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Welcome to the Grow Real Estate Investing Podcast.
I’m Joe White and in this podcast I’m going to look at condos as investments.
This will be part one of two podcasts designed to serve as a more complete investing in condos how to guide.
This part one of the podcast I will discuss condos as an investment strategy.
I’m going to go over the pros and the cons of condo investing.
And really not many, if any other real estate investing vehicles have such a wide range between the pros and cons.
The 2nd part won’t be an overview on condo investing, rather it will help you determine if a particular condo might be a good investment or not.
It will try to real estate agent you through your purchase.
In that video we will dissect the HOA itself and try to avoid many problems altogether.
Each podcast will be a stand alone solution. Meaning, you can watch one without having to watch the other. If you are interested in how to invest in condos, watch this podcast.
If you are thinking about purchasing a condo I recommend you watch the 2nd podcast.
Either podcast, remember I’m a real estate broker; but I’m not your real estate broker.
Nor am I an attorney, accountant, nor a financial advisor.
Speak to those individuals. Particularly because laws vary greatly state to state and this stuff is important.
Okay, Condos As Investments
Condo investing , as a rule, is a hard “No” with real estate investors and because of that there is very little information available on how to buy a condo as a rental property investment.
I study real estate investing 2-3 hours a day and I really haven’t come across any podcasts, video’s, blog articles or books that cover the subject with any worth.
And I have looked, because like you, I want to learn about this stuff.
And I find that odd because condos tend to have huge benefits over other real estate investments, like single family rental properties, so I tend to think about them alot, and I find it odd that I’m the only one.
For me, I can’t get past the huge benefits, so I often find myself trying to brainstorm the hurdles away so I can take advantage of the too big to ignore benefits.
Here’s a Warren Buffet quote you might know:
“fearful when others are greedy, and greedy when others are fearful.”.
How am I not supposed to be excited when a type of real estate investing is being ignored by everyone else?
I haven’t fully cracked this nut open but my mind has put in a lot of energy into condo investing and I have a lot of thoughts on it that you might find helpful.
But let me get through the benefits and we’ll see if you sense a big opportunity also.
So what always captures me is that condo rental property investing is a way to own fairly inexpensive rental properties that are in great locations.
In fact the same amount of money that buys a single family home in a D-Class neighborhood, can easily buy an A-Class neighborhood condo.
You get to rent to great tenants, for nice rents, and condos cost very little to maintain.
Great tenants and low maintenance equals an extremely low hassle investment.
And since other investors won’t touch them….there is very little competition!
The extremely low prices give condo investors a very low barrier to entry and what I love about condos is the very low cost of time value of money.
As an investor begins to grow, they become more and more aware of the time value of money.
How much is the time that you spend doing something worth to you?
How much is that time costing you in missed opportunities?
If you weren’t spending all your time trying to find discounted deals, or dealing with difficult tenants, what else would you be doing?
Think this way:
If it takes you 30 hours of effort to find a deal, and it only takes me 3 hours of effort, I will have 10 properties by the time you are buying your 1st property.
That’s thinking using the time value of money and that’s why investors often track it.
And condos have very good time value of money metrics:
- They Are Easy To Find.
There’s no competition. Other investors wrote condos off the 1st time they watched a real estate investing podcast or read a real estate investing book.
The time & the effort to find condo deals is a faction of the time & effort to find a single family or multifamily property.
- They Are Extremely Inexpensive.
Your buying power gets you far more condo. They have a very low barrier of entry. It's realistic that you can get three condos for the equivalent worth of two single family homes.
Meaning that if each property can rent for $1000, your buying power very likely will get you $3,000 in rent from three condos compared to $2,000 in rent from owning two single family homes.
Obviously, markets vary greatly. But in my market, here in Philadelphia, that is certainly true.
- Condos Are In Desirable Locations, so they attract higher quality tenants.
Due to the lower cost, you can buy a condo in a better area than the same money would buy for a single family property. We are talking about going from a D-Class to an A Class neighborhood.
I own a property management company so I know, lower rent units tend to attract lower quality tenants that are a lot of work.
In fact in my property management company I see the 80/20 rule constantly - 80% of our work load comes from the 20% lower rent units that we manage.
Frustrating since the lower the rents, the lower profit we are making. Virtually all of our workday effort is spent working for the lowest yielding units that we property manage.
The goal is to spend less time dealing with tenant hurdles and more time on things that matter. Especially if you can do so with more money.
- Maintenance Issues Go Way, Way Down.
As a condo owner, you are responsible only for what is within your own four walls. You own that area Fee Simple.
That’s yours, that space is your responsibility.
But outside your walls, in the common areas, that you own that as a group, so finding a roofer, getting the front steps repaired, shoveling the walks, mowing the lawn...these are all someone else’s problems. The board is responsible to get these items repaired, not you.
- Insurance Costs Go Way Down.
This gets overlooked in everyone’s numbers. The cost to insure a condo is much less than a single family home. The insurance company knows less can go wrong with the property and they also know the building as a whole has additional insured, to help carry the risks.
So these are the reasons that it has always been hard for me to dismiss condos.
The upsides have so much potential and scalability that I think I will forever go back to trying to figure them out. No one one else wants them and that keeps screaming “opportunity” to me.
I don’t think other investors see the benefits the same ways that I do, and they don’t calculate the above benefits into their numbers as I do.
If the insurance is less, that should be added into your numbers. Time value of money? Quantify that.
But there are certainly downsides, which are of course what are creating the upsides.
These downsides are why rental property investors ignore condos altogether.
But back to Warren Buffett: “fearful when others are greedy, and greedy when others are fearful.”.
Here are the downsides:
- I’ll start with the reason most investors think condos are a bad investment. The condo fees!
Condo fees are paid to the association, typically monthly and investors see these as extra expenses that steal their cash flow. That’s not completely accurate.
True, the HOA Fees are an expense; but part of the fees should be viewed as capital expenses since they should be going towards eventual repairs and improvements.
The “should” part of that will be covered in the 2nd podcast to help you determine if “should” is what is actually happening.
The problem is many investors ignore capital expenses in their numbers when analysing deals, be it a condo or not. How much rent can I get? How much is the mortgage payment? Because the remainder is mine. No!
It's as if they have no idea things break.
When a 13 year old hot water heater, that has a 10 year life expectancy breaks, they will be shocked by their bad luck.
That’s not bad luck….13 year old hot water heaters break.
When you are analyzing a deal, you calculate capital expenses into your numbers.
You might want to check out my podcast where I go in depth on how to analyze rental properties.
These same investors see HOA fees and they are shocked.
I guess if you don’t deduct capital expenses out of your rent, when analysing deals then you would be shocked if someone else does it.
A large portion of HOA fees should be money being set aside to fix the things you would be having to fix if you owned a single family home. The roof, for example.
Here’s a Formula: Subtract from the HOA Fees the Capex Deduction you would be paying with a single family, then subtract your insurance savings, minus your time value of money, minus the increase of rent due to any amenities like gyms, courtyards, pools, meeting rooms.
That’s not a formula I want you to use, as you are hopefully already crunching in your numbers as you analyze your deal, like adding in the insurance cost, the property tax, the expected rent, the HOA fee, and the cap ex anyways.
And since the insurance and capital expenses would all be lower, the HOA typically pays the water bill and the rents would be higher, these would naturally be offsetting the costs of the HOA fees anyways. You just might not see it like you would with the above formula.
What I do want you to see is that if the numbers work in a deal, then the numbers work.
- Special Assessments – The condo association might come across expenses they didn’t plan & save for with the HOA Fees; like new windows, elevator repairs or a new roof.
When this happens each condo owner will need to pay a Special Assessment fee to pay for it. This could be a one time charge, or an ongoing fee till that debt is paid for.
Due diligence before you buy into an association is important and the 2nd companion podcast is where we will dissect that.
But if you are buying into an association that seems ill prepared, you would just calculate that into your numbers. You could probably Increase your capital expense numbers.
Remember, special assessments are not expenses easily passed onto the tenant through rental increases. A renter doesn’t care if you need to put on a new roof. He can just move.
These two downsides are why most investors denounce condo investing but they really don’t concern me. Again, if the numbers are right, they are right.
But where I get stuck trying to make condo investing work are on these following hurdles:
- Harder To Force Appreciation.
If the strategy is to force appreciation so you can reuse equity again and again to build your portfolio (and I hope it is) you might have a harder time doing it with a condo.
Forcing appreciation, sometimes called the BRRRR method, an acronym where you buy a property, renovate it, rent it out, refinance it so you can repeat by using that money to buy your next rental property, requires you to so greatly improve a property to where you can create and then use that extra equity.
Equity is the amount the property is worth, over the debt (the mortgage) you have on it.
Most lenders will only loan you 75% of that equity and even if they will let you use more I advocate that you leave 25% of the equity anyways, as that’s your safety plan....
Your exit strategy if things go bad, or if the market values greatly dip.
To execute a BRRRR and to Force Appreciation by improving a property, it might be hard to find condos that need that much improvement, enough that you can greatly impact the equity.
Remember many of the condo repairs are out of your hands, like replacing windows, roofs and exterior features and the curb appeal.
But you can also get equity when you buy it, if you get a discount - meaning if you pay less for it then it is worth.
Which you might be able to do because of this fourth downside.
- Lending Can Be Very Difficult To Get On A Condo.
A single family home is very straightforward for a lender - they evaluate your financial situation and they make sure the property is worth more than they are lending on it, so they feel safe enough should you not be able to pay and they need to cover the loss through the property itself.
But with a condo, the lender will need to work harder to feel they are protected.
And that’s problem one….
you’re asking them to work harder.
Problem two is that single family properties fit into their system;
but you and your condo purchase are not only making them work harder, but you are taking them out of their system, putting them at risk of missing something.
And even if things look fine, the condo association itself is a another big risk...a buyer is a risk, a property is a risk and now they have this 3rd entity that puts them at risk. That’s 50% more risk just from adding a 3rd party.
So they will need to do their due diligence:
- The lender will want to review the finances of the homeowner’s association and evaluate if the association is even a good risk.
They will want to see if other units are in foreclosure; because that also creates a big concern for an association, as owners in foreclosure are very unlikely to be paying their HOA fees, which is a big problem for all the other unit owners.
If the dues aren’t covering the incoming expenses, that’s a big problem!
- The lender will want to review the condo docs, which act as a legal agreement, and each building is very different, so that’s more work.
The lender will need to review these to look for red flags, anything that they feel might depreciate the value of the property, putting their asset at risk.
As a rule condo docs tend to be pretty faulty and not written with lenders in mind, so lenders often refuse to loan on a building just based upon what they see there.
- They will generally require a percentage of owner occupied units.
Fannie May Guidelines alone require that less than 50% of the units in an HOA can be rented out and Fannie May accounts for 83% of all loans.
The reason is that owner occupied units are better cared for than rental units. So if a loan is possible, it will probably be a conventional loan
- The lender will want to review the finances of the homeowner’s association and evaluate if the association is even a good risk.
The reality is, you very well might need to pay cash to buy the condo unit and this is a big reason why it is likely being sold at a discount.
- That’s Why They Are Very Hard To Resell.
Again, a big reason condos sell at such deep discounts is that lenders often won’t loan on them.
So there goes your exit strategy of being able to quickly sell it if you need to!
If lenders won’t loan on a condo, that means you will need a cash-like buyer to be able to sell it and since many other condo sellers, just like you, also need that same cash-like borrower, you have a problem.
There will be far more condos available than people with that amount of cash available to buy them.
So this is hard for me….I’m a cash-like buyer and I could be a king here in this buyer’s market.
But if I choose, or need to sell my unit, I won’t be king anymore….the buyers would be.
I wouldn’t be able to easily sell my unit, so I would have to expect it to take considerable time.
- Cash Out Refinancing Would Also Be Very Difficult To Get.
Having trouble selling it wouldn’t be ideal; but I think I could handle that.
I’m not sure if I would try to manage that hurdle by financing it for the buyer myself or not.
But my problem is that if lending is so tough to get, that means re-financing it would also be tough and that’s my whole investment strategy! I force a property to appreciate and I take that equity back out so I can purchase more properties to do the same thing.
But what if I can’t take my cash back out? I would be stuck with a difficult to sell property and unable to use my equity to farther my investment.
- By Laws:
The board might try restricting investors in rental units in the building. You would probably be grandfathered in if you purchased it before the board created that rule. But not necessairly. And its unlikely that if you sold it, that buyer could keep it as a rental.
If you had a tenant placed, before that rule you would be fine with that current tenant; but if they move out, you might be restricted from getting a new tenant.
The same with short term rentals, like AirBnB. An association could pass a new rule against it. Again, you might be safe grandfathered in, or you might not be.
If your investment strategy and numbers rely upon the unit as a short term rental, you might have a problem.
The exit strategy of renting it conventionally would need those numbers to work.
So that where I am on condo investing...there are some very clear, profitable benefits; and most of the determinants don’t bother me.
Where I am stuck is the difficulty with the lending. Particularly with the hurdles of being able to do Cash Out Refi’s. I need to know I can get my equity back out. If you have anything to ad, post a comment on this video and lets get a smart discussion going.
If you are considering a condo watch the 2nd podcast on evaluating a condo investment.
I am Joe White, with the Grow Real Estate Investing Podcast.