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Using Condos as Rental Units

When I first got into real estate investing, every real estate self-help book talked about starting with condominiums.  They talk about finding one then laughing all the way to the bank.  They always skip over the potential ugliness that can come with having a condominium.  I never saw a story about Special Assessments that drove [...]

When I first got into real estate investing, every real estate self-help book talked about starting with condominiums.  They talk about finding one then laughing all the way to the bank.  They always skip over the potential ugliness that can come with having a condominium.  I never saw a story about Special Assessments that drove the cash flow negative for nearly a year.

Some investors recommend condominiums as investments due in part to their relative cheapness.  Compared to buying a single-family home (SFH) or even a duplex, condominiums are cheaper.  Are they really the better vehicle for investing?

Pros

Condos are typically cheaper to purchase than Single Family Homes (SFH).  The biggest difference: a yard.  Banks just love a property that stands on it’s own, surrounded by grass.

But that leads into the second benefit which is there isn’t a yard to maintain.  The exterior of the actual condo is the responsibility of the Home Owners Association (HOA).  They make sure the grass is cut, the pools are maintained, any public buildings are clean.

If anything public is affected and needs repaired, the HOA pays for it.  For instance, if you and several other units experienced blocked plumbing, the HOA would have the plumber come out and fix the problem.  Who pays the bill?  The HOA does using your monthly fees.

As a rental unit, HOA fees are tax deductible.  If not all then a portion certainly is.

Cons

No private yard usually translates into lower rents.  Tenants do like to store things on the property.  Broken down car, dog house, meth-lab and usually they are willing to pay a premium for it.  Because of this, condos typically rent less than a SFH would.

As the house market fluctuates, condos are typically the hardest hit.  When a market correction occurs, condos are the first to lose value and the last to recover.  

Read the HOA agreement carefully.  Several points:

-  HOA fees can be increased year over year without membership voting.  Either by a small percentage or a flat fee.  Build this into your business model.
-  Associations can decide if condos are used as rentals or not.  They may decide to screen your tenants and give final approval.  You’d have no say in the matter.
-  Special Assessment will become two words you’ll hate to hear.  The HOA may decide to install flamingo pink vinyl fences around the property.  YOU have to pay for it out of pocket.

Choosing not to pay HOA fees or the Special Assessment may result in your property being confiscated or liens being placed against your property.  A lien on your condo is a fast way to bring your investing career to a screaming halt.  Your library card may even be revoked.

Summary

This is not to scare you from considering condominiums as a rental income machine.  Many investors do it and are quite please with the results.  Before jumping in, make sure to review the HOA agreements thoroughly along with your other documents during escrow.  It is critical to ensure you are purchasing an asset, which will put money into your pocket rather than a money pit.

Extra Credit: More HOA Horror Stories

Impound fees with Mortgage

You say to your friend, "Friend, let’s go out tonight."
"I can’t," Friend says.  "My property tax bill came.  I have to save all my money."
For the next month, Friend eats only ramen noodles.  Before long, Friend starts looking a little ripe from not doing laundry.  "Have to save money to pay the tax bill!" Friend [...]

You say to your friend, "Friend, let’s go out tonight."

"I can’t," Friend says.  "My property tax bill came.  I have to save all my money."

For the next month, Friend eats only ramen noodles.  Before long, Friend starts looking a little ripe from not doing laundry.  "Have to save money to pay the tax bill!" Friend says.  After 30 days, Friend stumbles into work "I paid the tax bill!  I had to donate bone marrow for money to come up with the rest of the bill but it’s paid!"

Don’t be like Friend.

When buying that duplex, condo or other investment property, the lender may ask you if you want your property taxes, insurance, etc. impounded as part of your mortgage payment.  What exactly does this mean?

By "impounding", the lender adds a dollar amount to every mortgage payment for taxes and insurance.  This extra money is stored in an escrow account.  Once the taxes and insurance come due, the lender pays them.

Example:  Your purchased a property and your monthly mortgage payment is $1000.  Property taxes are $2,400 per year, that becomes $200 per month.  The insurance, which is $480 per year, is now $40 per  month. Instead of paying $1000 per month to your lender, your new monthly payment would be:

Mortgage	$1000
Taxes	$200
Insurance	$40
Total	$1240

Unlike your friend, who has to go on a ramen noodle diet and forsake doing laundry to pay his property tax bill, your bill is paid.

Caveats

Some states require that taxes and insurance are impounded.  If the state laws don’t specifically state, the lender may require impounding these fees if the Loan to Value (LTV) is greater than 90%.  Impound fees may be required if the residence is non-owner occupied (ie rental property).  Some lenders may even offer 1/4 of a point reduction if you agree to have your fees impounded.

You should ask your lender.

Summary

If your state doesn’t require impounding, then the decision rests with you.  Here are some things to think about when making the decision.

Pros:

• Property Taxes and Insurance will always be paid.
• Two less bills will clutter your desk.
• Ramen Noodle Diet is optional, not mandatory.

Cons:

• You can’t be a control freak.  Some people like to control everything; paying the property taxes certainly qualifies.
• Some people argue that giving up that $200 per month means you can’t put it into an interest bearing account.  You would be tossing away $10 in interest every six months.
• Your monthly payment will be higher.  But you planned for that, right?