Thinking of Buying a Condo - Top 3 Cautions
3 Things You Need to Know About Condos
The Real Estate market is going full steam, here come the condos!
Charleston, SC, real estate, and many other places in the country, are currently “seller’s markets”. During a “Seller’s Market” phase, more buyers begin to look at purchasing a condominium. Why do condo sales lag behind homes during average market conditions? Price, availability, location, etc. combined with scarcity of affordable homes are make owning a condominium more attractive to some. But condominiums and homes have important differences that can impact your investment. What do you, the consumer, need to know about them? Three main differences between the two are ownership, financing, and insuring.
Many are confused about what a condo is, and how it is different from a townhouse or a single family home. It is really quite simple. If you own the land (the dirt) under your residence by yourself, then your home is not a condominium. On the other hand, if your home is on land that is owned by a condominium regime, you own a portion of that land, but it not divisible from the other pieces. You can sell your condo without others owners doing the same, but your home can not be disconnected from the shared land and responsibilities of the development.
When many people think of condominiums, they envision tall buildings that are comprised of different residences. But a row home with nothing but sky over it can be a condo. Even a home that is not attached to any other homes can technically be a condominium. So, a residence is not defined as a condominium because it is in a stack of other condos, one on top of the other.
Condo regimes can be compared to communism. All for one and one for all. When you buy one, you also are buying your percentage of the the total development. There are good and bad to both. Most important is for you to make an informed decision. Before you start looking at residences, take a few minutes and decide whether you are open to buying a condominium. You will save yourself the heartbreak of seeing one, falling in love with it, only to then learn that you can’t live with the different risks involved. On the opposite end, if you decide you are willing to consider a condominium, you have more variety.
Condos have a perceived advantage that the maintenance and upkeep of its exterior is done for the homeowner through the regime. In exchange, you pay a monthly fee to a management company, usually called a regime fee. You do not have to worry about neighbors junking up the place by not caring for the outside of their homes. The downside is that a portion of your monthly regime payment will go to doing repairs on condos that are not yours.
Condominium regimes are owned by separate companies. A set percentage of your monthly regime payment goes to paying them for their services. The remainder is used for building upkeep, landscaping, and for the building(s)’ exterior insurance policies. Regime fees can increase. Pay special attention to how much and how often the management company is allowed to raise their fees. If the regime management company does not have enough money collected in reserve for a major necessary repair (re-roofing all the units is a good example), then you, the property owners have to make up the difference. This is done by taking the cost of the repair and dividing it among the owners. The owners must each pay their portion of the regime shortage, called a “special assessment”. Sometimes these repairs are needed for all units, other times they are needed for just a portion. But in either case, all owners are equally responsible.
When buying a condo, you and your investment is at the mercy of the other condo owners. If some or many of these other owners begin to not pay their monthly regime fees, let alone special assessments, things can go south very quickly. You and other responsible owners have to make up the shortages of the others, or risk the development falling into financial instability.
More often than not (it seems), condominium developments are involved in some stage of a lawsuit with the construction company, the maintenance firm, etc. These lawsuits affect the value of your property.
Before purchasing a condominium, give thought to whether you are comfortable with the shared ownership of your property and the risks that brings. Be sure the your real estate agent, your attorney, and/or yourself thoroughly read all the regime documentation to see if there have been special assessments, how much and how often they were, and if it was or is currently involved in any lawsuits.
Financing condominiums is not for the faint of heart. Mortgage companies/banks much prefer to lend money to you to purchase a single family home, or a fee simple townhome. Their reasons are mostly for the reasons I outlined above. Mortgage companies are very finicky when it comes to condos. Remember, lenders make decisions to loan you money to purchase a home based on numerous risk factors. In order for them to make money, they need to write loans that have a good chance of being repaid. Condominiums have a higher risk factor for default for several different reasons:
Condos: Know before you show.
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- If the monthly regime payments increase because the management company has a shortage, that increase can push some owners over limit of what they can afford. There will be more defaults.
- If the market changes from a Seller’s Market to a Buyer’s Market, some may not be able to sell because they owe more than what the condo is worth. Some begin to default, which causes the property value to decrease, which cause more people to be under water in their homes, which causes more defaults.
- Condominiums are often purchased as second homes or rental property. If an owner starts getting into financial trouble, they are going to pay the mortgage on their main home before paying for their second/rental home. Default rates are higher than normal.
- Because condos are often tied up in litigation of one kind or another, which impacts the ability of other owner’s abilities to sell theirs, leading to a higher default rate.
- Insurance coverage of condominium regimes can be increased. If and when it does, the extra expense is passed onto the owners, again increasing the default rate.
Those and other factors make the mortgage companies very hesitant to loan money for the purchase of condominiums. Not all condominium projects have this issue, but enough do that the government requires all condos requesting loans have the “Condo Questionnaire” completed and submitted to determine if it is eligible for a mortgage. Loan officers must get the regime company to fill out and return the required “Condominium Questionnaire”. The FHA, Federal Housing Association, a public entity, determines what is on the questionnaire and, after review, determines in a condo development is “warrantable” or “non-warrantable”.
That is determined by these and other criteria:
- The percentage of full time residents vs second homes vs rented properties in any one project.
- The percentage of owners that are late and/or in default on their regime fees.
- Are there any active/ongoing lawsuits
- The number of the past and present “special assessments”, as well as any scheduled for the future.
If a condo is determined to be “warrantable” at this time, it can be financed with a mortgage. If it is “non-warrantable”, it can not have a mortgage placed on it. If it “warrantable” now, does not necessarily it will be at a later date.
When deciding whether buying a condominium is an option, remember that the financing issues discussed above not only affect you purchase of the dwelling. It also weighs heavily when you go to sell it.
All purchasers of condos should satisfy themselves that the condo development is warrantable --- one that units can be financed. Real estate agents can assist with determining this. The big issue, even if one is paying cash, is how much trouble will you have in selling when the time comes to sell. The big word when purchasing a condo is "caution".
If you plan to sell the condominium in the future, consider:
- Even if the condo is “warrantable’ now & you can get a loan for it, does not mean that it will be when you sell it.
- “Non-warrantable” condos will be worth less because only cash buyers can buy them. Your potential buyers are dramatically reduced.
- If your budget can handle your loan payment, regime fee, and homeowner’s association fee, make sure you leave yourself room for any special assessments or lawsuit expenses.
- Be sure you are prepared to be able to pay more into the regime if the property insurance goes up.
- Remember, you are responsible for obtaining insurance to cover the contents and the interior for your unit (sheetrock,appliances, furniture, floors, etc.).
- Weigh the fact that if there is a hurricane or fire that damages the building(s), and some of your neighbors did not have their interior insured, the development can be rebuilt, but those may not. Again, affecting the value of your property.
When you purchase a fee-simple home (not a condo), your homeowner’s insurance is fairly straight forward. The insurance company will walk you through the different options and help you decide which is best for you. Here, you get insurance for the amount it would cost to rebuild the structure, plus contents, etc. You do not insure it for the price of the property. The reasoning? The structure may be destroyed, but the land will still be there. You don’t insure the land.
With condos, the condo development itself gets one large policy to cover all of the dwellings. This insurance protects the exterior of the building(s) itself only. As a homeowner of a condo, you need to get additional insurance for everything that is structural INSIDE the unit; sheetrock, ovens, flooring, etc. You also need enough insurance to replace your belongings, anything that is not attached to the building. And you are at the mercy of the other condo owners for them to have the correct insurance to rebuild.
Insurance companies can and do sometimes drop developments, just like they can and do homes. Another carrier will have to be found, but often, it is at a significant increase, causing your monthly regime to go up. If the government changes the flood map lines, your condo may need new flood insurance, again a potential increase in your expenses.
If you want to buy a condo or if you already own one, it is not all gloom and doom. Just be aware of the potential issues going in and ask the right questions. Be sure to work with a real estate agent that knows condos and that development particularly, if possible. This applies whether you are looking to purchase a condo or sell one you own. Professional assistance is key. If you are selling a condo, ask your agent to get a mortgage company to do a limited review Pre-Cert. This will let you know if the project is FHA allowable or not, strongly affecting its market value. If buying a condo, balance the risk with its price. Every home is worth buying, the question is, at what price?
If you go into purchasing a condo with your eyes wide open, and take the risks into account when determining how much you are willing to pay for it, then you can get some fantastic deals. Go forth and condo all you want now that you are armed!