In Ontario, when condominiums find themselves short on funds they have three options: 1) increase monthly fees; 2) levy a special assessment; and 3) borrow the money. The board could choose one option or a combination of two or three options.
One option, increasing monthly fees, works well for small shortfalls such as a deficit for a year that is unlikely to occur again in future years. It doesn’t work well with a large deficit or unexpected repair project as a shortage of cash can make it hard to pay expenses as they become due. It also doesn’t work well when the issue is an underfunded reserve fund as it could take months (or likely years) to get it back to where it should be if the reserve fund has been underfunded for years.
Levying a special assessment is never a popular decision, but sometimes it is the best option. A special assessment is the quickest way to increase funds. However, if the amount levied is too high some of the owners may be unable to make the payments and they may default. If too many owners default the condominium could be in financial trouble as it may take months or even years to complete the power of sale process to sell the units to recover the amount owing by the owners, and market values may suffer in the meantime. A special assessment might not be the best option when the amount the condominium needs to raise is quite large.
Another option is borrowing. Typically borrowing is used in situations where the condominium needs a large amount of money in a short amount of time (i.e. 6 months). It is typically used for major repair projects or to purchase assets that the condominium is required to purchase from the declarant, such as a guest suite.
Most people are familiar with increasing fees or levying special assessments, but many people are unfamiliar with borrowing because it is much less common than the other two options. As a result, myths about borrowing are widespread in the industry. This post will debunk some of the most common myths.
Myth #1: All of the owners must approve the loan and sign documents approving the terms of the loan.
Truth: The Act only requires the owners of a majority of the units to approve a borrowing by-law, which usually authorizes the board to borrow up to a certain amount and negotiate the terms with the lender. The owners do not sign any of the loan documents. The board negotiates the terms and signs the documents.
Myth#2: The owners have to put up their homes as collateral for the loan before the lender will loan the condominium money.
Truth: There is no security granted by the owners. No mortgage. No lien. The security is granted by the condominium and typically includes a general security agreement over any equipment, assets, and other property owned by the condominium.
Myth#3: The condominium should never sign a general security agreement (GSA) since lenders will loan condominiums money without one.
Truth: GSAs are common. If you have purchased or leased a vehicle in recent years you probably signed a GSA with the car company. I asked Ryan Griffiths of CWB Maxium to explain it from a lender’s perspective. This is what he had to say:
A GSA is generally the security provided for a condo corporation loan which allows for a broad use of the loan money towards repair and remediation projects, while title to the individual units remains free of any charge or registration. A mortgage can be an alternative if the corporation has unencumbered real property, such as a guest suite or superintendent suite.
It is unlikely that a lender would loan money to a condominium without any security at all. If they did it would likely include a very high rate of interest to compensate for the additional risks associated with unsecured loans. In short, if a condominium doesn’t want to sign a GSA with a lender it will have to find other security to satisfy the lender, such as a mortgage (if the condominium has real property).
Myth #4: The interest rates are too high for condo loans.
Truth: Twenty years ago the rates for loans to condominiums were prohibitive, but today the rates offered are reasonable for commercial rates (i.e. prime plus 2% to 4%).
Myth #5: The interest rate is the most important part of the loan proposal.
Truth: Each lender structures the loan differently so you can’t go by the interest rate alone. Look for additional fees for items like loan application review, renewals, annual fees, and other charges. Legal fees may also vary by lender, so check with your legal counsel for their feedback and experience. Make sure you are looking at all of the terms, not just the interest rate.
Myth #6: Having a loan will hurt the resale value of the units and make it hard for owners to sell their units.
Truth: A large special assessment showing on the status certificate would likely be more troubling to a potential purchaser than a loan. For some purchasers, the special assessment might be seen as more risky and unpredictable than a loan with predictable monthly payments.
There are plenty of options out there for condominium loans these days, including refinancing existing loans. Special assessments and increasing monthly fees are not the only options. Boards should talk to different lenders and find a proposal that works best for their condominium’s needs.