Thursday, December 4, 2008

Never Buy a Condo!

A condominium can be a nightmare for the average consumer, particularly if they pay too much for it.

NEVER buy a condominium!  OK, maybe not never-ever. But you wouldn't be inclined to read an article entitled "You really should think about a condo carefully before buying because a lot of people get burned badly."

And besides, that title is too long.

But seriously, you should think long and hard before buying a Condo. Why? Here's a short list:
1. You are not buying Real Property.

2. You are overpaying for what you are getting.

3. Prices can fluctuate wildly and go down dramatically.

4. Condo Boards are Hell.

5. Special Assessments are even worse.

6. All the pleasures of renting and all the pain of owning.
Let me review these items one at a time, and maybe you'll agree with me that you should never buy a Condo. Bear in mind that I've owned three and made money on all three. But even then, I don't recommend them to others or the faint of heart. I've also owned three "free-standing" properties and made much more money on those, as a percentage of the purchase price. You can make money on a Condo, sure. But you can make a lot MORE money on free-standing Real Estate!
1. You are not buying Real Property.  First of all, even though they call it "Real Estate" and legally it may qualify as "Real" Property, owning a condominium is really just gives you the right to occupy a certain portion of a property. In general, you do not own a section of land distinct from others. In fact, you don't even own a portion of the building you are in. Generally, as a Condo owner, you own the insides of your condo - basically everything up to and including the paint on the walls. In most cases, the plumbing and infrastructure are part of the common element, of which you are just a shareholder.

That's the rub. By owning a Condo, you are now an unwilling shareholder in a very, very poorly run Corporation (very few Condo Associations run smoothly, trust me). So any decision on the structure of the building or how to repair it has to go through the Condo Board (more about that later!). You have little or no control over your destiny as an owner.

And since you only own the land as a shareholder with the other Condo owners, you can't sell off your share to a developer, for example, only your rights to occupy. To sell the underlying land, you usually need a 2/3 or 3/4 agreement among owners (nearly impossible to get). In one situation I witnessed, a developer offered an initial "fair" price to buy out the owners of a run-down Condominium, only to be told by the Board that the Condo was not for sale unless the price was tripled. A year later, the Board realized that the Condo was falling down and that selling out would have been a good idea. Too late - the developer and the market were both gone.
Compare this to my experience with my Fee Simple (free-standing) home. A developer knocked on my door and offered me $200,000 over market value for the home. I said yes on the spot. I could because I owned the home and the land and everything and didn't have to get a "vote" on it.

2. You are overpaying for what you are getting.  The people who really make money on Condos are the developers. For example, take an apartment building with 10 units in it. As an Apartment building, it may fetch $1,000,000 in sales price (for example) if you were to sell it outright as an apartment building. There are not a lot of folks in the apartment building market, so the prices can be fairly low.

Take that same building and divide it into 10 Condos. You can sell those for $200,000 apiece and double your money. Why? Because Joe Working Class has $200,000 he can spend on a "home" or invest in an "investment" but certainly doesn't have a million bucks lying around.

In addition, you can easily get (or could easily get) home loans at reasonable rates with low down payments. If you wanted to borrow a million bucks to buy the whole building, you'd have to get a commercial loan and pay commercial rates, which is a whole different deal.

So it is lucrative to buy an apartment building, gussy it up and then sell it off as Condos.

In terms of bang for the buck, it also is not a very good value. Condos in a given market may cost 1/2 to 3/4 as much as a comparably sized standalone home, and thus are attractive to first-time buyers and folks without a lot of money. However, even at half price, you are getting less than half in value. Since you don't own the land the condo is under, you can't add on to your condo (make a 2 bedroom house into a 5-bedroom luxury mansion) and it can never appreciate as much. There are other, more pragmatic considerations, as we will see.

It may "cost less" to buy a Condo than a house, but you are getting less - a lot less - in the bargain.

3. Prices can fluctuate wildly and go down dramatically. 
When home prices go up, condo prices go up faster, as the high price of homes make buying a condo more attractive. In Northern Virginia in the late 1980's, the price of Condos skyrocketed, and many Real Estate Agents tried to convince me to buy a Condo for over $100,000 when similarly sized homes were selling for $150,000 to $200,000.

When the market went bust in 1989, the free-standing homes stayed about the same in value, but the Condo values plummeted. And this is very typical of the market, historically. In today's market, nearly everything is dropping in value. But Condos by and large are dropping faster and further than free-standing Real Estate. So if you buy a Condo, you might be in for quite a bumpy sleigh ride.

Condo prices fluctuate based on other factors as well. For example, many investors (and the developer) will try to keep the condo fees artificially low to entice buyers. Since most buyers purchase a home based on monthly cost (BAD IDEA for anything, see my other postings) if the Condo fee is LOW, then they can finance MORE to buy the Condo, and prices can go up.

The problem with this scenario is that if the Condo fee goes up (which it always does) then the amount available for monthly financing goes down, and hence the value of the condo.

For example, I bought a Condo for $40,000. The monthly mortgage was $300 and the Condo fee was $300. The insurance and taxes were another $100 a month. So for $700 a month, I could rent this Condo out and break even.

Now fast-forward 10 years. The Condo is now paid for. The Condo fee is now $500 a month and the insurance and taxes are now $150 a month. Rents have gone up to $900 a month there, so there is $250 left over to pay for the mortgage, if someone wanted to buy the unit and pay the same monthly cost as renting (why pay more to own? It makes no sense).

As you can see, $250 finances a lot less than $300, so theoretically, the condo should be worth LESS in value. As the other fees go UP, the value of the condo goes DOWN. And as people play with the fees, the values can zig-zag all over the place. Developers keep fees low, and prices are high. Then repairs are needed, so Condo fees go up, and prices drop. It is a see-saw effect.

Other scenarios include the neighborhood changing, a major assessment needed (more about that later) or a lawsuit involving the Condo is filed. An example of this latter case occurred where a friend of mine bought a Condo in Crystal City in the 1980s for $170,000, which was a lot of money back then when houses in the County could be had for the same amount. The developer cut corners on the construction and the sides of the high-rise started peeling off and falling on people and cars below. The Condo Board sued the developer.

Immediately, prices plummeted. One rule of thumb is that if the Condo Board gets involved in a lawsuit, prices drop dramatically. No one wants to buy into a lawsuit, and that is exactly what you would be doing if you bought a unit there. Add to that the uncertainty of the outcome (How much would the repairs be? Who would pay for them?) and the ugly scaffolding on the side of the building, and my friend's $170,000 luxury Condo is now worth $80,000 a few years later.

Now, eventually, the suit settled, and 10 years later, he sold at a tidy profit. But if he had to sell in the interim, well, he would have lost everything. And many people in his building did.

Condos fluctuate in value dramatically, and much more so than a free-standing home.

4. Condo Boards are Hell. I have alluded to some of the problems of Condo Boards above. The problem with Condo Boards is not that they are evil or "Nazis" but that they are basically amateurs at what they are doing. Very few Board Members have the experience to manage what can be a 200, 300 or even a 1000 unit property.

Being on the Board is a thankless job, as no matter how good a job you think you are doing, someone is going to call you a "Nazi" or say you are not doing a very good job. And usually, you are not getting paid a nickel for all that grief. So most people quit after a year or two and more inexperienced people get on the Board and the process repeats.

The problem too is that owners are basically spoiled children. They don't own a real home, so they don't understand that repairs and maintenance have to be done. So they want the condo fee slashed (which drives up resale prices) at the expense of long-term maintenance. In one condo I owned, this ended up causing no end of grief, as special assessments had to be made later on (more on that later) to make repairs that money should have been set aside for years earlier.

Condo Boards are also easily distracted with trivia and social issues. Boards end up wasting hours and hours of time and alienating residents by issuing trivial regulations on how balconies should be used and what size doorknocker you can have. Granted, some of these regulations are needed, as when no rules are made, all heck breaks loose. But often, these rules come across as arbitrary and trivial and detract from the enjoyment of the property. If you own a HOUSE, you can paint it purple if you want to (in most cases) without having to deal with some amateur Board of Busybodies.

In short, Condo Boards spend too much time on nonsense (silly rules), and not enough time on the real work - maintaining the Condominium structure, common elements, and finances.

5. Special Assessments are even worse.  
Special Assessments are usually made when major repairs are needed. For example, in one Condo I was in, the balconies started falling off the buildings. Each owner needed to kick in $10,000 to repair the balconies. This was tough, as not many people have $10,000 laying around and it is a lot of money to come up with.

As a result, some owners had to sell their Condos when the special assessment was made. Since the assessment was due, it depresses the Condo price. Special Assessments are bad for Condo prices, as they tell the story of poor Condo management by the Board, and the presence of expensive repairs needed to the buildings. So Joe Condo Owner sells his condo at a loss because he can't make the assessment. Sometimes, Joe Condo Owner ends up losing his Condo when a lien is placed on the property.

Meanwhile, Joe Investor, who shouted down the Board and insisted on low, low Condo fees had already sold his Condo at the peak of the market, before the assessment was due. So he makes a pile of dough.
Assessments can end up being an unfair tax on owners who happen to be owning at a particular point in time. So some owners, who buy and sell at the wrong times, might end up paying one, two, or even three "special assessments" in the tens of thousands of dollars. Meanwhile, other owners, who buy and sell at different times may dodge the bullet and not have to pay anything. Arguably it is not a "fair" way of paying for such repairs, which should be amortized over time.

Most States (Florida, for example) have laws that Condo Associations have to set aside money for repairs, so these assessments do not have to be made. But I've been there - and been shouted down by the non-resident investors, who wanted "low condos fees" so they could "flip" their Condos for a tidy profit.

A special note on Assessments and Repairs: Getting someone to repair a Condo is a nightmarish headache. Few Contractors want to deal with vacillating Condo Boards, who will bicker and argue over every last detail. As a result, if you need a new roof, Joe's Roofing likely will not take the job or even return your phone calls. Condos end up paying extra - a lot extra - to get work done. And since every detail and part is discussed and bickered over, it takes forever to get anything done. And when it is done, no one is ever happy, as everything was a compromise and all the Johnny Fence-sitters will just sit around and say "I told you so!" and of course, blame the hapless Board Members. If you want to see passive-aggression in action, buy a Condo!

6. All the pleasures of renting and all the pain of owning.  In addition to all the financial burdens, a Condo provides all the "pleasures" of renting an apartment with all the "pains" of owning a house.

With an apartment, you have to learn to live with the neighbor's loud stereo and his nightly tap-dancing lessons on the floor above. You might have to share a coin-op washer and dryer, fight over parking spaces, and live with your neighbor's cooking smells. Renting can be a pain in the butt, which is why many people look to buying a home in the first place.

If you live in a big city, the problems of apartment living are pretty much inevitable, as buying a free-standing home in Manhattan is not an option for many. But more and more lately, Condos are going up in the COUNTRY, miles from anywhere, where land is cheap. It makes no sense at all, except to the developer, of course.

Owning a home can be a hassle, too. You have to paint the house, mow the lawn, and clean the gutters. Most of these "outside" chores are handled by your Condo fee. So you don't have to do them physically, but you do have to PAY for them - and you don't get to chose the provider of those services. And you don't have the option of saving money by "doing it yourself" as you do with a free-standing home.

But, like a home, you are generally responsible for all the inside stuff. So unlike renting an apartment, when you own a Condo and the stove breaks or the toilet backs up, there is no landlord to call - you have to fix it yourself or pay someone to fix it.

And even though you own the "insides", you still may have to let the Condo maintenance man into your apartment to repair some of the common elements (air conditioning, for example, in one of my units). So, just like a tenant in an apartment, you have to let Harry the Maintenance Man have a key to your place. If you thought owning a Condo meant peace and quiet and having your own space, think again.

And even though you "own" the insides of your unit, in many Condos, moving walls or other changes require an extensive approval procedure from the Board (see above). Even hanging a wreath on your door or putting out a floor mat may get you in trouble with the Condo Board (See Silly Rules, above).

So you have none of the advantages of owning and all the problems of renting.
So, why do people buy Condos? For some, in the big city (New York), that is all there is, other than mansions and brownstones, which are out of reach of most folks. But for many, they are sold as a "less expensive" alternative to a home. I think for this latter group, buying a Condo can often be a costly mistake.

While a home may cost a little more, it is worthwhile to actually own real land, and have the "quiet enjoyment" of it than to deal with the hassles and possible financial problems of Condo ownership.

Many others like the idea of "no maintenance" which, as I have noted, is really a fantasy. While the Association may mow the lawn, you are still liable for maintenance of the unit. If "no maintenance" is high on your list, renting a luxury apartment might be a better alternative, as in addition to "no maintenance" you have "no worries" about the market value of your unit.

While rents may fluctuate, historically, they tend to increase only gradually. When rents spike, even a small amount, this encourages construction of more rental properties or more properties are converted to rentals. So the idea that you will be left out on the street by rent increases is a bit dramatic. Yes, it is possible to be priced out of a particular neighborhood or apartment building, but the same can happen with Condos, as fees and taxes skyrocket. So owning a Condo doesn't make you "safe" from increased costs.

And that is the one very odd thing about Condos. Many people will PAY MORE to OWN a Condo than they would to rent the same Condo in the same development. They argue they are "building equity" and that the resale value will be higher. But as my examples above illustrate, and the recent market aptly demonstrates, Condos can be a neat way to create negative equity in a real hurry.

I've done well with three Condos and a duplex, but I always kept in mind the following:
1. Do the Math: The condo should not cost more to own (in monthly costs) that it does to rent. If it cheaper to rent one than to buy, don't buy, period. In one instance, I bought one for a friend to rent. Since it was cheaper to buy than rent, I could rent it to her and break even. In another case, I bought one as a vacation home and rental. It was cheaper for me to stay there than in a hotel, so it made sense, and I visited it often. When I wasn't there, I rented it out to cover costs. If it had cost more to own than it would to stay in a decent hotel, it would have made no sense to own it.

 2. A Condo is not a "poor man's house": You should not look at a Condo as a "starter home" because you cannot afford a house. If a house is only slightly more, or similarly priced houses can be had for the price of a Condo (but perhaps not as opulent) then bite the bullet and buy the house. When I was shopping for my first home, it was tempting to look at a Condo as an "affordable alternative" but I was glad that I bought REAL LAND in the long run. 1/3 of a an acre in Fairfax County appreciated much further than a comparably priced Condo ever could (and my house, it was bulldozed, so that goes to show you where the real value in REAL ESTATE is - in the LAND, not the structures).

3. Condo Prices Go UP and go DOWN: When I bought the $40,000 Condo, it was for what the original owner had paid for it - 10 years prior when the unit went Condo. In the interim, the price skyrocketed to $80,000 and then fell back to $40,000. Since I've owned it, prices have jumped to nearly $300,000 and then back down to the mid 100's. You have to be prepared for the value to drop down and live with that. For that reason, never pay too much for a Condo! If prices have recently gone up, ask yourself if you really think they will keep going up and up and up, or might level off or drop. If you look at his realistically, you likely won't get burned.

But all that being said, the best bet is to hold out for a real home on a real lot of land, if it is not that much more than a Condo. Don't confuse the new sheet-rock and shiny appliances of a "luxury" Condo with real value. A run down house on a 1/4-acre lot is worth more because you actually own the land. Appliances and sheet-rock can be replaced relatively inexpensively, and thus a house can be improved in value greatly. A Condo, on the other hand, has nowhere to do but down.

Edited 12/15/2014

UPDATE May 2017:  A reader sends a link to this story which discloses extreme abuse by board members, some of which appear not to even own units in the buildings.   This illustrates the conundrum with Condo ownership.  If you get involved in Condo politics, you will be frustrated and angry.   If you don't get involved, bad things will happen!

Hard to feel sorry for owners of "luxury" condos who let this sort of thing happen.

UPDATE 2021:  It is sad to see, but when people defer maintenance because "they are on a fixed income" then bad things can happen.  Billion-dollar buildings, managed by amateurs!  Better off renting!  And when bad things happen, prices can collapse.