CONDOMINIUM INVESTING PAY HEED TO THE NEED TO “LOOK UNDER THE HOOD” BEFORE BUYING

Condominium investing as a buy and hold strategy can be very worthwhile. There is a building, and a unit in that building which you rent to a good tenant, and providing you purchase at the right price, life is good. The tenant’s rent pays the mortgage, taxes, insurance and homeowner’s association dues and some increment over that is left over for positive cash flow. This is what we all would like to see.

But sometimes there are hidden financial perils awaiting the condominium investor. Think again of the building. You as an investor only own up to the inner surfaces of the unit you have bought. Everything else is what is called “common area” or “limited common area,” which means you do not have a direct role in maintaining that structure. Especially in the case of mature buildings this can become a source of financial pain for the unwary buyer.

The homeowners’ association may be required by the condominium declaration to maintain and replace the structure as parts wear out, and if so it is entitled to assess the owners of the units regular charges to pay for the cost of that maintenance and replacement. But owners generally do not like high monthly assessments, and that dislike can produce problems of deferred maintenance and a deficiency when it comes time to replace major portions of the building. And there is no statutory requirement that the homeowners’ association actually maintain the building or replace worn out components. Any such requirement is in the declaration which is part of the documents the prospective buyer receives before closing the sale.

Some parts of a building can be expected to last a fixed number of years before they need replacement. Examples are an asphalt roof, wooden siding and vinyl windows.

When the anticipated time of replacement of such items comes up, there should be a reserve account and there should be money in the reserve account to pay for that replacement. Otherwise the homeowners’ association has nowhere to look for the money except to the current owners. And this can be the source of in some cases very large special assessments to replace deteriorated building parts. Such special assessments, if they are not paid currently, become a lien on the owner’s unit. In some cases the size of the assessment is enough, if it is financed, to cause an otherwise positively performing rental to become a negative cash flow producer, or “an alligator.”

Two years ago the Legislature adopted a law that generally requires homeowners’ associations to conduct reserve studies annually of the physical condition of the condominium building. These studies are to be done after a physical inspection and are to be performed by a professional in the field of reserve studies. However, the homeowners’ associations are not required by statute to make assessments on condominium owners to fund the reserves that the studies indicate will be required to replace life limited parts of the building when they need replacement. The declaration of an individual condominium may require such studies and proper funding of reserve accounts to cover expected maintenance and replacement costs.

It is a good idea therefore, as part of your pre purchase inspection, to obtain a copy of the most recent reserve study for the building in which you are considering buying, and also to obtain the declaration and the most recent financial records of the homeowners’ association. Check to see first that there is a reserve for building replacement required in the declaration and second that the reserve is “on track” for what it should be at the building’s current stage of its useful life. Also check to see that the owners are paying reasonable assessments that are calculated to keep the reserve in the proper balance to building replacement cost over time. If you buy a unit in a building in which previous owners have not paid enough to build a proper reserve for replacement of worn out building elements, then it is you who will have to make up the difference at the time the replacement occurs. There is no way to recover those deficiencies from the previous owners, or from the homeowners’ association board members or officers. It is better to pass on purchasing a unit in such a building because once the special assessment occurs, your options as an investor are limited and bleak. Sometimes the best investments are those you do not make.

The foregoing is intended for education only and should not be considered legal advice.