Many condo buyers purchase a condominium based on the actual unit, but they often fail to consider the underlying association that binds them.
Living in a condominium is joining a community where the rules are set by the association and you agree to follow them when you buy your condo. In our experience, the health, management, and organization of the governing body can have an equal, if not greater, impact on the enjoyment of your condo than the actual space.
So when evaluating the purchase of a condo, here are some things to consider:
- Condo fees: When buyers think about the association, they tend to focus on the condo fees (the amount they will need to pay each month), and what’s included. Sometimes utilities are included, but sometimes they are not. If they are, which ones? All this feeds into your bottom line each month. Also, the association’s responsibility and the owner’s responsibility need to be clearly understood. For example, we recently sold a condo where the association owns the window frames and the homeowner owns the glass. Window replacements in this case were split 50/50.
- Financial health of the association: A condo building should have an operating budget, reserves and insurance. The operating budget covers the day-to-day operation and maintenance of the building, such as the landscaping or the cost of a front desk, if the building has one. The reserves are there in case a big-ticket item, like the roof, needs repairs.
The community in a well-run building foresees upcoming larger projects and has the funds in reserves to cover the expense. For example, if the balconies need resurfacing every five years, funds to cover that may come from the reserves. What if a large repair is needed and the building does not have adequate reserves? Then you and everyone else may need to pay a special assessment. What if special assessments happen more than occasionally? Then, the financial health of the building needs to be further assessed before you opt-in.
You know who else closely examines the financial health of the project? The lender. When a buyer is using a loan to acquire the property, lenders require the management company to complete a questionnaire designed to uncover any potential risks. For example, regarding the condo association, the lender is looking for poor budgeting or insurance issues. The lender also examines the project as a whole and looks for risks such as outstanding litigation, a large percentage of commercial space, the ratio of owner-occupied vs. investor-owned units, high condo fee delinquency rates, and more. Most lenders adopt Fannie Mae’s condo approval policy and look for characteristics that would make the project ineligible for financing, which they refer to as “non-warrantable.”
What happens if a condo association is mismanaged or not financially healthy? First, as we just explained, fewer lenders may lend on the building, making it harder to sell when that time comes. Second, the building’s property values may go down. For example, a luxury building in Bethesda, Md., recently had several of its units foreclosed on, and a new investor came in and slashed the prices of the remaining units. In contrast, there are other luxury buildings in the area with solid reserves, professional on-site management and well-thought-out operating budgets. Where would you prefer to invest?
- Rules and regulations: Besides the financial health of the building, you want to know the rules of the community you are buying into. Are pets allowed? If so, some buildings have restrictions regarding types of pets, size of pets and even the number of pets per unit. Are there restrictions on renting? Buildings often like to maintain a certain number of owner-occupied units, so there may be a waiting list for renting. Also, some buildings impose restrictions on the length of leases, the number of years you can rent consecutively and whether you can use your unit as an Airbnb.
The condo association may also be involved in your unit’s renovations. Some associations are strict and have many rules and oversight rights. Others are much more laissez-faire. For example, in a building where we recently listed a unit, the condo association required a 30-day notice before the renovation start date to review the application, as well as a $1,000 deposit, in case the building’s engineer was needed to review the proposed renovation plans. This adds to your renovation timeline and project budget.
- Maintenance: Who do you call when a pipe bursts in the hallway? In other words, who is managing the building? The condo association can hire a professional management company or manage the building itself, probably at less expense. Is there someone on-site, part-time, full-time, ever? Are you comfortable with the level of service and the association’s general approach?
- Community: Ultimately, you’re buying into a community. Some communities get along well, host social events throughout the year, and are generally happy places to live. Others, not so much, sometimes with significant discord among residents. For example, a common schism is that some residents may want to increase fees to renovate/increase the level of services, while other residents prioritize keeping fees low. If most neighbors aren’t on the same page, the sense of community can quickly deteriorate.
So how do you do your due diligence? First, review the condominium documents. Each jurisdiction has a statutory period for a buyer to review these documents, with the right to void the contract during this window if you don’t like what you see. The list of documents varies slightly from jurisdiction to jurisdiction, but generally includes recent financial statements, rules and bylaws, engineering studies, reserve amounts, and proof of insurance.
Second, talk to the management company and/or board members of the association. They should be able to answer most of your questions and give you at least a sense of how things are run.
Third, and perhaps best, ask around. Try to talk to residents or former residents who can give you the inside scoop. You can’t always pick up the real challenges from legal documents or talking to professional managers.
So what’s the bottom line? Before you buy a condo, look beyond the condo fees and the unit itself. Make sure you understand the financial health of the building and condo association, the rules, regulations and culture, to ensure you are making a sound investment you will enjoy for years to come.