Fractional condo ownership - pros & cons

13 Replies

I'm considering the acquisition of a batch of rental condos from a single owner with about 40% ownership of the total number of units within the condo bldg. The batch has significant NOI with immediate opportunity to increase it by 25% with less than $200k in rehab.

Pros:

1 Strong cash flow as is and rent premiums make it that much more attractive.
2 My end goal would be to resale the individual units to cash out.
3 Even if the environment for resale changes, there's still upside from rental income to hold on to the asset.

Cons:

1 HOAs can be a pain and could enforce restrictions that make it tougher to rent to new tenants or sell the individual units all at once or since.

2 Since this is just fractional ownership with the remaining owners owning individual units, the value & marketability of my units could be affected by the actions and upkeep of the other units.

Are there any other cons that I should consider besides the ones I have already listed?

    Updated over 1 year ago

    I've also asked to review the HOA's bylaws and process for changing rules if that became necessary.

    Updated over 1 year ago

    One additional downside is that the property tax bill is much higher for the batch of condos because each unit is individually assessed local property taxes instead of how a typical multifamily building would be taxed for the entire building and not individual units.

    Many folks over-estimate increase in income and/or the time to get there; what is your plan of action to increase the rent immediately by 25%? Are units within the building getting rental income of over 25%?

    Ameet Mehta
    Syndication Pro

    SyndicationPro
    If your ultimate plan is to sell off the units, know who you will be marketing to. If it's investors, it may be difficult for them to get loans on a low owner occupancy building. If it's homeowners, that shouldn't be an issue. The HOAs on my condos have increased significantly since buying them, so you may want to consider that. You don't have a lot of control over it. Special assessments are definitely killer.

    @Ameet Mehta Rent increase is based on current market rate and a survey of tenants on how much more they would be willing to pay with certain upgrades to the units (i.e updated baths, stainless steel appliances, granite kitchen etc). Even with out the rent increase NOI is about $150k. So the rent increase is a bonus.

    @Greg Dickerson Good idea about the special assessments. Deferred maintenance isn't significant and the HOA has been doing a lot of updates to the building. So I feel confident about that part.

    @Danielle Wolter Resale would be to owner occupants and not other investors. As mentioned before, NOI is very healthy and would justify a long term hold if needed, but resale within 2 years would be the end game on this deal so long as market conditions are still favorable.

    Are you buying a collection of condos in one complex (individual titles for 100% of the each unit) or are you buying a collection of partial titles (1 unit's title split into fractions where a group of owners will own the specific unit)?

    @John Corey It's a collection of condos in one complex with individual titles for 100% of each of the units. The remaining units are individually owned. 

    Originally posted by @Fabiola F. :

    @John Corey It's a collection of condos in one complex with individual titles for 100% of each of the units. The remaining units are individually owned. 

    Got it. Thanks.

    You will have issues selling units to end buyers until something like 70% or even 80% are owner occupied. Lenders on individual units will ask the HOA to explain the mix of ownership. A significant number of investor owned units is supposed to indicate owners who will not pay as agreed or otherwise let the complex become rundown.

    It has been a while since I was looking at the threshold. A competent mortgage broker will likely know what the current rules are.

    So, buying a group of units for a discount might not be much of a discount at all. You will have to sell at a discount. One possible way to improve the situation is to arrange a number of sales all that the same time to owner occupants. Or, to provide seller financing for a period so the percentage of OO units flips.

    Otherwise, you are buying them for cash flow and you will be able to sell them for cash flow and not much more.

     

    @John Corey Does it adjust your perspective the fact that the remaining 60% of the condo units are owner occupied? For clarity, only the batch of condos are non-owner occupied rentals. And yes, the intent is to resale a few at a time instead of going through the time it takes to sell 1 unit at a time.

    Originally posted by @Fabiola F. :

    @John Corey Does it adjust your perspective the fact that the remaining 60% of the condo units are owner occupied? For clarity, only the batch of condos are non-owner occupied rentals. And yes, the intent is to resale a few at a time instead of going through the time it takes to sell 1 unit at a time.

    They work from the unit count. If 60% of the units are OO and the magic number is 70%, a lot of lender will never approve a loan for a unit in the building until 70% are OO. So, you need to force the issue by selling 10% at what ever price you can achieve before more conventional lenders. When OO buyers struggle to get a loan, the price they will pay is significantly lower.

    This is why I am saying you might need to sell a batch all at the same time if the lenders accept that by the time the loan for a unit is put in place, you will high the target percentage. Or, offer OOs buyers seller financing to tip the percentage. They can refinance later to cash you out of those loans.

    Now, if any of the 60% choose to rent their unit, that will shift the percentage in the wrong direction. Unless there is something in the title that stops them from renting, it can happen at any time. Each of the future buyers will pick a lender and the lender will ask the HOA at the time the loan is being processed. That is when the current percentage will be checked.

    Definitely buy if the deal is a great deal to you. The problem I am highlighting has already negatively impacted everyone in the complex. Not just your seller. So, you should not be accepting the problem unless you are being paid well to accept the seller's bad situation. Just be prepared to live through the issue until you can fix it. Or, be prepared to offer the same sort of discount to the next buyer when you want to exit and OO buyers can not qualify.

    There will be a few lenders who will lend to an OO even with a higher percentage of rental units. Find those lenders and make sure any OO buyers agree to use them so you can get the deals done. They are likely portfolio lenders who are not going to resell the loans after origination. Most lenders resell (to a government agency) and the buyers of the resold loans are the ones with the high threshold.

    Ask a competent mortgage broker what the lay of the land is at present. My experience is old. With one building and a specific lender, they declined when I hit 10% of the building's units under one name.