Discover the hidden dangers of investing in Condos, Townhomes and Single Family Houses that are in Associations. You'll learn the pitfalls of investing in HOAs (also known as homeowners or condo associations) as well as how to navigate challenges and still profit. This is important information for anyone considering purchasing a condo, townhome or single family home in an HOA.
Challenges of Condos
A condo might make sense for a developer who is trying to build more units per area; but for real estate investors buying individual condos can be a massive problem. A lot of things can go wrong and there are extra costs that go beyond the costs associated with purchasing a normal family home.
The first extra cost is the monthly HOA dues. The HOA collects monthly dues every month to assist with maintenance of the properties within the association. Association members can vote to increase dues to rebuild or improve things in the community.
I purchased a townhome within an HOA that had dues of $75 a month. This was a really good price and very appealing to buyers because it was a lot cheaper than other HOAS in the area. The HOA increased the fee up to $150 a month in order to cover the cost of a large fence around the property, but they never even built the fence.
The next extra cost can be the scariest cost related to an HOA. Assessments are any extra bills the HOA gives out that goes beyond what the monthly dues cover. Assessments pay for things like new roofs, sewage, and even community pool repairs.
I received an assessment on one of my properties for $4,500 to change from a septic tank to the sewer system. Every single unit owner had to pay $4,500. AND if you do not pay these bills, the HOA has the power to foreclose on you!
HOAS are actually reporting to credit bureaus. If you do not pay your lawn care or pool maintenance it's as serious as not paying your mortgage or property tax. The extra costs can completely demolish any cash flow and ruin your credit score.
Rules When You Want to Sell
When you purchase a condo and decide to sell it, the HOA has rules that you must follow. One common rule is, "the right of refusal". This means that the association, which is controlled by the developer, has the right of refusal to buy any property before a buyer can purchase it. I once dealt with an HOA that had to approve the buyer, and if the buyer was not what they wanted, they could refuse the buyer. Now, they cannot discriminate against race, religion, or anything like that, but they find a way to stay within the rules and still discard buyers.
There are also HOA rules pertaining to the materials used in renovations. I once bought a condo that had suffered a water leak which damaged some of the wood flooring. The previous owner hired a contractor to fix it, but the contractor had to be approved by the HOA first. In order to get approved the contractor had to go through a 1-month orientation, $2,000 deposit, and increased insurance. In the end, the contractor's work was not approved so the seller ended up with a bunch of assessment fees.
When I purchased the deal I had to rip up the brand new flooring he put in because it had the wrong underlayment and they wanted it to be 1/4-inch thicker. As a condo, if you're on the upper level and you have the wrong underlayment, it can make a lot of noise for the person below you. The HOA can dictate what kind of materials you use and what kind of contractors you use.
This particular condo I was referencing, also had a rule that only one person could move out per day. It was a 500 unit high-rise condo that only allowed one elevator to be utilized by a moving company. As a result, I had to be added to a moving schedule which caused the deal to take three extra weeks.
So Many Rules
These rules can be absolutely ridiculous sometimes. They make it very difficult for you to sell a property and/or they make it very undesirable to new buyers. If you want to turn it into a vacation rental, the HOA will often have a rule prohibiting that.
Typically, the people who are creating the rules are the original developer, so they're going to set rules that make their situation better. A lot of times developers make it very difficult to re-sell because they still have new units in the development, that they want to sell. They will make your life miserable if you're trying to resell a property because they're competing against you, and they're going to beat you every time.
Other HOAS consist primarily of people that have absolutely nothing better to do with their time. They are the ones that go to all of the board meetings, become the president, and then they spend their entire life trying to create more and more bureaucracy.
The next issue you're going to deal with when you try to resell a condo is all the lending problems that can occur. First off, if the HOA is having financial problems, or not meeting their financial ratios, most of the conventional lenders won't lend on it. This means that you will have to go the non-conventional route, so the price of the loan will go up.
Another lending problem is the ratio of owner occupant to non-owner occupant. If a bunch of investors are buying condos, this is completely out of your control. If the ratios get out of whack, then a lot of lenders won't lend on that condo because they don't like the ratio.
I have a friend that is currently having issues with an HOA listing because the insurance is not adequate. The association insurance level is not adequate, so none of the conventional lenders will lend on it. The association is basically saying, "We're not going to pay more for insurance. You need to go find somebody else to lend you money or pay cash." The great lesson here is to be very aware.
Before purchasing an HOA, get the seller and the HOA to put in writing that there aren't any upcoming. Make them put that in writing because on an estoppel letter, they only have to list active assessments not any upcoming. Condo sellers will often try to get rid of a condo quickly, because they know that there is a $10,000 assessment coming in.
Be careful if there are other units still available by the original developer.I once saw a developer offer 2 years free of HOA dues which were $800 a month. This means that the person would save $9,600 a year for two years if they purchased directly from the developer.
This concession wasn't shown on the MLS or anywhere else, because it was kept a secret. It was something the developers used to help the newly-built condos outsell the existing ones.
Challenges of Townhomes
Townhomes suck as investments. They're undesirable because they're not really a condo and they're not really a house. The psychology of most buyers is that they want a single-family home with a white picket fence. Others want to live downtown or ocean-front, so they want a condo. The townhome is kind of in the middle, but it's the worst of both worlds. Now there are a few buyers out there that would prefer a townhome, but the vast majority of buyers don't. You will run across a lot of motivated sellers trying to get rid of their townhome.
Most townhomes are developed by developers that buy land, but cannot make enough money building single-family homes on it. So they compress a bunch of units with townhomes, and offer all sorts of incentives to get people to purchase them. They are brand new and typically less expensive than single-family homes. In high-priced zipcode areas people will move into townhomes purely to get into the good school districts. But, all of this is a lot more difficult when you are trying to sell a previously-owned townhouse.
I once had a townhome I rented out as a rent-to-own. There were some strict rules, and one of them was that you had to bring the garbage can out to the edge of the road, so that the garbage person could pick it up. If the garbage was not put back by the end of the day, you would be fined $25. My tenant's schedule was irregular so he was unable to bring the garbage can back in until the following morning. My tenant began to receive fines in the mail that he refused to pay, so I eventually had to evict him. All because of some garbage cans left by the road overnight.
Challenges of Single-Family Homes
Single-family homes in an association can still run into all sorts of problems.
Home Exterior Restrictions
An HOA can dictate what your house looks like on the outside. The HOA can restrict anything on the exterior of the home such as roofing materials, house color, fences, and even what you are allowed to have in your yard.
You need to know all the rules and issues involved in single-family homes in associations. When you resell HOA properties, the association rules and dues can be a deterrent for potential buyers.
Dangers of HOA Properties
I hope I have covered most of the reasons why you have to be so aware of the dangers of purchasing an HOA property. The only solution to these problems is to purchase a deal within a margin of safety. I have a great video on that subject.
Margin of Safety
It's important to have a massive margin of safety with HOA deals because of the costs and delays that occur. Be aware of the rules of an HOA before purchasing, because mistakes can ruin your investing career.
Share Your HOA Stories
Please share your HOA horror stories below. I would also love to hear any real success stories where the HOA was wonderful.