Buying a Condominium
A condominium is a special type of residential structure, consisting of individual units, often simply referred to as condo units, that share a common area. All states have laws, collectively referred to as the Horizontal Property Acts, that govern condominiums. Condominiums are often structured like apartments, but can be townhouses or even detached structures. Only the form of ownership characterizes a condominium. The main advantage of owning a condo over a single-family home is a generally lower cost per given floor space and lower cost to maintain the property using professional services. Floor space is cheaper because the cost of common areas is shared by owners of the condo units. Likewise, the condominium association has greater buying power in contracting for professional services to maintain and repair the property.
The owner of the unit holds a fee simple title to that unit and an undivided interest in the common elements, including land, exterior structures, hallways, stairways, elevators, lobbies, courtyards, and the roof, and may also include recreational facilities such as swimming pools, tennis courts, and golf courses. Unlike tenants in common, unit owners have no right to partition their interest.
Under the Uniform Condominium Act, adopted by many states, a condominium is created when the owner of the building or a developer executes and records a Declaration of Condominium, which includes:
- a legal description of the units and the common elements
- a copy of the condominiums bylaws, which govern the operation of the owners association
- a survey of the property and architectural drawings, defining the vertical and horizontal boundaries of each unit
- restrictive covenants that limit the rights of ownership.
Condominiums are managed and maintained by a homeowners association (aka HOA, condominium association). The association enforces the rules of the property and is responsible for maintenance and repair, and the cleaning of the common elements and structural portions of the property. The association also buys insurance to cover fire and liability. One of the advantages of condominiums is that the common areas are usually maintained by professional services, often for a better price than individual homeowners can get, since condominiums can generally offer more business in return for lower prices.
There are numerous fees arising out of condo ownership. There is the annual maintenance fee to cover maintenance of the common area and there may be a fee to replenish reserve funds, to cover unexpected expenses or a defaulting owner's maintenance costs. Assessment fees cover unexpected repairs or replacements, such as storm damage, so they are not included in the annual budget. Since they are unpredictable, the condo owner should reserve at least several thousand dollars to cover such fees. Generally, older buildings will have higher assessment fees. If the developers of the condominium complex are still trying to sell the condo units, then they may also charge an occupancy fee to cover maintenance and the mortgage payment. Some expenses, especially for repairing or replacing common elements, may be greater than what condo owners can pay, so the HOA will take on a common loan to pay for these expenses. The loan is repaid by a special assessment on the condo unit owners. Utility bills may also add to costs. If the condo units are not separately metered, then the owner will have less control over utility costs.
The condo bylaws stipulate how frequently the fees must be paid: monthly, quarterly, semiannually, or annually. Generally, the fee is proportional to the size of the condo unit. Likewise, for assessments.
Buying a Condo Unit
There are several factors to consider before buying a condo unit: real estate taxes, quality of the schools, whether the local economy is growing or shrinking, construction in the near future of other condominiums or other buildings that may obstruct a view. Information on impending construction projects can often be obtained from the local municipality.
Generally, the condominium can be owned like a single home, which can include any type of ownership allowed by state law. However, sales may be restricted if the condominium association has the right of 1st refusal, where an owner cannot offer the condo unit to the public until it is 1st offered either to another owner of the condominium complex or to the homeowners association.
Some financing factors affecting affordability are the same whether buying a single-family home or a condo unit: interest rates over the term of the loan, and demand for real estate. The total mortgage payments, maintenance fees, and realty taxes should not exceed 1/3 of your income. You should also consider whether communal ownership is worth the advantages of owning a condominium. Because condominiums have various rules, state law requires a condo association to provide the condominium documents to buyers. If the mortgage term exceeds 10 years, and house payments are close to 1/3 of annual income, then a fixed rate loan should be sought to reduce risk of rising interest rates.
Examine factors that affect the marketability of the condo units. Amenities that increase the value of a condo unit include:
- parking spaces
- floor space exceeding 700 ft.Â²
- higher ceilings, and
- a growing area.
Other factors decrease the value and the appreciation potential for the property:
- a high crime area
- obstructed views
- a deteriorating neighborhood, and
- nearby power lines, congested roadways, or railroad tracks.
Note that, although negative or less positive factors may lower the selling price of the condo unit, the same factors will also make it cheaper to buy.
Avoid being pressured by sales pitches and never rely on developer promises. Furthermore, forecasts of future condo prices by real estate brokers or bank analysts are often hyped, to increase your likelihood of buying. Avoid bidding wars, since it is more likely that you will overpay; some bidding wars may even be faked by brokers or developers to increase prices and their commissions, especially if you look enthusiastic about the property.
Financial Status of the Condominium Complex
Financial status of the condominium complex should be assessed before buying any of its condo units, since any financial problems ultimately become the problems of the condo unit owners. Some condominium complexes are financially stressed because of mismanagement or poor construction. Consequently, the condominium association increases its fees to compensate, which lowers selling prices for the individual condominium units. Special assessment surcharges may be added to replenish the reserve fund or to service a common loan. HOAs can foreclose on properties for nonpayment of fees.
Hence, any potential buyers should compare condo fees with what other HOAs are charging. Many poorly managed condominiums end up insolvent or bankrupt. To reduce risk, a potential buyer should also examine the estoppel certificate for the unit and the condominium's annual financial reports — past, current, and projected.
The estoppel certificate (aka estoppel letter) indicates the financial health of the complex, any dues owed by the seller of the condo unit, and any current or projected fees that will be assessed. The estoppel certificate is a legally binding document, so the condo association cannot renege on the facts that it asserts in the certificate. The estoppel certificate from a condo association will generally include the most recent audited financial statements, a record of assessments, forecasted repairs or replacements for the common elements, any pending or anticipated litigation, the current or anticipated monthly payments for common loans, anticipated structural or mechanical repairs, and municipal work orders. If this information is not provided in the estoppel certificate, then the buyer should receive written information that would help in assessing the financial health of the condominium complex. The buyer should beware if the HOA is not willing to provide this information in writing.
The law of most states requires that an estoppel letter be placed in the escrowed documents when the property transfers title. Before the condo unit is sold, the estoppel letter is requested by either the owner or the title company. The HOA must provide the letter within a statutory time, such as 10 days, and may charge a fee that may also be capped by state law. Estoppel certificates may also be requested by a lender when the owner of the property with tenants seeks a loan, in which case, the tenants fill out the estoppel certificate, certifying the lease amount, the terms of the lease, the amount of any deposit, and other related information that the lender may want.
The estoppel letter is legally binding, so inaccuracies can lead to civil lawsuits. Most state laws require that the estoppel letter be added to the escrow documents when the property title is transferred. Since the estoppel letter will list any amount that must be paid, escrow cannot be closed until the amount stipulated in the estoppel letter is settled. The buyer and the seller can negotiate as to who pays the amount due. If it is a foreclosed property, many banks will not pay the HOA, unless required by state law. Fannie Mae and Freddie Mac do pay the HOA until the property is sold. In many states, the buyer is not held responsible for charges incurred prior to the transfer of title.
Some condominiums are self-managed, but many use outside management companies. In either case, potential buyers should investigate the quality of the management, as this will have a major effect on fees and on the potential future of the condominium complex. It would behoove any potential buyer to investigate the property and to talk to owners and even renters about the management of the property, especially if there is any discord among the owners of the condo units. Discord will often lead to mismanagement and may lead to lawsuits that must be paid by the HOA, who, in turn, will bill the condo unit owners. Board members of the condo association are the people who actually manage the property, but changing the board members is usually difficult, since a special meeting is generally required, and a majority, usually 80% to 85%, of the condo owners must agree on the change.
Buying a Preconstruction Condo Unit
There is a higher risk in buying a preconstruction condo unit. Architectural drawings at the developer's sales site showing unit layouts are often changed as the buildings are being constructed. Purchase contracts are written by the developer, so the terms are generally favorable to the developer. For instance, the buyer may be forced to delay moving in. A particular risk to avoid occurs when developers who still own more than 50% of the condo units cannot sell the remaining units at their projected prices, thereby forcing a discount of the remaining units. To compensate, the developer may enforce a buyback provision, allowing them to buy back the already sold units at reduced prices. Even if the developer does not buy back the unit, the assessed value of all the condo units will be reduced to the lower selling price of the remaining units. A buyer should demand an expiration date, such that if the condominium is not completed by then, then the deposit or sale price will be refunded. Additionally, a buyer should seek to have any paid funds held in escrow until the majority of the units are sold.
One caveat is that condominium fees are generally low while the condo units are being sold, to attract more buyers and to sell the units at better prices. However, condominium fees are only guaranteed for a specific time, usually 1 year. Thereafter, fees will likely rise, to compensate for actual higher costs and to pay for cost overruns in constructing and marketing the property. To minimize these types of risks, potential buyers should investigate the developer, especially if similar units have been constructed by the developer before, and what their current maintenance fees are.
One factor that affects the pricing of the condo units is the proportion of the units that are rented out. Financial institutions perceive a greater risk with condominiums that is proportional to the number of units that are rented. Consequently, they are less likely to lend money to potential buyers of the condo units. Renters usually do not care for the property as well as owners, so it tends to deteriorate over time. Renters are also less likely to abide by the rules designed to improve communal living, such as maintaining the common area and reducing noise. However, rentals can be advantageous in tourist resort areas or major population centers, where a higher rent can generally be charged.
As with any purchase of real estate, the buyer should never sign a contract that does not have contingency clauses to allow the buyer time to inspect the property, to perform due diligence, or to perform general searches for factors that may affect the property or the neighborhood.