Monday, March 9, 2015

Your Home Doesn't Owe Money, You Do.

You can make money on a Condo if you buy it for cheap and hold it a long time. But even then, with condo fees and special assessments, it ain't much of an investment.  As a personal residence, I would rather rent a condo than own one.  Better yet, I would rather live in an apartment.  At least I would know who is in charge.

In a recent piece in Al Jeezera, they took typical pot-shots at America, by claiming that a "new law" was forced through the Florida legislature, to allow developers to force condominiums to turn into rental apartments.

And of course, that really isn't the case.  Al Jeezera loves to run down America, because they live in Qatar, which is the land of freedom and justice.   Yes, I am being sarcastic.

In any condominium, there is an agreement (contract) among the owners, known as the "Condo Docs" and most Condo Docs have a termination clause.   If X% of the owners vote to terminate the condominium, it may then be sold and the proceeds paid out to the owners pro rata.

What X% is depends on the Condo Docs.  Usually it is 80% or more.  Sometimes 100%, which means that the Condo will never be terminated.  This is not some "special law" pushed through the Florida legislature by developers, but basically the law of Condominiums everywhere.

Why would you want to terminate a condo?  Well, the land may be worth more than the buildings, which may be falling apart.  And a developer may want to pay a lot more money for the units as a develop-able land than owners could ever hope to get as run-down condos.

I own a condo in Northern Virginia that is going through this right now.  A developer will pay about 61% more than market value, without any real estate agent fees (another 6%) if we sell out and they tear the place down.   We could keep the condo, but we would face another mountain of special assessments to pay for repairs.   If 80% of owners agree, we sell.   We'll see how that works out.

To get 61% more than what these units are worth today would require us to wait 10, perhaps 20 years, for them to appreciate as condos.  And that might not happen, if the development becomes run down and is hit with one special assessment after another.   And the development is kind of run-down and we are getting hit with special assessments, which is why prices are depressed.   So we might NEVER get 61% more than current market values.  It makes sense to sell.

In the Florida case, the condos were sold for ridiculously high prices during the bubble of 2009.   I know how this works, as I was there in Florida and sold my condos when the prices went crazy.   After the market crashed, some clever developers started snapping up the condos in this one particular development for very low prices - likely through foreclosure sales.   In no time at all, they owned 80% of the units, and called for a vote to terminate the Condominium, which under the law - and the Condo Docs, they are allowed to do.

Why did they do this?  Well, the demand for rental apartments is skyrocketing.  So they can make more money as rental apartments than as condos.   Of course, technically, they could rent the units they already have (and likely are).  But by eliminating the condo association, they can run the place as a single apartment building, rather than having to elect representatives to a "board" and then vote on things.   And, owning 80%, you could see why they would want to do this.

And of course, maybe someday they'd like to bulldoze the place and start over, which they can't do, if it is a condo.   They want to make money, plain and simple, and that is not against the law in America.  They ponied up the dough to buy 80% of the units in the development, and under the Condo Docs, that basically means they own the development.   Read and understand your Condo Docs!

(During the height of the recession, there were condos on Route 1 in Ft. Lauderdale, that were selling for $20,000 each.  Just a few years earlier, they had sold for $100,000 when they went from apartment to condo.   You could snap up most of a building for not a lot of dough at that point).

Of course, some owners, who paid top dollar at the peak of the market are upset.   They owe a lot of money on their units, and a buyout at a "fair market value" price isn't even going to pay off their mortgage.  Of course, these folks, some of whom paid $250,000 or more for their units were never going to get that, in market value for their condos, in their lifetimes.   When values go from $250,000 to less than $100,000, there is no quick "bounce back".

The smarter owners walked away from these mortgages, declared bankruptcy, and moved on.   To hang onto a condo that you owe more than twice market value on, is sort of dumb.   And you can't expect someone to pay off your mortgage when the condo is bought out, either.  Why is this?

Because you owe the money, not the condo.   You see, while we say a piece of property is "encumbered" by a mortgage, the property doesn't owe the money, you do.   It is a personal debt, only secured by the property.   And that is why when you do a "short sale" you may be surprised to see that even through the house was sold for less than the mortgage amount, you still owe the difference and in fact, you may have to declare bankruptcy to get out from under the debt.

While it is easy to feel sorry for the people in the story, we have to realize that they made a lot of bad financial decisions.   They paid way too much for a condo - far more than it was worth - during the bubble times.   And instead of just walking away and starting over, they stayed with this horrific mortgage.

Of course, we are assuming here that the amount owed was in a Purchase Money Mortgage (PMM) used to buy the condo, and not a "re-fi" that took cash out to buy a car or pay off credit card debt.   Would your opinion of these folks' troubles be altered if that was the case?   And yes, during the bubble time, many folks refinanced their homes for more and more money, based on specious appraisals, and then went out and spent the money on cars, vacations, and even fast-food (by paying off credit card debt).

And yes, I refinanced my house that way once.   A lot of people did it.  It wasn't a smart move, which is why I recommend that if you are thinking of refinancing your house to pay off credit card debts, you need to sit down with your spouse and have a long, hard conversation.  Then you need to whack yourself with a stick until you wake up.  Your financial ship is going off a cliff.  Change course immediately!

How can you avoid such a financial fiasco?   Well, to begin with, Never buy a Condo!    As I noted in that posting, you are not buying real property, just the right to occupy.  And you are not buying control of your property, just membership in a half-assed and poorly run corporation.  You have little in the way of rights and a lot in the way of responsibilities.   Free-standing properties are always a better value as a result.

If you do buy a condo, don't overpay for one.   It is tempting to think that since a free-standing house nearby sells for $400,000 that a condo for $250,000 is a relative "bargain" in comparison.  Yet people do this, based on the monthly payment mentality.   While you might be able to "afford" the monthly payment, increases in condo fees and special assessments (which are inevitable) could make such a deal unaffordable in a real hurry.   Moreover, if it is cheaper to RENT a condo than it is to OWN one, then there is really no advantage in owning a condo.

So, what will happen to these folks?  Are they facing a real injustice here?  I think not and let me tell you why.

First of all, they are being forced to sell at a price below what they owe at a time not of their choosing.   However, there is no time in the foreseeable future (her lifetime) where these units may be worth more than what they paid for it.   In other words, it is only the timing of the sale that is an injustice.  The inevitable short sale was a foregone conclusion.

Second, other owners hired lawyers and "settled" for undisclosed amounts.  No doubt, they used legal leverage to extract some additional dough from the developers.   These other owners chose not to.  They decided that complaining to Al Jezeera was a better tactic.   And leverage they had, as if 10% of the owners opposed termination of the condo, they could have blocked it.   And if they and the other owners banded together, they could have extracted concessions from the developers, such as increased buyout prices.

But all that taken aside, if they declare bankruptcy and moves on, they can buy the same condo for about 1/4 the price of what they originally paid.  Or rent for far less than the P&I on a $250,000 mortgage.   In other words, their monthly cash-flow will improve immediately, once they gets this condo monkey off their backs - which is why I say that the smart move would have been to declare bankruptcy in 2009 and allow the unit to go to foreclosure.   If they had done that, well, it would be almost seven years now and their credit would be largely repaired.

I've said it before and I will say it again - the worst thing you can do is "hang on" to a bad deal getting worse.  And I've seen people cash in their 401(k) or IRA (the only assets protected in bankruptcy) to "save" an upside-down mini-mansion.  They use these resources to pay the mortgage payments, which don't knock down the balance one iota, and then lay waste to their retirement funds.   

Instead of "walking away" from a bad deal and taking their lumps (and keeping their 401(k) and IRA) they walk away with nothing and have to start over again in life at age 50.   It is foolish, so just don't do it.  No house is worth going broke over.

Sadly, most people don't have much in the way of financial acumen - and don't gain it until it is too late in life.  Some never figure it out.   And these folks go through life leasing cars and buying condos and smart phones and telling you how clever they are because they clip coupons and get cash-back bonus miles.

I would feel sorry for them, and did at first.  But these are also the sort of folks who are the first to shout down the ideas in this blog as being unrealistic, stupid, or even dangerous.  One young software developer opined that I should be in jail for advocating that saving your money, rather than spending it, is a good idea.

When you hear opinions like that from people, it is a lot harder to feel sorry for them.   People are their own worst enemies, and you can't save people from themselves.   So I don't bother trying.   If you read this blog and get something from it, great.  If not, that's OK too.  If you read it and say, "this is a bunch of bullshit" and end up broke and destitute in your old age because you spent it all now - am I supposed to feel sorry for you?

No, not really.   You are in charge of your own life - and that includes the good and the bad.