It is vital that you know how to protect your cash flow or capital growth when you consider investing in Condos or Town Homes! It is true that exit strategy should be considered when investing in any investment property, however Condos and Town Homes have many overlooked challenges.
Condos can, when bought correctly, be a good source of cash flow. BUT there are things to know about Condos and Town Homes that can rapidly diminish the cash flow and often times makes it go negative.
First of all, it is important to point out that Condos and Town Homes have either an H.O.A. (Homeowners Association) or a Condo Association (these are referred to as C.I. or common interest communities). Whichever name you give it, they all have monthly fees attached to them and these fees, which cannot be controlled by you the land lord, are where you will want to be extra careful and do your proper diligence when buying so your exit strategies are protected.
Here are the challenges effecting cash flow
An improperly funded H.O.A. This will show many properties being an attractive purchase because of the low prices, BUT make sure you research the financials statements of the association. Often the complex will have experienced a number of units that went into foreclosure and therefore the H.O.A. fees have not been collected for those units. This will often need to be absorbed by the existing property owners. Simply reviewing this information up front can prevent you from positioning yourself to become liable for the short fall.
Bad budgeting or the Bait and Switch pricing of H.O.A. dues. Even if the H.O.A. appears to have been collecting all of its monthly dues, you will want to study the financials to make sure it has items designated for the replacement cost of natural wear and tear items such as roofs, retaining walls, etc. Sometimes these items are not incorporated into the budget. As a result, when it comes time to replace these items and the H.O.A. does not have sufficient funds to cover the repairs or replacements they will put an assessment onto your property. This assessment can turn a cash flowing property negative very quickly. Many new investors fall prey to this challenge, so make sure you review the financial statements very closely.
Here are items to watch out for that can affect your capital growth (appreciation) of the property
Of course, bad H.O.A. budgeting can affect your capital growth as well, if the owners are unable to produce the needed funds to bring the worn items up to date the values will rapidly diminish.
Not having FHA approval. The FHA which stands for Federal Housing Authority, insures the loans for real estate and is the most common type of financing in the U.S. today, roughly 70 to 90% purchase with an FHA backed loan. If a Condo project does not have FHA endorsements, this means the largest population of home buyers will not be able to purchase the property. This suddenly reduces your buying audience down to 10 to 30% (varying by location).
When it comes time to sell, your exit strategy should be to have fewer homes available than buyers to buy them. This will increase your ability to get top dollar for your property. As you can see, by reducing your buying audience down to the exclude FHA buyers, you are left with the cash buyer or the buyer that has at least 20% to put as a down payment an acquire a conventional loan. With this small buying audience of buyers that have money, you can see that you are not well positioned to negotiate top dollar for your property.
There are Condos and Town Homes that make great investments as long as 1) you are purposeful up front and understand the financial viability of the complex and 2) your exit strategy is in mind when purchasing the property. To get a great capital gain you want a highly sought after property that can be purchased by the masses.
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