Learn the ins and outs of investing in condos

March 29, 2013

Second in a series

Buying and renting out a condo may be the way to go for people who want to invest in property but don’t want the responsibility of owning, renovating and maintaining a single-family house.

Before buying a condo, there are three things you should learn about.

First, you should have a professional home inspector examine the unit’s components and systems. Second, you need to study the condominium’s financial statements. This examination is designed to determine if it is solvent on a day-to-day operating basis. The financial exam should also assess whether the condo’s reserve account will be sufficient to handle any scheduled and unscheduled repairs and replacements. If the condo does not have sufficient reserves, there is likelihood that you will incur a special assessment. Special assessments can seriously cut into your profits.

Third, you should carefully review the legal documents — including the declaration, bylaws and house rules — that govern your condo unit’s use and ownership.

The declaration will detail the condo unit’s legal existence and describe the unit’s dimensions. The declaration also will identify the common elements (such as hallways, lobby, stairway which are used by all condo-unit owners), and limited common elements (such as storage units, parking spaces and balconies, which are generally for one unit’s exclusive use). The declaration also will spell out the percentage interest each unit possesses in the condo association.

The monthly condo fees are assessed in proportion to each unit’s percentage interest. The declaration also will reveal if there are any restrictions on your unit’s sale — whether the association has the right to purchase your unit.

The bylaws outline the condo association’s rules of operation for annual meetings, voting, officer elections and the board of directors. Bylaws also specify whether a unit can be rented, and if so, under what terms. It is critical that you confirm that you are able to rent the condo unit before you buy it.

Many condo associations restrict how owners can rent. These restrictions often are approved by unit owners to comply with a Fannie Mae requirement that no more than 50 percent of the units can be investor-owned for one to qualify for financing.

Fannie Mae guidelines also require that, to qualify for financing, the association not have too many delinquent condo fees.

House rules are binding on owners and tenants. They cover things like pet policies, move-in and move-out policies, penalties for noise or other nuisances. You need to become familiar with the house rules. You also need to attach the house rules to your lease and make sure your tenants agree to comply with them. It is a good idea to add a clause to your condo lease that makes your tenants responsible for any fines the condo association imposes on you for their violations.

One of the main benefits of investing in rental condos is that you are only responsible for maintaining the condo unit’s interior. All other systems and components such as the roof, basement, HVAC, plumbing and electrical systems are generally the condo association’s responsibility. You are still responsible for those systems that are contained within your unit.

Another advantage is that when those systems need repair, the board of directors is responsible for making them. Granted, they make those repairs using your condo fees. But you are not necessarily the one who has to find, contract and supervise the repairs.

There also are drawbacks. When analyzing whether your investment will generate a positive cash flow each month, you have to factor your condo fee into your mortgage principal, interest and taxes and all other expenses.

Another potential negative is that a distress sale in the building can negatively impact all the other units in the condo. So if only one or two owners have financial reverses and have to sell their units at a discount, they will drive your unit’s price down as well.

There is always the risk that your fellow owners will vote to prohibit or severely restrict renting the condo units. If that happens, you may have to sell at a time when the market conditions may not be favorable.

Finally, condos often suffer from poor or tyrannical management. Therefore, if you decide to invest in rental condos, you should strongly consider becoming actively involved in their governance.

You should get to know the other owners, consider running for the board and at a minimum, attend every condo meeting.

Next time: Investing in mortgage notes

Harvey S. Jacobs is a real estate lawyer in the Rockville office of Joseph, Greenwald & Laake. He is an active real estate investor, developer, landlord settlement lawyer and lender. This column is not legal advice and should not be acted upon without obtaining legal counsel. Jacobs can be reached at 240-399-7900 or ask@thehouselawyer.com.

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