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.
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.