Is Now the Time to Buy Condo Foreclosures?

It’s probably just a coincidence, but a very large number of distressed properties in the nation’s leading foreclosure centers are condos. Florida, California, Nevada and Arizona are filled with condos, units which in many cases now sell at huge discounts.

Given vast supply, sputtering prices and interest rates around 4.5 percent, is now the time to buy investment condos, especially distressed units in distressed communities?

Condos
A condominium can be seen as a form of ownership rather than as a type of property. Physically, a condo might be a detached home, townhouse, apartment flat, professional office or industrial space. Shape and square footage matter with condos, and so do such paperwork as bylaws, declarations and budgets.

Condos began to be popularized in the 1970s, in part because they offered several core attractions.
First, they often have fewer square feet than a fee-simple house and thus a lower cost. Second, owners don’t have to worry about lawn mowing and snow removal because exterior maintenance is handled by the condo association. Third, condo projects often have amenities which are unavailable to individual homeowners. Fourth, unlike co-ops, condo units are individually titled and financed so buying and selling are equivalent to a fee-simple property transaction.

Condos, of course, also have aspects which can be unattractive. That exterior maintenance doesn’t happen by chance, there’s a condo association and the association is funded with a monthly condo fee. Don’t pay the fee and your unit can be foreclosed. Condo associations can have some picky — and very enforceable — rules regarding exterior paint colors, decoration, flags, pets, home offices, etc. In some cases developers sold units but then kept the amenities as income-producing assets. Lastly, if a condo has a big problem that costs lots and lots of money to fix, unit owners can be hit with “special assessments,” sometimes thousands of dollars. Just like condo fees, special assessments are a lien against the property and if unpaid can lead to foreclosure.

Condo Investments
“For investors — especially entry-level investors — condos have advantages over detached properties with one to four units,” says Jim Saccacio, Chairman and CEO at RealtyTrac.com. “Exterior maintenance is eliminated as a concern and the units are essentially self-managed by the tenant. The cost to get in has often been far-lower than the expense of a stand-alone property and condo fees are at least tax deductible for investors. Because the condo housing stock is relatively new there are few issues with age-related replacements. Given such attractions it has not unusual to find one investor with several units in the same condo project.”
 
Today typical condo prices are actually higher than fee-simple properties according to the National Association of Realtors. NAR says in May that an existing home was likely to cost $179,400 while a condo sold for $181,300. The single-family home median price was up 2.7 percent from a year earlier while the condo value had increased 3.4 percent during the same period.

However, these national pricing figures mask a marketplace reality: Home values are not increasing at the same rate in every market. Real estate is a localized commodity and in some markets home prices continue to take a beating. For instance, the Federal Housing Finance Agency says home prices in April rose 3.2 percent in the Pacific states when compared with a year earlier while they fell 4.5 in the South Atlantic region.

Condo Finances
The cost of a condo is not just the purchase price of a unit, it also involves the economics of the condo project in general. Getting a condo with a big discount may not be a good deal if you’re later hit with a massive special assessment or if the condo association actually goes bankrupt.

To buy condos successfully you have to carefully look at the unit, the project’s overall economics and the local marketplace. You want a project to qualify for FHA financing because it means that residential buyers will be able purchase with as little as 3.5 percent down. Also, HUD has waived its 90-day anti-flipping rule until at least January 2011, meaning that during this period investors can sell units in approved projects to FHA-qualified buyers without waiting three months after acquisition.

The FHA will not approve condo projects unless they meet certain baseline standards. Since last December HUD has had in place new and more liberal condo project condo project qualification rules. These rules suggest some of the issues condo buyers might want to consider. For instance:

  • The FHA will not provide loans for condominium hotel units (“condotels”), timeshares, houseboats, multi-dwelling units (units with more than one dwelling per condominium unit) and projects which are predominantly investor owned.
  • At least 50 percent of the units of a project must be owner-occupied or sold to owners who intend to occupy the units. (The old standard was that at least 70 percent of the units had to be owner-occupied and not more than 30 percent could be owned by investors.)
  • No more than 10 percent of the units may be owned by one investor.
  • No more than 15 percent of the total units can be in arrears (more than 30 days past due) on their condominium association fee payments.
  • Replacement reserves for capital expenditures and deferred maintenance must represent at least 10 percent of the budget. (This is hugely important. A condo without adequate reserves is a project just begging for special assessments. With reserves, more is better.)
  • No more than 25 percent of a project’s total floor area can be used for commercial purposes.

Even if a project is FHA-approved there are still big questions to ask. For instance, are you buying property as a residence or an investment? Using a property as a residence means easier access to financing and no worries about tenants, management or rental rates.

If you want property as an investment is it rentable? One of the problems in areas now saturated with foreclosures is that there are huge numbers of properties available and thus high vacancy rates. Such inventory drives down both purchase prices and rental levels.

What’s the local “absorption rate;” that is, at current sale levels how long it will take before all the properties now available are purchased. Shorter is better. NAR reports that as of May it would take 8.3 months to buy up all the properties then available for sale nationwide.
 
In addition to being FHA-qualified, condo buyers should ask about the project’s overall finances and condition. For instance, when was the last special assessment? Is a special assessment now planned or being considered? Is the association being sued? What percentage of the units are in foreclosure? What percentage of the units are not paying their monthly fees? Who owns the amenities? What maintenance has been deferred? Who owns the land (some projects are actually on 99-year land leases and will revert back to the developer’s heirs eventually). Etc.

What about past sales and the offering prices of units now on the market? Be sure to check back six months or a year to track recent sale trends. In my area, for example, there are particular projects where units are available for $25,000 — down from $100,000 in past years. Are such properties world-class luxury destinations? Not likely. Are they good investments? That’s a question worth study.

For assistance, work with a local real estate broker who has extensive condo experience and will act as a buyer’s representative. The reason to prefer an experienced broker is that past sale prices in slow markets often do not reflect seller “contributions” and other owner concessions, information knowledgeable brokers may have. You want a broker to represent you as a purchaser because then you’ll have an advocate, someone obligated to advance your interests.
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Peter G. Miller is syndicated in more than 100 newspapers and operates the consumer real estate site, OurBroker.com.

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