take action. To whatever degree the owner is handicapped in enforcing responsible behavior by a strata corporation, the lender is even more vulnerable in that the lender has even less in the way of access to due process than does the owner.
And while the law requires the strata corporation to maintain a contingency fund to pay for repairs and other liabilities of the strata corporation, in the event that a strata council doesn’t set fees high enough to ensure an adequate fund, there is little that an individual owner can do to force the council to do so.
This is one of the reasons that a lawyer would be doubly concerned about a self-managed strata corporation. In the absence of a professional management company there is very little way for an owner (or the lender) to even know that there is a problem regarding the strata council and its conduct in maintaining and protecting the ownership interest.
There is no requirement for audited annual financial statements from the strata corporation so there is no way to know how adequately they have been reported. The preparation of Form 9 disclosure statements by self managed strata corporation is necessarily a function of the elected executive of the strata council. There are no consequences of misreporting or under reporting of potential liabilities against a strata property. The law provides a form of disclosure that requires certain behavior but does little to enforce it.
Lenders (and their lawyers) are understandably nervous about disclosures from self managed strata corporations. Even when there is a professional management company responsible for the strata management, there can be no guarantee of fair, plain, and true disclosure necessary for the registration of a proper security interest. Strata corporations rank with governments in obtain position on title for any obligations of a unit holder to the corporation. Failure to fully disclose potential liabilities to a lender may open a manager to legal consequences for failure to disclose, but practical remedies that do not include suing third parties for negligence do not exist.
Lenders also have no way of knowing when a strata corporation is getting into trouble, either as a result of deficient property management practices and deferred maintenance, or as a result of structure problems, i.e.: leaky condo syndrome.
These problems, and others, which arise out of a fundamentally flawed set of legislative Acts, can ultimately only be resolved by legislation designed to address them. Lenders, on the other, can’t wait for a pie in the sky solution but rather have to take measures to protect themselves.
Which is one of the reasons why many lenders, including private lenders, are seeking independent inspections on all strata mortgages where the strata is self managed, as well as on any strata mortgage where there are any alarm bells at all arising out of an appraisal or an investor interview done at the time of loan approval prior to loan advance.
While issues related to deferred maintenance, structure deficiencies, environmental hazards are potentially present in all real estate transactions and therefore all mortgages, where title is more complicated and processes for resolutions of disputes more difficult, the risk is exacerbated.
Therefore it would be prudent to obtain a higher level of disclosure on Strata Titled properties during underwriting.
Conclusions and closing thoughts
In regards to private investors making direct or indirect investments in strata mortgages, it is important during the review of an investment opportunity to comfort yourself as to whether or not a strata is managed by a professional management team, or self managed; and, either way, that there is an adequate contingency fund as well as a well planned and self-evident maintenance program for the whole strata building. Look closely at the appraisal for any evidence of deferred maintenance or potential deficiencies arising out of the design or execution of the design of the building in the first place. Have your broker talk to the borrower, and see if they have any concerns about the property.
At the end of the day, if investors are going to invest in mortgages, which are still one of the safest and most secure investments available in the marketplace, it is important that investors be aware of any potential risks, and the scale of those risks.
In the case example given at the beginning of this blog, clearly the lawyer is correct. Not only is the property self managed (an alarm bell all by itself, not necessarily fatal, but still of concern) but in the minutes of the strata meeting the disclosure of no contingency fund and some deferred maintenance, combined with an unwillingness to increase strata fees to cover necessary repairs would disqualify this strata unit owner from obtaining a second mortgage. It may also prevent the unit owner from refinancing if these deficits are not remedied within a reasonable period.
[i] This initial quotation is a quotation from an email exchange between a broker and our office.
[ii] All other references in this blog are to a report - Ensuring Transparency and Accountability in BC Strata Developments May 2, 2008, Vancouver Island Strata Owners Association - http://www.visoa.bc.ca/static/VISOA%20Report%20on%20Strata%20Legislation%20Issues%20-%20May%202,.pdf
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