Many think HOAs are a deal-breaker? Kevin Mercadante believes “you should avoid buying in HOA neighborhoods” because of the power that the Homeowners Association can have over you. He writes:
“…The primary purpose of HOAs is to maintain and improve property values in the neighborhood. Before you go thinking that’s a good thing, imagine that your house is controlled by a stock broker, whose only objective is to increase the value of your property.”
That doesn’t sound particularly pleasant. But it’s a broad brush to paint all HOAs with. Many are extremely benign. Indeed, we have several houses in an HOA that do nothing more than monitor for trash in people’s yards and clean the snow off the road. The annual (!) bill is $30.
Mr. Frugalwoods, for his part, lists seven reasons condos (which always have HOA) can be a bad investment:
- Condo fees
- Condo assessments
- Condo association financial health
- Condo association rules
- Condo governance
- FHA lending rules
- Your neighbors are really close
My own position differs from Mr. Frugalwoods. I believe that HOAs are a detriment to purchasing a property but by no means a non-starter. In my previous article, I noted how “condos and co-ops usually make for difficult investments. But they are by no means impossible.” HOAs—whether for houses, condos, or co-ops—are a similar can of worms. They make things more difficult, but by no means impossible.
Here I will address all of Mr. Frugalwoods’ concerns and deem each one as a deal-breaker or not. Since No. 7 is a personal preference and mostly about buying a home to live in, I will skip that one. I will also discuss this in regards to HOAs in general despite Mr. Frugalwoods only discussing them in relation to condos.
Related: The Ultimate Guide to Investing in Condos and Townhomes
1. Condo (HOA) Fees
We once ran across a 3-bed, 4.2-bath, 4259-square foot luxury condo near downtown Kansas City in a building where a 1-bed, 2.1-bath, 1812 square foot condo had sold the previous year for $412,500. The original listing price was $1.2 million. By the time it came to my attention, the listing price was a mere $124,200! Despite massive temptation, we didn’t buy it.
Problem was the HOA fee was $7,089 per month!
But the way to look at this is just like you would with any other expense; does it make the deal unworkable? Imagine the condo fees are instead extremely high taxes. Are those taxes too high for the property to cash flow? If so, either move on or flip it if there is a good market for homeowners in that area. (But remember, your holding costs will be higher because of the monthly HOA fee.)
Generally, our condos don’t cash flow as well as our houses, but we’ve found a few good ones that do cash flow a decent amount. The rule of thumb for us (although this will differ based on the average rent and value in a market) is that a monthly HOA fee can be no more than $250/month for the condo (or house for that matter) to have a chance at working.
2. Condo (HOA) Assessments
HOAs can charge special assessments for improvements to each homeowner in the association. (The amount is usually based on the homeowner’s percentage share of the total square footage.) These assessments can be quite arduous sometimes. We bought into one HOA that had just put on a $3,000 per condo special assessment to deal with drainage issues. That would have easily wiped away more than a year of cash flow.
You can never know for certain if a special assessment is coming down the pike, but you can protect yourself with a few steps:
- Evaluate the property itself, not just the unit. If the property is in bad shape, then a special assessment is likely needed.
- Ask the HOA while you are under contract if there have been any recent special assessments or if any are planned or likely.
- Make sure there’s room enough in your cash flow projections to handle a reasonably sized special assessment if need be.
I will note that most HOAs for houses are in relatively new subdivisions (or are very small like the one I mentioned above). New subdivisions have all of the necessary amenities (storm drains, sidewalks, etc.) so they rarely require special assessments. It will usually only be condominiums and co-ops that do.
3. Condo (HOA) Financial Health
A general inspection of the property itself can usually let you know if the HOA is in decent shape. If there is peeling paint everywhere or other signs of disrepair, it’s probably best to run. But remember, this is true of regular neighborhoods too (unless lower-end properties are your specialty). With HOAs, it’s the same, only more so.
You can also request financial information from the HOA to see how much money they have in the account and how much they are bringing in versus spending. They might be forthcoming. On our large purchase of 17 condos, they ponied up the documents because we demanded them. Other times, we haven’t even requested them. It never hurts to ask though.
4. Condo (HOA) Association Rules
Always, and I mean always request the HOA bylaws before closing. Yes, it’s a pain to read them, but it’s necessary. For example, on one deal I forgot to request the bylaws and it turned out you weren’t even allowed to rent in that complex. As a guy who wrote a series on due diligence, this mistake will haunt me with everlasting shame. Luckily, we made about $2,500 on that “flip.”
A friend of mine once told me how her brother built a dog house in the backyard of his house. Unfortunately, the HOA allowed for no structures to be put up without board approval. They actually made him tear it down. Yes, HOAs can be a pain.
From my experience, bylaws rarely change drastically, so if the rules are acceptable when you purchase the property, most of the time, you will be OK. That being said, you need to know what those rules are going in, and they need to be acceptable to you.
5. Condo Governance
There is a stereotype that HOA presidents are petty and tyrannical, want-to-be dictators that would—if given the power—rule in a manner that would make Joseph Stalin blush. This stereotype is true.
That being said, most of the time you’re just not important enough to be noticed if you are paying your dues and following the rules. What helps here is if you have enough equity in the condo or house that makes selling a good escape hatch.
And again, you want to evaluate the grounds and property itself. We once looked at a condo in a really good area that was selling for really cheap. But most of the units were vacant and the grounds and property were in disrepair.
The HOA was an obvious mess and had run the building into the ground. Special assessments were likely coming and there was no way we were going to trust that HOA to manage the building that housed our investment. We passed.
6. FHA Lending Rules
There are several FHA rules with regards to condos, one being that, as Mr. Frugalwoods points out, “at least 50 percent of the units need to be owner-occupied.” (This is not true for houses in neighborhoods with HOAs.) However, some HOAs actually have the power to decline tenants or loans. So again, check the bylaws.
To me, this just makes the investment riskier and would thereby require a wider margin in order for me to feel comfortable investing. This is especially true if I planned to flip a condo as there might be a smaller pool of potential buyers if FHA-approved borrowers can’t buy your property. Again though, you can always ask the HOA what the breakdown of owners to tenants is. And again, they might be forthcoming.
So there you have it. HOAs are generally an added hindrance, although they aren’t completely useless by any means. In condos and co-ops, they usually pay the trash and often the water and sewer as well as the exterior building insurance. And they keep up the maintenance on the exterior and common areas too.
With houses, they will put plenty of pressure on your neighbors to prevent them from letting their homes fall into disrepair or yards become overgrown. With houses HOAs are something to investigate, but not hugely concerning. With condos and co-ops they definitely are a concern, but they’re also part and parcel for condos and co-ops.
Do they make the deal harder? Sure. Are they a deal-breaker? Not at all.
What is your take on investing in condos?
Please share with a comment below!