by Ben Leybovich
A friend who happens to also be a business partner in one of my non-real estate ventures reached out this week with a question. He does this from time to time, seeing as I am such a big shot real estate expert and all…
This time, the text read: Hey, Ben – how about this condo…?
This was worth a telephone call. He needed to understand a few things!
Two Basic Reasons to Buy Real Estate
There are only two reasons to buy real estate – cash flow and capital gain. Cash flow accomplishes the objective of financial freedom, which is defined as capacity to generate income outside of W2/1099. Equity, on the other hand, builds the balance sheet, which makes us rich. No big, earth-shaking discoveries here…
Why Condos Are Problematic
Indeed, condos are problematic with respect to both of the stated objectives. First, by and large, condos don’t appreciate as much as free-standing single family residences. Also, the cash flow can be unpredictable…
While there are obviously exceptions to the rule, mostly this is true, and there is a good reason for this:
Condos have an extra cost of ownership, which most houses do not — the condo association fee. Let’s remember that a lot of what drives values of owner-occupied real estate is availability and affordability of credit, which is to say the more people can afford to borrow, the more they will pay. Consumerism galore.
Well, when qualifying folks for mortgage loans, banks underwrite two metrics: the Debt to Income Ratio (DTI) and the housing expense ratio. I haven’t looked at the exact percentages in a long time since they are not pertinent to my business model, but essentially you are permitted to spend only a certain percentage of your income on all of your combined expenses, not including the debt service on the mortgage loan that you are applying for. And that new mortgage payment can’t inflate your total DTI above a certain percentage more.
Therefore, since your income is what it is, the crux of the matter relative to how much you can borrow is a function of expenses. Obviously, anything that adds to the expenses has the effect of diminishing the amount of P&I that your DTI can absorb…
Condo association fee is an expense, is it not? If your DTI permits your total hosing expense to be $1,200/month, then without a condo association fee, you’d be able to borrow the full amount of mortgage, resulting in PITI of $1,200. However, if there is a $275/month association fee, then since your total housing expense has to remain at $1,200/month and since taxes and insurance are what they are, you now must compress the P&I to result in lower debt service by $275/month. Well, crap…
Such is the logic. There are caveats, exclusions and intricacies that apply. If interested, please do further research. But since prices are set by what ready and willing buyers can afford to pay, which in a lot of ways is a function of what they can borrow, hopefully this explains why valuations of condos are structurally compressed.
So What’s the Problem?
The problem is that we want two things in a real estate investment – cash flow and equity appreciation. The condo association fee compresses appreciation of equity, as we just discussed. And since rents on most condos are not higher than rents on SFRs, but there is this additional and often substantial expense, the cash flow objective is also problematic indeed.
We have many “wants” when it comes to our investments, but there is only one “must have” — control, and this is perhaps the biggest issue with condos. The association fee will go up in tandem with CapEx, and unless you have substantive vote on the committee, you won’t be able to avoid paying.
Importantly, as that fee goes up (while the building is aging), your rents will likely not keep up. There’ll be newer and better amenitized condos in the marketplace by then. Ouch.
So, these will get cheaper, and investors will start buying more and more of them… because investors often think that cheap is good. Guess what? When there are too many investors in a condo development, the banks lose appetite for providing mortgages to investors, which completes the spiral cycle, and when you are ready to refi and bridge the equity, you may not be able to.
There is but one strategy that works well with condos, but that’s beyond the scope of this article. All and all, there are some serious problems with condos. Be smart!
[Editor’s Note: We are republishing this article so our newer members can weigh in!]
Interested in Finding out More? Reach out below
Address: 1415 Main St. #823, Grandview, MO 64030
Ireland Investments llc
This information is intended only for the use of the intended recipient(s) and it may be privileged and confidential. Please note that any views or opinions presented in this post are solely those of the author and do not necessarily represent those of the company. This is reposted information and is not original thought of Ireland Investments or anyone associated with the business.
Popular areas we service;
Kansas city Missouri, overland park Kansas, Kansas city Kansas, Olathe Kansas, Independence Missouri, Shawnee Kansas, Blue Springs Missouri, Lenexa Kansas, Leavenworth, Kansas, Leawood Kansas, Liberty Missouri, Raytown Missouri, Gladstone Missouri, Grandview Missouri, Belton Missouri, Prairie Village Kansas, Gardner Kansas, Raymore Missouri, Grain Valley Missouri, Ottawa, Kansas, Lansing Kansas, Excelsior Springs Missouri, Merriam Kansas, Harrisonville Missouri, Cameron Missouri, Mission Kansas, Kearney Missouri, Smithville Missouri, Pleasant Hill Missouri, Oak Grove Missouri, Bonner Springs Kansas, Roeland Park Kansas, Parkville Missouri, De Soto Kansas, Richmond Missouri, Greenwood Missouri, Paola Kansas, Basehor Kansas, Tonganoxie Kansas, Odessa Missouri, Peculiar Missouri, Platte City, Missouri, Higginsville Missouri, Lexington Missouri, Edwardsville Kansas, North Kansas City Missouri, Osawatomie Kansas, Louisburg Kansas, Fairway Kansas, Mission Hills Kansas, Sugar Creek Missouri, Riverside Missouri, Buckner Missouri, Pleasant Valley Missouri, Lawson Missouri, Plattsburg Missouri, Lake Lotawana Missouri, Weatherby Lake Missouri, Wellsville Kansas, Edgerton Kansas, Westwood Kansas, Garden City Missouri, Gower Missouri, Claycomo Missouri, Lone Jack Missouri, Drexel Missouri, Lake Tapawingo Missouri, Glenaire Missouri, Dearborn Missouri, Avondale Missouri, Osborn Missouri, Sibley Missouri, Oaks Missouri, Unity Village Missouri, Levasy Missouri, Randolf Missouri, River Bend Missouri, Jackson County Missouri, Johnson County Kansas, Clay County Missouri, Wyandotte County Kansas, Cass County Missouri, Platte County Missouri, Leavenworth County Kansas, Miami county Kansas, Lafayette County Missouri, Ray County Missouri, Clinton County Missouri, Bates County Missouri, Linn County Kansas, Caldwell County Missouri, Crossroads Real estate, 18th and vine Real estate, Hospital Hill real estate, library district real estate, longfellow real estate, dutch hill real estate, quality hill real estate, river market real estate union hill real estate, Greater downtown KCMO real estate, East Side KCMO real estate, Midtown KCMO real estate, Westport Real estate, Hyde Park real estate, Northeast KCMO real estate, Northland real estate, Plaza Real estate, South Kansas City Real estate, Fairway Kansas real estate, Kansas city Kansas real estate, lake quivira Kansas real estate, Lenexa Kansas real estate, Mission hills Kansas real estate, overland park Kansas real estate, prairie village Kansas real estate, Shawnee Kansas real estate, weatherby lake Missouri real estate, westwood Kansas real estate
Leave a Reply