Potential real estate investors with cash burning a hole in their pocket offer turn to condominiums. Condos are usually cheap in comparison to houses, so it makes it easier for more investors to acquire them. However, there are some serious pitfalls to owning a condo as a rental property that should steer many long-term investors away.
- Rental caps are your enemy – Many condos have a limit on the % of rentals allowed in the building, known as a rental cap. Once that limit is reached, you are prevented from renting out your unit. If your investment is rented when the cap is reached, you might be OK until that tenant decides to leave. Once vacant, the HOA rules may have you fall to the bottom of the rental waiting list. When this happens, you can either occupy the unit yourself or leave it vacant. A condo without a rental cap can implement one later on, if the residents vote in favor of it. This is largely out of your control as the owner of one unit.
- Rental caps are your friend – Rental caps are bad for investors, right? Nope. As a condo owner, whether an investor or owner occupant, limiting the amount of renters in the complex is critical to the long-term value of your condo. Banks don’t like to loan on condos that are primarily filled with renters. Some banks stop making regular condo mortgages when the % of rentals exceeds 30%. Once it reaches 50%, no banks will make a regular condo loan. In the absence of conventional financing, the value of the condo tanks because only cash buyers or investors willing to take on arduous investor loans are willing to buy.
- You don’t control how your building is managed and maintained – The value of any investment property is linked to the condition of the building. A well-maintained building is easier to rent, rents for more money and will experience less maintenance costs over the long-term. In a condo, the homeowners association is responsible for maintenance of common areas, building systems and usually the exterior, like roof, windows and siding. There are well-run condos and poorly-run condos. A poorly-run condo may leave you with run down or outdated common areas. Worse, you could experience large and unexpected special assessments to cover the costs of needed repairs that were never budgeted for. You can certainly try to take an active role in the HOA yourself, but your one vote may get steamrolled by intransigent, cheapskate owners in the other units.
- HOA dues are tough on your cash flow – While you may be betting on appreciation, cash flow is important in any long-term rental property. No one wants to feed the cash flow alligator every month if the rent doesn’t cover expenses. A condo can easily have $300-$500/month in HOA dues that a single-family home or apartment building does not have. Not everything is bad about HOA dues. It does give you a predictable maintenance expense and removes the headaches of having to worry about it yourself. However, it is a forced savings plan that you may or may not benefit from, depending on how long you own the property. Let’s say the condo saves up $1M over 10 years to replace the roof & windows. You sell in year 9 of that cycle, never benefiting from all of those years of contribution. While you face similar capital expenditures in a stand-alone house or apartment building, at least you control the spend and do not lose out on any “forced savings” schemes.
- Litigation can ruin your day – Condos can run into litigation. Most often this is a construction defect lawsuit with the developer. A condo in active litigation runs into the same problem as a condo with too many renters. Regular condo lenders usually won’t make a mortgage until the condo exits litigation. Once it is done, the building can recover nicely, but you need to be prepared for the possibility that litigation extends for 1-3 years. If you are trying to sell during that time frame, your sale price will be seriously compromised.
Not all condos may be a bad investment. There may be opportunities for short-term gains or a chance to flip one after improving it. However, if buying a condo as a long-term rental, the buy and hold investor needs to enter such a transaction with full knowledge of some of the pitfalls that come with renting out a condo.