When to Avoid Buying a Condo

Casey Fleming

I am often asked whether buying a condo is a good investment.

These look very nice
These look very nice

The short answer – I own one in New Mexico and yes, they can be a great investment. If you are buying a condo to live in it, it’s great to have all your exterior maintenance taken care of, and nice to have access to common amenities like a pool and clubhouse.

Buying a condo means you live in a resort! (Maybe)
Buying a condo means you live in a resort! (Maybe)

If you buy one as an investment property, most of your maintenance problems are taken care of in your HOA dues.

But there’s the rub – the HOA dues, or more to the point, the Home Owner’s Association. The association is managed by a board of directors elected by the home owners. Typically each unit gets one vote in electing directors. The board of directors then (typically) hires an outside property manager who collects the monthly dues from the homeowners and manages the maintenance of the common grounds, and usually the exterior of the units as well.

Is this your HOA Board of directors?
Is this your HOA’s Board of directors?

The property manager also prepares a budget each year which the board of directors has to approve. This budget must include reserves for big-ticket items that have to be done periodically, such as re-paving, roofs, exterior painting, and the like. If the reserve fund isn’t adequate, major routine maintenance can’t be done when it’s needed, and the project will deteriorate.

This is where things can get dicey. The quality of the management of the project has a very direct impact on the desirability of the community, and therefore the appeal of your home or the future value of your investment. The management agent must be competent and ethical, and the goals of the board of directors must be in alignment with your own personal goals.

Under what circumstances might that not be the case? Bear with me while I take a slight corollary here.

Fannie Mae
Will Fannie or Freddie lend on your condo?

Fannie Mae and Freddie Mac – which purchase the vast majority of all mortgage loans written in the U.S. today – will not lend in projects with certain characteristics. Those that are most relevant to this discussion include:

  • If one owner owns more than 10% of the units within the project
  • If the home owners are not in control of the HOA (e.g. if the developer still owns more than 10% of the units.)
  • If the developer / builder or the HOA is named as a party in a lawsuit
  • If the reserve fund is deemed inadequate to meet future needs
  • If more than 15% of the units in the project are delinquent on the HOA assessments
  • If more than 50% of the units are rented (or conversely if less than 50% are occupied by the owner)

There are more, but those are the areas that are most commonly problematic.

Getting back to the original subject: Why would Fannie / Freddie not make loans in certain projects? Because they have characteristics that are likely to make the units difficult to market in the future, and therefore do not represent good collateral for the loan.

This is relevant for us today because one of my clients was looking at buying a condo in an ineligible project. In this case, there were 168 units. Of them:

  • 90 were still owned by the developer
  • 80 of the developer’s units were rented
  • A local non-profit housing agency owns 34, which are all rented to low-income residents
  • There are a total of 40 units in the project that are owner-occupied

So,

  • More than 10% are owned by two different entities. The developer owns 53.5% of the units, and the housing agency owns 20.2% of the units
  • By definition the unit owners do not control the HOA (The developer owns more than 50% of the units, and has more than 50% of the votes to elect the board)
  • 76% of the units are rented (or vacant)

…and, as it turns out, the reserves may not be sufficient to meet future needs. An audit is currently underway. Why might this have come about? If you were the developer and owned 53.5% of the units and the HOA was short on reserve funds, would you allow the board to vote to substantially increase the HOA dues to make up the shortfall?

No, you wouldn’t.

So, would you consider buying a condo in this project? How about if it were really inexpensive – much less than competitive units nearby? What if financing was more expensive because the loan can’t be sold to Fannie Mae or Freddie Mac?

I might buy one as an investment if I thought that the situation could be reversed within a couple of years. Once the issues are resolved the appeal (and therefore value) of the units should increase. But that means the developer has to sell 90 more units, mostly to buyers who intend to occupy the property, and – and this one is harder – the housing authority would have to sell at least 18 of their 34 units. That just doesn’t seem likely.

In the meantime, if the audit currently under way determines that the reserves are too small for future needs, there will be either a special assessment for each unit – potentially thousands of dollars – or the monthly HOA dues will have to be raised substantially. Either way, I think I would want that information before buying a condo here.

Poorly managed condominium associations are not that common, but they aren’t unique either. With Millenials jumping into the first-time home buyer market demand for condos is likely to grow. I would never say avoid condominiums altogether – my own investment is working out reasonably well.

But most of my clients don’t review the HOA documents they are given when the make an offer. Do not make this mistake. These are important documents that could very well give you information about the appeal of the home you are buying, or the future value of the investment you are making. If you want a “red flag” to help indicate when there might be a problem, ask “Will Fannie Mae or Freddie Mac buy this loan?” If not, ask why.

And choose wisely.

Casey Fleming, Author The Loan Guide: How to Get the Best Possible Mortgage (On Amazon)
Mortgage Advisor, C2 FINANCIAL CORPORATION
408-348-3442 mobile
 
Follow me on Twitter for interest rate updates: @TheLoanGuide
 
NMLS 344375 / DRE 00889527

Comments (3)

  1. I totally get the appeal of the condo – I have owned two in my lifetime, and there is where my tally stops forever.

    The first one I owned by myself, my first investment. Almost as soon as the ink was dry on the closing papers, I got notification that there would be a special assessment for the boiler/roof/parking lot/pool – I can’t remember which one.

    Guess what happened next year? Same thing. And the next and the next. I lived there four years and paid a special assessment – essentially double what I thought I would be paying when I purchased the property – every year I was there.

    A few years later, my husband and I wanted to live in the big city. We couldn’t afford a house there, so we bought a condo. We didn’t read the documents, because we didn’t know what we were looking at anyway. The developer still owned a significant portion of the units, and had greatly underpriced them. He was bleeding money, and did shoddy work to stem his losses. Our unit didn’t have any issues, but we were pretty lucky. Right after we put the property on the market, but before we had it under contract, there was a special assessment of $700 per unit.

    I think the best piece of advice in this article is to make sure there are adequate reserves. The roof will need to be replaced eventually. Start preparing for that when the need isn’t imminent. Ditto pool repairs, parking lot repaving, furnaces, water systems, etc etc etc. A condo can be a great investment. It can also cost you a lot of money, so extra due diligence is required.

    1. Thanks for the comments, Mindy. I’m sorry to hear about your experiences, but they are all too common. Thanks for the contributions!

  2. Very interesting. We’re considering downsizing but have never lived in a condo before, so this is helpful information.

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