Invest in a Condo To Rent: Most Investors do But I don`t
You are in the market to invest in real estate. You have looked upon various deals but every deal is like breaking your bank. Then, one fine day, you occur to condos and instantly recognize them as your long-awaited opportunity to enter into real estate investing. They are cheap, listed for a few dollars and even are renting well. You get instantly lured and make up your mind to invest in a condo. But do the condos really make a good investment?
Don’t hurry to invest in a condo just because it is an affordable real estate and can easily bring rent every month without much of a headache. Investing in a Condo may project 8%-10% returns on your money. But, the risk that comes with this investment is not worth your efforts.
What is a Condo?
The condo is an often-used short term for Condominium. These are basically private-owned residences within a large building or a community. In general, a condo is not to refer to a type of property but the way, a property is owned.
A condo is somewhat similar to having an apartment in which each apartment has an individual owner. Whereas in an apartment, there can be multiple units. But all the units are owned by one individual or by one company.
In a Condo arrangement, the owners share the common areas including the land on which the condo is built and the exteriors areas like garden, pools, parking areas, clubhouses, etc. It’s more of a community living under one space.
Is it Worth Investing in Condos?
Investing in condos is trying to capture the beauty of a rose having thorns with tight hands. No doubt the rose is beautiful but that doesn’t mean you can hold it tight in your hands. Likewise investing in condos may appear profitable but most investors clearly turn a blind to the risks.
The Kind of investors who stay interested in investing a Condo are
- A First Time Investor having an aspiration of earning some cash flow but have a little investment in hand.
- An Individual who has saved a lot in his lifetime and is now thinking of a condo investment as a retirement home, or a source of some income after the retirement.
- An Investor who owns multiple rental properties in their portfolio but not a single condo in it.
Do you know what is common among all the above types of investors? Nobody has got any kind of prior experience investing in condos. They are most likely to be unaware of the risks of investing in a condo. Though there are still some investors who have cracked the code of Condo Investing. But they are few and certainly have learned from their lessons in the past.
I must say if you belong to any of the above three classes of investors. Condo Investing is not worth your time. What you should do instead, that you will learn at the end of this article.
Read: How to Start a Rental Property Business From Scratch?
Why Do Investors consider Investing in Condos Worthy? (Even it`s not)
1. Low Entry Point
A condo of 516 sq ft in Austin Texas starts at about $69,900 whereas a Single Family Home starts at about $280,000 for a 520 sq ft area. Consider yourself as an investor who has few dollars in hand. Which real estate will grab your attention? Clearly it is the condo investment that will lure you for its low price.
Think Why Condos costs less than a Single Family Home even if both have about the same area.
2. Cost on a Dollar
A $69,000 condo easily rents at $900 in Austin, Texas. And for a Single Family home which costs about $280,000 rents at about $1650. Now if you calculate the Gross Rental Returns from these two different properties, it would come as
Gross Rental Returns (GRR)= (Annual Gross Rents/ Property Value)x100
GRR (Condo)= 15.65%
GRR (SFH)= 7.07%
If you have bought these properties in cash, the condo will give you a 15.65% return on your money whereas the SFH will return you a 7.07% return on your money. Clearly, a condo provided a better cost on a dollar as compared to returns from a Single Family Rental.
Condo may visualize a better flat out return on the invested money. But it is just one way of calculating returns and the investor clearly hasn’t accounted for the expenses that will occur on his condo property.
3. Managing the Rental Business
Not every investor wants to deal with tenants and toilets. And having a property rental business, maintenance requests from tenantsmaintenance requests from tenants is a common routine. But when you invest in a condo, the maintenance requests are the responsibility of the HOA`s (Home Owner`s Association).
You pay some amount monthly towards HOA Fees and then they care of the maintenance of your unit. In general, the HOA takes care of (be it written)
- Floors, Walls, Paint and Ceiling of the Unit
- Trash Removal
- Pool Maintenance
- Exterior Maintenance (Landscaping, Boundary Walls, Parking Spaces, Etc. )
Expect to pay about $100 on a lower end and up to $700 on the higher end towards HOA Monthly Fees.
4. Better Control Over your Property
The HOA is taking care of your investment property. They make rules and limit the bad behaviour of the people living in that society. Moreover, societies with condos have more owners living rather than renters.
This means the upkeep of the society will be better taken care of compared to when more renters live in a society. With this perspective, an investor feels that he has better control over his property.
Not every HOA is the same and it can be a case with your HOA. What will you do if they are not managing the society in a proper manner? What if they impose unwanted rules? There is nothing much you can do about it. The HOA has more power than you think.
5. More Amenities Attract More Renters
No doubt about a condo living that it offers extensive amenities to the people living in these societies. Most condo buildings have a pool, gymnasium, spa, etc that can easily attract more renters to your property.
Even, the condos that are being built today are within the city and more and more people want to live close to the city. With such a notion, an investor clearly assumes that investing in a condo is a much better deal. He can offer extra amenities and that can be a driving point for his sales.
If you see the trend more and more people are renting single family homes today because of its privacy quotient. People are more concerned about their privacy. Condos mostly attract those groups of renters that are college students and single working professionals.
Why You Should Not Invest in a Condo?
Imagine you have limited equity to invest. You invested it thinking you will get some monthly cash flow but after some time of investing the money, you lose it all. How would you feel? Investing in a condo can run you to that situation if you aren’t careful.
If you are unaware of negative cash flowing property, a condo investment can exactly do that to you especially when you have no experience of investing in rentals so far. So in my opinion, a first investor or a beginner in the condo domain should stay away from investing in a condo.
1. Rental Cap
Most of the HOA has a certain limit on the number of units that can be rented vs the owner-occupied properties. Even worse, some of the HOA doesn`t allow a single condo unit to be rented. Imagine purchasing a condo under one such HOA. It can occur because you haven’t asked for it, or you had no knowledge of it prior to this.
When you purchase a condo, you agree to the terms and conditions of the HOA. Even if the condos haven’t reached the 20% renting threshold (Common Threshold in Most HOA), you can still face troubles in renting due to HOA rules. Some of these common restrictions include
- There can be a waiting period for you to be able to rent your unit. An owner must occupy the unit for at least a year before renting it to someone.
- Owners can rent their units only once or twice a year.
- There can be some restrictions regarding the lease period.
You don’t have control over the policies and the rules of HOA. New rules can be implemented anytime which can cause a wrench to your plans. Your business ripped off, equity got locked. Have a good time finding sellers for the property.
2. Expenses can go over Budget anytime
The biggest risk of owning a condo is the expenses which can go over budget anytime. The responsibility of maintenance comes under the HOA. For maintenance, HOA conducts special assessments. If the building needs repairs and budget exceeds the reserves of the HOA, you have to make additional payments.
Trust me, HOA Assessments can be very costly sometimes. It can even break your bank. And if you have little margins on your hand, you can instantly occur to negative cash flowing property. Never invest in such a property where you have no control over things.
Read: What to do if Your Rental Property is generating Negative Returns?
3. Securing a Mortgage
You can always own an investment property by using some kind of leverage. Even, you can invest in a rental property by putting as low as 3%-5% down. But investing in a condo is altogether a big task in itself.
Read: How to Buy a Rental Property with No Money Down?
First thing, not all condos can qualify for financing. A condo must be approved under either Fannie Mae or Freddie Mac. The Condos which aren`t approved can`t be qualified for conventional loans. Even if they do, most lenders require at least 25% down. A 25% down even on a $69,000 condo comes at $17,250.
Though there are still some condos where you are good to go with FHA Loans which only requires 3.5% down. But the condos which have been approved under FHA Loans have strict policies regarding renting your unit and may not be investor-friendly.
Furthermore, the Condos that can’t qualify for any type of financing are
- Condominiums that operate as Hotel or Motels
- Condo Projects that have additional business arrangements like clubs and spas
- The HOA which charges additional membership fees for providing amenities owned by third parties like clubs, spas, etc.
- Condo Projects that have a lien on their name for unpaid expenses
- The Projects which have commercial spaces exceeding 25% of the project space.
- The Condo is an investment security registered with the US SEC (Securities and Exchange Commision)
4. Refinancing a Condo
You build equity in one of your investment properties and then refinance it to buy more income-producing properties. But when you want to refinance a condo, it’s not an easy thing to do. There are many hurdles on the way of refinancing a condo. Similar to financing, a condo must be approved to get a refinance.
In order to get a Refinance on your condo, you must meet these requirements
- You must own the condo. It shouldn’t just be the right to use and have a clear title on your name.
- The Condo owner must have sole and undivided ownership on the condo unit.
- The Rental Cap must be met. In some areas, it is 90% and in some areas, it is 75%. This means, 90% or 75% of condos must be owner-occupied.
Clearly the cons of investing in a condo outweigh the pros of investing in a condo. You are then better off with not investing in a condo. Rather, you must put your attention towards buying Single Family Homes.
The Single Family Homes make a great rental property and still comes under an affordable class of real estate. The best benefit is that you are in 100% control of your Rental Property.