Investing in a Condo: No Financing Allowed!

by JT McGee

Get FHA financing for a condo.The Federal Housing Authority (FHA) wants the price of condos to implode.

In a search for properties in a great area, I found several properties ranging from 600-900 square feet with 1-2 bedrooms for $30,000 to $40,000.

I live in a very inexpensive part of the United States, but even by the standards of my area, that’s pretty darn cheap.

Something had to be wrong.

The building is older, but in great shape. The zip code is desirable, and the school districts are some of the best, so it couldn’t be the area. I know that the condo building is mostly older, single people, so other than sexual tension there probably wasn’t anything wrong with the community.

Then I dug deeper. It’s the financing.

FHA Rules for Condos

The FHA plays a very important part in the lending process. Unfortunately for condo shoppers, the FHA isn’t interested in giving condo buyers a loan. Sorry!

No, really. In looking through recently-made-important regulations, the FHA will only lend in buildings that are pre-approved. Now, this presents a problem because

1) Getting a property approved is apparently costly, and a pain in the rear.
2) The HOA faces a catch-22 in seeking approval (which would increase property values) but the costs would have to be passed on (which would reduce property values).

One of the interesting bits of the new regulatory guidelines is a clause that does not permit the FHA to make loans to a buyer purchasing a condo in a building where 35% or more of the units are leased. Some condos have other, private restrictions like no more than 10% can be leased, or what have you. However, one HOA is one HOA. One FHA is one massive piece of the financing business.

Condo Cash Flow

Based on my brief research and comparable properties (nearby apartments), you should be able to bring at least $500 a month in cash for rent each month after all related costs. That’s $6,000 per year, or 15-20% of the condo price. Can you say, “cap rate!?!?”

Obviously, this is a pretty ballin’ investment with a lot of scalability, assuming that you have financing. If you don’t, then…well, it’s a no-go.

Private lenders are still licking their wounds from the initial condo bust. The approval process and restrictions make loans through the FHA impossible. Eek.

So what you have here is a market where participants are 100% cash buyers, which might explain why there are so many cash buyers in investment property right now. I wrote about this in an article about all cash real estate. Obviously, some of those “all cash” buyers are probably using hard money loans from private investors with equity from other properties. This can’t be quantified, so I’m not going to bother thinking about it.

It also explains why these properties have gone from $50,000 to $30,000. Investors buy future cash flow. Homeowners buy future happiness. People will spend a lot more on happiness than they will future cash flow. Proof? Look at American credit card debt. Happy homeowners have CC debt, investors don’t.

Condo Thoughts

So, I’m starting to think. I’ve a bunch of thoughts:

Condo Baron – You could be a total punk and find properties that are on the verge of losing their pre-approval. After you buy a few, you could essentially force condo values down because you have leased them, forcing other owners to go out looking for cash buyers instead of financed buyers. Whenever you reduce demand (not many live-in buyers are playing with all-cash) you reduce prices. Leverage up, buy as long term owners leave for higher ground, and call it “JT Tower.”

Race to the bottom? – What’s up for the condo market if financing doesn’t come back? Without the FHA, which is one of the very few ways most Americans can finance a home, condo values necessarily go into the toilet, which I guess isn’t really that big of a deal as long as you’re in it for the cash flow. It is a big deal if you’re in it to live in it, or if you want some kind of assurance you can sell it for what you paid.

I’m buying a condo – Not really, but almost. I mean, when I look at this from the standpoint of having a structural advantage, condos have it all. The worst has already come for condos—the FHA isn’t making loans on them. Things can only go up from here, unless the condos go to garbage due to sketchy tenants before the FHA comes back. It’s almost worth the gamble. I could finance one of these things on open credit card lines they’re that cheap. (Don’t skewer me, readers, I wouldn’t finance it with a credit card.)

Play with options – I know this is soooooo real estate bubble, but options exist with real estate, too. It’d almost be a worthwhile bet to offer a condo owner $2,000 for the right to buy the condo from them at a pre-determined price 1 year from today. It covers their cost of HOA, and I get a levered bet on condo values. Structure the deal with buyout clause so that the owner has to think long and hard about accepting a near-term lowballer. Cost to me is minimal, upside is huge (percentage-wise) if FHA comes back, and I could get financing to buy it should I want to. I might even consider living in it to give it a healthy dose of dude stench.

P.S. Since I wrote this, my girlfriend (who appears in this recent post about financial differences in relationships) confirmed that we would not, under any circumstances, be living in this building. Tough cookies, home girl! Financed over 10 years, the cost is $450 per month plus the HOA. That number assumes a 7% interest rate, which is steep considering that US Treasuries with a similar duration yield just over 3%. So cheap.

{ 18 comments… read them below or add one }

Kevin July 27, 2011 at 05:26

That is cheap! Condo prices are about 8 to 10x in a large city in Canada’s east coast.

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JT McGee July 27, 2011 at 12:03

What can I say, the Chinese interest that is in hot and heavy in Canada isn’t interested in Midwestern US properties. 😛

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No Debt MBA July 27, 2011 at 08:01

I’m curious if the rental market in your area is still strong if condo prices are stagnating to that degree. We’re in a high cost of living market right now where those would be picked up by renters like candy even all-cash, but maybe your market is different? If you’re not going to live in the condo you’d need to be able to find renters.

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JT McGee July 27, 2011 at 09:56

Median household income in my city is $40,000. Cost of living is cheap, but if you’re in the market for a live-in home, and the FHA won’t finance a condo for you, what are you to do?

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Financial Uproar July 27, 2011 at 09:20

Do it. Buy a condo or three. Buy as many as you can.

This is the exactly the same situation I found myself in 6-8 years ago when I started buying rental houses. Since then, I’ve averaged at least a 20% cash flow annually, and the properties have doubled in value. Since I have no plans to sell anytime soon I view the appreciation as more of a bonus.

If you’re paying 30k per condo, you could easily pay it off in 2-5 years. Repeat as often as you can. If I lived in your part of the world, I’d be going all in on real estate.

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JT McGee July 27, 2011 at 12:06

Looks like you’re sitting pretty then, Nelson.

Those cash flow numbers are excellent, and the appreciation is great too. While you’re not looking to sell to lock those profits in, are you using the equity to make more investments? Do you have any posts you can link me on your real estate holdings because I’m interested in reading them.

Great minds think alike. Buy it, pay it off, and extract the equity later, when the financing returns to normal. Maybe I’ll start a RE brokerage for Canadians who want access to the US market. The Canadian dollar is going pretty far in the US as of late. 😉

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Melissa @ BrokeTO July 27, 2011 at 11:22

Oh my gosh, I think I about cried when I read that. $40k for an ENTIRE condo? $40k wouldn’t even buy a parking spacing in a condo in my city. (I am, honest to God, not exaggerating.)

Forget what your girlfriend says. Buy the condo!! Heck, buy three.

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JT McGee July 27, 2011 at 12:08

Yep, $40,000 for the whole thing, not just half! I live in an area where there is plenty of land on the outskirts to build, and new buildings go up with each incremental increase in real estate values. We’re heavily undervalued in comparison to replacement value, so it’ll be awhile before growth continues. Even still, there aren’t many BIG condo units like this one…mostly smaller single family homes or individual condo-style/townhouse homes.

I like the way you think. I’ll talk her into it. I’ve time. 😀

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krantcents July 27, 2011 at 15:12

I think the last time I saw those prices in Los Angeles it was 1976! Financing is king. I am surprised the developer is not offering financing, since it is key to the sale. Maybe at these prices, there are enough cash buyers. It helps to have spare cash!

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Norman July 27, 2011 at 15:39

I am looking to downsize in preparation for retirement and have sold my house and have purchased a condo contingent on the final sale of my house. The condo is an a great area of the city and it is only costing me $66,000 so I will be paying cash. The realtor told me that over 80% of the buyers for these condos are cash buyers and they are selling within a month of being listed. However, the downside is that 55% are rentals rather than owner occupied. As I did, make sure you get a copy of the HOAs current balance sheet to see the financial condition of the HOA…otherwise a nasty assessment could wipe out your gains.

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JT July 27, 2011 at 18:46

Thanks for posting your experience. This explains a lot.

Since 55% of the units are rentals, then we know the FHA can’t make loans on them. And if 80% of buyers are coming in with cash, then clearly even the private lenders aren’t lending.

Would you care to share what is a reasonable rental value for a property like that?

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Norman July 28, 2011 at 08:31

Because of the area it is in, literally within a block of the trendiest area in town, my (soon to be) condo would rent for $650 a month easy.

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JT McGee August 4, 2011 at 10:34

Thanks for this comment. That implies an “easy” cap rate of 12%, which is pretty darn good considering that it’s heavy on renters already.

So I guess 12-15% is the return on cash that investors are looking for. Hmm..

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retirebyforty July 29, 2011 at 14:49

30k per unit is pretty insane. The cheapest condo in our area is about 150k now. What part of the country are you in? Do you know the HOA and property tax?

A 150k condo in our area can rent for around $1,100/month. HOA is quite expensive at $300/month…

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JT July 29, 2011 at 19:28

Indiana. Property taxes are 1% on assessed value, which is probably in the 30k range. No idea what HOA is…haven’t asked.

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Ashley @ Money Talks July 29, 2011 at 17:14

Prices are the same in my area for condos, possibly lower… but they seem to be in sketchy areas so I haven’t looked into it seriously. Sometimes I do get caught up in the MLS saying “OMG look at this one!… Honey, no look!”

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JT July 29, 2011 at 21:32

Yeah, there’s a few downtown that would definitely be in the sketchy consideration. MLS is way too fun.

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SB @ One Cent At A Time July 31, 2011 at 08:28

I am now more interested in buying condos as rental properties

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