Bad News for Condos
Re-printed from the Viewpoint e-newsletter service. Sign Up Here to receive this free-premium content as soon as it’s released.
Viewpoint 04/07/2010
Bad News for Condos
I’ve recently written about momentum in neighborhoods – how good neighborhoods get better while bad neighborhoods get worse, and how difficult it can be for neighborhoods to change their momentum – but the current market conditions are making these facts even more extreme for condos.
When you buy a house (single family, detached home), you’re buying into the neighborhood figuratively, but your actual home is different from your neighbors’. You have your own roof, plumbing, driveway, and insurance policy. And banks will make loans against these properties (to qualified borrowers) as long as all these are in working order & properly maintained.
When you buy a condo, on the other hand, you’re buying into the neighborhood literally; you will actually share parts of the building and infrastructure with your neighbors. Because of this, banks may want to review the entire complex, in addition to you and your unit, before making a loan.
The concept is simple: the banks don’t want to lose money. If they see problems lurking within the complex which could reduce your unit’s value, they are at risk of losing money if you default on your loan.
Occupancy Rates
One method banks use to predict long-term stability within a complex is the Occupancy Rate – what percentage of the units within the complex are owner-occupied? Conventional wisdom says people are more likely to let a bank foreclose on an investment or second home, but they’ll do just about anything to keep their primary roof over their head.
In addition, owners take better care of their units than renters and are more likely to be proactive when they see something within the complex needs maintenance.
If that’s the case, so the banks reason, then a complex with more owner-occupied units is going to maintain a better condition and have a more solidly funded HOA.
Over the years Fannie Mae, Freddie Mac, and FHA have updated their guidelines regarding required owner occupancy ratios, ranging from 50% to 70% with various caveats. Today I understand the requirement to be 50% owner occupied, with 2nd homes & vacation homes not counting as owner occupied. (lenders out there – if I’m wrong please correct me.) This means if at least half of the units aren’t owner-occupied, a buyer won’t be able to get “regular” financing to buy in that complex.
Downward Spiral
Complexes valley-wide have seen their owner-occupancy ratios dropping over the last couple of years (a sign of the times), and many are now below the 50% threshold. Reasons include:
** Foreclosures. A vacant or bank-owned home is obviously not owner-occupied. Unfortunately many, or even most, of these bank-owned homes are being purchased by people who do not intent to live in them as their primary residence.
** Investors. As prices have fallen and some complexes had many bank-owned units up for sale, investors were able to buy units using low prices and low interest rates to generate positive cash flow. These units are now tenant-occupied.
** 2nd Homes. Prices in Phoenix have fallen more than they have in other parts of the country, prompting people from other parts of the country, and even other countries, to take advantage of a rare opportunity to own a vacation home in Phoenix at affordable prices. (Heather & I have helped several people with this.) And of course if it’s their second home (or third home) then it isn’t their primary residence.
The Death Knell
Once a complex dips below the 50% owner-occupied ratio, things go from bad to worse, quickly.
Traditional financing dries up immediately – buyers can no longer use FHA or FNMA loans, leaving cash and private money loans (with large downpayments and high interest rates) as the only available alternatives for buyers. Many buyers look at condos as a less-expensive alternative to houses because they can get similar square footage for less money; these buyers cannot pay cash or large downpayments – they’re looking at affordability specifically because they don’t have lots of money to throw around.
Almost overnight, the majority of people who want to buy the condo to live in it (and raise the occupancy ratio) are not able to buy. This means each time another unit is sold, the buyer is less likely to live in it full-time, and the occupancy ratio is further decreased.
But wait, it can get even worse..
At this point the pool of buyers has been reduced, which causes units to sit on the market longer, which causes prices to drop further, which could cause other owners to let their property go back to the bank, which means even more vacant, bank-owned units are for sale. This makes investor-buyers nervous, because they don’t want to buy when prices are still falling.
In addition, these vacant units aren’t paying HOA dues, and the HOA becomes underfunded – unable to do roof repairs or property maintenance. The HOA is then left with 3 options:
1. Don’t make repairs. Obviously it won’t be long before the complex becomes dilapidated, and nobody would want to buy a unit in that complex at any price.
2. Raise HOA dues. This puts a strain on current owners, and future owners will require a lower purchase price to offset the higher monthly fee. Compared with other properties of similar quality, this complex will now have a higher monthly cost of ownership; the market will force prices down to adjust for this.
3. Charge a one-time special assessment. This also puts a strain on current owners, but it runs the risk of chasing people away. If people can’t afford to pay several thousand dollars, they may be forced to sell or walk away from their unit, which means less owner-occupants. In addition, any buyer (investor) is going to demand a lower price to offset the assessment charge.
The Future as I see it
I’ve written before about good neighborhoods and bad neighborhoods (and linked to these articles at the top of this letter), and I’ll say it again: not all neighborhoods are created equally, and the end result will not be the same for each complex. I think we’ll see different outcomes according to the inherent desirability of the complex, based on factors such as price, location, and amenities. For simplicity’s sake I’ll outline 3 different types of complexes:
Low End Complexes
Complexes which were considered entry level or affordable before all this began may have been changed forever. These are places where people who can afford to pay cash (or make large down payments) would not want to live, and people who would want to live there cannot afford big chunks of money.
Prices fall, occupancy rates fall, investors buy. Rinse & repeat. Eventually the complex is mostly tenant occupied, which makes it even less desirable for the rare home-buyer who could afford to make the loan work.
Over time the complex becomes almost completely investor-owned. Tenants can’t afford to buy and buyers won’t live there. There’s not enough money to be made for banks to make radical changes to their guidelines. I don’t see a scenario in which this complex rebounds in the next decade or two*; it’s been condemned by market forces to low income rental housing. (* short of government regulations forcing banks to make loans in a particular complex.)
Mid Range Complexes
The scenario is very similar to the low-end complexes, except these units appeal to people with a little more means.
Maybe owners can better afford the increase in HOA fees. Maybe the complex is more desirable and it sees more 2nd home buyers than investors, which long-term makes it more desirable to resident-buyers. Maybe the dollars are a little higher, and banks realize they can profit by making loans to well-qualified buyers in this price range.
In the long term I think some of these complexes will survive and live to thrive again. Not all of them, and I can’t guess which ones – it’ll take a combination of subtle factors and a little bit of luck. Location, what happens in nearby neighborhoods, future trends in landscaping likes and dislikes, or color choices, who knows? But people who can afford to make choices will choose some of these complexes, and the complexes will come back to life.
In the short term these complexes are going to have same difficulties as the low-end complexes – traditional buyers will be shut out and the chain reaction of bad events will start.
High End Complexes
The game is completely different at the high end. Many of the high end condos were purchased with cash, meaning there are fewer opportunities for bank-owned units. And the people who do have a mortgage are typically better able to withstand bad economic times, so the percentage of foreclosures is lower.
In addition, these properties offer something the others don’t – superior locations (mountains, golf courses, high-end shopping districts, high-rise living, etc.), top of the line amenities, larger units, etc. These are complexes where people *want* to live – they have inherent desirability.
And because we’re talking about larger dollars, banks and financiers want to be involved – bigger loans equals bigger profits.
Short term – these complexes are experiencing more vacancy and downward pressure on prices than normal.
Long term – these complexes will bounce back just fine, in step with the rest of the luxury market.
Condo Buyers Beware!
There are 2 things that make me nervous when I buy property: uncertainty about the future, and things outside my control which can negatively impact me. Right now condo-buyers are facing large doses of both.
If you’re buying a condo today, be wary that values in the complex could plummet if the complex crosses below the magical owner-occupancy ratio. And this ratio is completely, 100% outside your control.
Additional Reading
Here are a couple/few things we’ve written recently which you might find interesting:
Moving Stills – pictures from out & about in the Phoenix area, as taken from my car!
I hope you enjoyed this e-newsletter and found something of value you can take away from it. You can leave a comment on something you read or add to the discussion by clicking here and using the comment form at the bottom of the page.
And don’t you find it a little ironic (or moronic) that the lending agencies who are sticking to the owner-occupancy ratios “to protect themselves” are the same agencies who were making 100% loans to investors without proof of income, assets, or credit? Hmmm.
Chris Butterworth
Chris & Heather, The Phoenix Agents
at Thompson’s Realty
http://thephoenixagents.com
623-570-9940
Chris Butterworth and Heather Barr are The Phoenix Agents at Thompson’s Realty. The Phoenix Agents are Realtors in the Greater Phoenix area, who have built a loyal following over the years by offering superior service levels coupled with a low-pressure approach. You can visit http://ThePhoenixAgents.com online to learn more about Chris, Heather, and the Phoenix-area real estate market. If you have real estate questions or needs, please contact us anytime; we’d love to hear from you.
Share This Email! While this email is FREE in terms of money, we accept ‘sharing’ as a currency. In fact, it’s the only way we spread the word! If you found this article enjoyable/informative/helpful, please tell 2 people you know to subscribe to this service. They can subscribe online at: http://thephoenixagents.com/free-premium
Privacy. We will NEVER sell, rent, or otherwise distribute your email address to other marketers. We promise.
Reproduction & Redistribution. Via Email, you may forward this message to as many people as you’d like. In fact, we hope you do! Via Web, you may reproduce &/or redistribute this content in full or in part provided you meet these 3 requests:
-
Citation – you must provide a citation to The Phoenix Agents as the author, a link to The Phoenix Agents’ web site (http://thephoenixagents.com), and a link to allow readers to subscribe to this Viewpoint service (http://thephoenixagents.com/free-premium/).
-
Notification – you must provide a notice to The Phoenix Agents with a link to show how/where you are using our content. (news@thephoenixagents.com)
-
Monetization – this content is FREE and shall remain FREE. You are not allowed to profit from this information.
Legal Disclaimer & Disclosure, in plain English. The views expressed in this article are solely the views of the author, and are intended to provide one person’s thoughts on the topic put forth. The author cannot see the future, so please don’t make any investment, financial, or other important decisions based solely on what you’ve just read & then blame the author if things don’t work out the way you planned. Reader agrees to hold the author and any other member of The Phoenix Agents &/or Thompson’s Realty (including the Broker) harmless for anything the reader connects with having happened due to reading this article.
Remove Me. Don’t want to receive anymore emails like this? That’s ok – just click the “Manage my Subscription” link down below & you’ll be removed, simple as pie.
