For years I’ve cautioned real estate entrepreneurs regarding the perils of buying condos as rental property investments. As with any type of property investment, there are strategies and situations that can make condos either good investments or financial disasters. Let’s look at the pro’s and con’s of adding condos to a rental property portfolio so we can develop objective criteria for evaluating most condo purchase decisions.
Let’s start by clearly identifying the primary characteristics and types of a “condominium” or “condo.” There are five characteristics that define specific types of condos in most markets. The first two are low rise or high rise, referring to the number of floors (stories) in the building. The primary reason investors should care if the condo is low rise or high rise is that mortgage lenders offer different interest rates for each. Most lenders in a particular market area define low and high rise using the same criteria, perhaps calling five floors or more a high rise. If the purchase is to be financed, we’ll need to check with our lender regarding their definition of low rise or high rise, loan qualification criteria and interest rates that apply to our particular type of condo.
Condos can also be attached or detached. Most condos are attached – one unit among many within a building. Detached condos can be found in some forms of a Planned Unit Development (PUD), where residential units are detached but maintain other features normally found in condos, such as shared ownership interest in common areas and some shared utility services. Investors should always check the zoning and legal definition of a property, especially detached units, to confirm their classification.
Another type of condo, condotel, is frequently found in resort areas and urban business centers. A condotel is basically a room in a hotel or similar facility that is sold and maintained as a condo. Condotels may comprise all the rooms in a hotel or just a portion. Mortgage lenders typically require minimum square footage and a kitchen or kitchenette to be eligible for financing. Standard features of condotels include availability of services offered to hotel guests, such as housekeeping, room service, a front desk, and use of the hotel’s recreational areas (pool, gym, etc.). A condotel is not a time share or fractional ownership unit, that’s a completely different type of property.
Let’s look at a few real estate investment criteria and pro’s and con’s as they apply specifically to condos.
Pro: Condos are often located close to business centers or resort areas, services and public transportation.
Con: Condos may be located in areas subject to street noise and traffic congestion.
Location is always the top consideration when buying any rental property, since location directly effects demand, income potential and long-term value. My recommendation is to look where demand is greatest, usually near business centers and resort areas. I’ll address discrete locations below as a feature.
Pro: Condo complexes typically offer amenities that would be more expensive in single family rentals, e.g. swimming pool, gym.
Con: Condo complexes often have restrictions on the number of rental units allowed, pet restrictions and may not always maintain common areas to landlord’s standards.
Conducting a thorough Market Rent Analysis provides insight into how the condo you’re considering stacks up against similar complexes and units in the area. Look for the small things that contribute significantly to income potential and value. For example, a condo can be beachfront (on the beach), beach view, ocean view (not on the beach, but water can be seen), within walking distance to the beach (open to interpretation) or a short drive to the beach. Each of those characteristics has a degree of value. I recommend sticking with beachfront.
Pro: Condos are typically priced lower than single family homes similar in quality and location.
Con: Low price often indicates low demand and/or low rent.
Pro: Costs for common area maintenance and amenities are included in the HOA fee.
Con: Utilities not billed directly to each unit can result in disproportional cost allocation across all owners.
For example, I managed several rental condos in a complex where each unit had a water meter, but the cost of water were measured at a master meter for the entire complex. Each unit paid an equal share of the complex’s total water bill in their monthly HOA bill, adjusted based on each unit’s bedroom count. This went on for almost 30 years, until an HOA board member who resided in the complex read the individual water meters over six months and found that three of the complex’s 38 units were using over 30% of the water. The billing policy was eventually changed so that residents shared equally the cost of water used in common areas, but was billed individually for water consumed as measured by each unit’s meter.
Ease Of Management
Pro: Complex management is usually responsible for problems with the exterior of the unit, neighbor noise and similar issues.
Con: HOA management and boards are not always responsive to resident needs and may not share our standard of care for common area maintenance.
A major consideration when purchasing condos is HOA management control over rental units. Some HOA’s cap the number of units that may be rented or have restrictive covenants that reduce market value, such as pet restrictions or unreasonable quiet times. Most HOA’s require a copy of the tenant’s lease and proof from the landlord that tenants have been properly screened regarding past criminal activity.
Net Operating Income
Pro: HOA fees spread the cost of common area maintenance across all the units in the complex, thereby reducing the cost impact on individual units when a major repair is required.
Con: HOA fees and special assessments for capital repairs or improvements can significantly reduce net operating income. To determine potential financial risk relating to HOA board decisions, review prior year financial reports (go back at least three years) and read the minutes of recent board meetings to see if any potential assessments are being considered. Also check for pending litigation that could trigger special assessments.
Pro: Condos with a great location, competitive features and in high demand may hold or increase in value during ownership.
Con: Condos are the fist property type to lose value in softening markets and the last to increase in value when markets recover. Condos in complexes with common areas that are not well maintained often do not hold value.
Ease Of Exit
Pro: Condos in desirable areas will usually sell quickly.
Con: Condos sell slower when inventory of single family homes for sale is relatively high or when the condo complex is poorly managed and maintained.
The above are basic considerations unique to condos as rental property investments. Always create a preliminary operating plan and budget prior to making an offer and research these considerations and others specific to the property you’re evaluating.
One last thing, is a townhome a condo? Although configured differently, townhomes are usually subject to the same investment considerations as condos.
Have questions about condos as rental property investments or other real estate issues? Drop me a line!