As a real estate investor, I am often tempted by the idea of buying condos and turning them into rentals. Living in a “condo-centric” city like Miami, it is often hard to find decent opportunities in the multifamily and single family space, though condos are always in abundance. And given that we are currently on the tail-end of a construction boom, there is a lot of condo supply either already on the market or becoming available in the near future, which will make it very cheap to pick up a unit or two.
Though every time I find (or think I have found) what seems to be a condo that meets my minimum cash-on-cash return for rentals, one small factor always turns me off, the monthly condo fees (aka HOA fees). This arbitrary, and sometimes very high monthly expense seems to always kill any shred of cash-flow that I believed I could squeeze out of the property. This one factor continues to be a constant reminder of the reason why I don’t buy condos.
Lack of Control
HOA stands for Home Owners’ Association. When you live in a condominium building, every unit has it’s own individual owner, however, the common areas (pools, gym, roof, parking, exterior walls, etc.) are all shared. In order to maintain all of these shared “amenities” the unit owners must form an organization that serves as the governing body of the building. This organization is in charge of developing and enforcing a “budget,” which will be used to maintain all of the common areas. This budget gets divided among the unit owners in the form of a monthly (sometimes quarterly or annual) fee. The owners pay this fee, which goes into a cash reserve account that is then used to pay for all of the upkeep of the building. HOA officials are elected by the owners of the building in order to take charge of ensuring that the building is maintained properly and within budget.
Therein lies the problem. If you do not own 51% or more of the units in a building, as an investor you pretty much do not have any control over the management of the building. Sure you can run for the HOA board, but this is often riddled with politics and bureaucracy, as most “governing bodies” tend to be. If you own 51% or more of the units then you pretty much have the majority vote when it comes to deciding how the building is managed. Otherwise you have no control of your investment.
There are some single family home communities that operate like pseudo-condos. I have two houses in Indianapolis that are inside an HOA. I received a letter a few months ago that the association was voting on the percentage of houses within the community that could be operated as rentals. Currently only 10% of the houses in the community could be operated as rentals. The purpose of the vote was to increase this to 20%. As a rental investor, I obviously voted ‘yes,’ though my one vote would be worthless if most of the owners voted otherwise. If that community ever becomes mostly owned by homeowners who decide they don’t want investors in their “hood,” I could be screwed. This lack of control is not something that you want when you invest in real estate.
Special assessments occur when a capital expenditure arises that was not originally accounted for in the HOA budget. This results in the owners having to come out of pocket with additional cash to fund this expense. Special assessments can come in many shapes and sizes and the individual condo owner does not always have control over deciding when these assessments will occur. If you are an investor looking to make a return on rents, a special assessment could completely annihilate your profits for months.
In the darkest days of the recession, somewhere around 2009-2010, my wife and I considered buying a condo in South Beach. It was a well known building that had converted some hotel rooms into studio apartments, which were going for about $30,000. This was a steal! My wife and I could not believe how cheap these units were. We were set on making an offer. On our way out of the building, we met an existing owner and got to talking. Turns out the reason the units were so cheap is because of a ridiculous special assessment of $50,000 per owner, which was causing the owners to have to come out of pocket around $2,000 per month in condo fees. Most owners refused to pay, which caused their units to go into foreclosure, which then led to unit prices plummeting. Whoever ended up buying those units would inherit that special assessment, thereby making this seemingly great deal, into a nightmare.
When to Buy Condos
While condos don’t usually make great rental investments, they do have their place. For one, they could be great places to live. If you are looking for a primary residence that will require relatively low maintenance, a condo may be for you, since you will get most of the maintenance included within your HOA. For investment purposes, condos make great fix-and-flips, if you can get them at the right price. I have some great investor friends that have made a lot of money buying and flipping condos in Miami Beach. This requires intricate market knowledge on the acquisitions side to ensure you are not “over-paying” for the property and the repairs. It also requires calculated timing to ensure you do not end up having to sell during a market downturn and taking a loss. My investment strategy has always focused on long-term holds with an emphasis on maximizing cash-flows, which makes it very challenging to find a condo that meets my criteria.