Define
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
Property Analysis Oct 2008
Towards the end of the month, I’m going to pick a property at random off of Craigslist and analyze it using the methodology in the book and the tools on this site. My approach is that of an out of state investor, looking to expand my empire.
In Tulsa, OK I found this duplex on Craigslist.
Here are [...]
Towards the end of the month, I’m going to pick a property at random off of Craigslist and analyze it using the methodology in the book and the tools on this site. My approach is that of an out of state investor, looking to expand my empire.
In Tulsa, OK I found this duplex on Craigslist.
Here are the highlights of the ad (in case it was removed).
- Asking Price: $110,000
- Gross Rent: $900 (Could be more)
- Taxes and Insurance: $1300/year
- Current owners live out of state. Want to sell ASAP. Welcome all offers.
First Step: Define my model.
My investment property should provide at least $100/month in cashflow.
Second Step: Use the online Business Modeler to analyze the cashflow.
Using the application, I enter the negotiated price and rent. Since taxes and insurance are grouped into a yearly payment, I’m going to assume $65 per month each. This should equal out to about $1300. Ten percent down ($11,000) financing seems about right.
My first analysis (click to view) shows immediately a negative cashflow of $263 per month. Ouch.
Can we make this property work?
Everything is negotiable. Rerun the application and knock of $20,000 from the asking price. Then we could put down 20%. The ad says that rents could be raised so let’s see what happens with a $50 increase per unit. The seller emailed, saying the tenants pay all utilities. He budgets $25 per month for maintenance.
The second analysis (click to view) shows a positive cashflow of $104. Barely fits my model. This only happens however if three conditions are met.
- $20,000 reduction in the asking price
- $50 increase in rents per tenant
- $18,000 down payment
Question: Do you think you could get all three?
It seems the only way for this to work for an out of state investor is a "pie in the sky" scenario. Don’t become obsessed with trying to make an investment work. It either does or it doesn’t.
Summary
My model tells me this property doesn’t work. If the seller raised the rents to market rate and would accept a lower asking price, I’d still have to come up with a hefty down payment. If I lived locally and could manage the property myself, this would probably work.
Other opportunities await.
Real Estate Networks and Kool Aid
Real Estate Networks are here to help you. Yeah, I don’t believe that either.
The REI Networks advertise that they are around to help new investors build their real estate portfolio. Quickly. They hold free seminars, give you kool-aid and cookies, and then pound you into submission with a two hour infomercial with no bathroom breaks.
What goes [...]
Real Estate Networks are here to help you. Yeah, I don’t believe that either.
The REI Networks advertise that they are around to help new investors build their real estate portfolio. Quickly. They hold free seminars, give you kool-aid and cookies, and then pound you into submission with a two hour infomercial with no bathroom breaks.
What goes on behind the scenes of these Networks?
These Networks provide everything to start investing. Real Estate Agents, Lenders, and Property Management companies. Guess how the Network makes money? By charging the Real Estate Agents, Lenders, and Property Management companies. That kool-aid you drank costs money. So it’s in the best interest of the Network that you buy something. Anything. But through their network.
They promise cashflow and a new house!
First, their calculation of cashflow is off base. Sorry but Rent minus Mortgage is not considered cashflow. Second the new house they are offering? It’s one of 50 new homes in a subdivision, all sold to new members of the Network. Do you think the Property Management company is going to be able to rent all 50 homes?
But they offer partners since I have no money.
Yes, they do. You and your partner sign an agreement, drafted by lawyers of the Network, and the rental property is yours. But who gets what in the deal? The partner gets 50% of the sales when the property is sold. They also claim the tax write-offs of the property.
You get to make the mortgage payment when the house sits empty, next to the other 50 empty houses. You get to scream at the answering machine of the Property Management company because they won’t pick up. You also get free kool-aid at the next Network seminar. In other words, the partner gets all the benefits and you assume all the risks.
Are Networks evil?
Not necessarily. Look, people should expand their investment portfolios. If Networks can help, use them. But make sure to ask the tough questions. Don’t buy the "sales pitch" they give you. Put the kool-aid down and perform your own analysis. Use the Business Modeler to analyze what the cash flow would really be. Also I would never buy "site unseen". If the Network won’t allow you to do your own investigating, then seek help elsewhere.
Real Estate Clubs are a different story . . .
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