Buying a Starter Part II: The Skinny on Coops and Condos

Ok, so we discussed the limitations of purchasing a starter home, so what about purchasing a condo or coop?  Let’s start with coops.  Short term ownership plans may not fare well for coops.  The coop market waxes and wanes from year to year, and is much more sensitive to market fluctuations and volatility than any other type of housing.  Although coops are the most affordable type of property to own, they are also the least popular.  The reason is that ownership interest in a coop is diluted, you own shares in the building/complex rather than anything tangible, yet are still responsible for the maintenance of everything within your unit.  You have a board to deal with from whom you must get approval on everything from home renovations to occupancy.  Renting is often severely restricted if not prohibited, and there are generally a lot more rules associated with living there.  There are also often strict income and down payment requirements, thus further diminishing an already limited buyer pool.  For these reasons, coops are often tough to sell.  And even when you do find a buyer, they have to be approved by the board, making it even more difficult.  Having said that, in a hot market, coops are very viable low hanging fruits, and can be attractive to first time home buyers on a limited budget desperate to get into a conveniently located neighborhood that’s hot and take advantage of interest rates while they are still low.  But when the market tanks, they are the first to take the hit, and it’s often substantial.  Hence, the coop market can be very volatile.  So let’s say you are in a hot market, and a coop is your only affordable option.  If you only have ownership plans for 3-5 years, and do not consider yourself much of a gambler, what do you do?  One word: RENT.

Condos are a little more stable in terms of withstanding market volatility, but there are still risks in purchasing one short term:

• Assessments – this actually applies to coops as well. When you move into a condo or any property that carries home owner association/maintenance fees, there is always a chance that those fees can go up, particularly if there is a special assessment that gets applied.  An assessment is a fee that is padded on top of HOA fees to cover the cost of any work that will be done to the exterior of the complex, or to replenish a diminishing capital reserve for general maintenance.  So let’s say the building needs a new roof, the Home Owner’s Association will hire a roofer to do the work, and have the home owners share the cost among them.  Assessments can range from the double to the triple digits.  They can be long term, spanning several years, or can be only a few months.  It depends on the complex, the capital budget, the building’s overall financial picture, and the work that needs to be done.  So if the external appearance leaves you wary that there might be work needed on the horizon, or that work was recently performed, you might run the risk of inheriting a special assessment.  When an assessment gets applied, the fees go up, and the complex can become less attractive to buyers.  Before you buy, you should always check the last several year’s financials, and inquire as to whether an assessment is in the near future, but such due diligence doesn’t come with any guarantees.  And if you plan to sell within a few years of your purchase, an additional assessment may hurt your market value.  You may not have amassed enough equity after a few years to off-set the potential value hit that an assessment can deliver.
• Warrantability – the warrantability, that is, the risk a condo project presents to any given lender varies from month to month. This means that many banks will not lend to certain projects that are not, or have become, unwarrantable.  What affects warrantability?  Well, there are any number of factors from investor concentration to slip-n-fall lawsuits against the complex.  I guess the biggie would be owner concentration.  Owner concentration refers to the amount of units within a project that are presently owner occupied.  Most condos have far more limited restrictions on the ability to rent, and hence, you can have a widely fluctuating rate of rented units per month.  When there are too many renters in a complex, the project may be deemed unwarrantable and, as I mentioned, many lenders will not lend to it.  If they do, they will often require a certain percentage down, usually 20% minimum.  Limited financing ability means a diminished buyer pool, and that could take a toll on your ability to sell.  If you need to sell quickly and have not amassed enough equity in order to do so, you may have to sell at a loss.  The obvious benefit to a condo over a coop in this case is the fact that you stand a much better chance of being able to rent out the former.  Therefore, if you do need to sell quickly, you can hold onto a condo and rent it out until you have amassed enough equity to the point that it makes sense to sell.  However, being a landlord/property manager comes with other risks and headaches which we will discuss in another entry.

I don’t mean to discourage any buyers from short term purchases, only to advise of the inherent risks.  In all honesty, I am not a fan of purchasing with an intended occupancy of less than 10 years in any type of dwelling, but that is a personal choice that you alone must make, based on your own personal and financial situation.  Just do as much due diligence as possible before you buy.  While there is though is no guarantee that there will not be change on the horizon, doing your homework upfront can go a long way to mitigate risk.

One more parting tip:  if you MUST buy a short term condo or coop, it is my recommendation that you do not buy the one with all the bells and whistles.  Given a choice between two units of similar size and bed/bath count, with all other things being equal, go with the less updated unit that is less expensive.  Do not pay a premium on someone else’s finishes that are ever depreciating.  Buy the cheapest unit in the building and throw a few thousand into renovations, or wrap the renovation fees into the mortgage if need be.  Buying the lowest price unit and gaining sweat equity by doing a little work will somewhat insulate you from the effects of a market crash, or at least mitigate loss in the event of one.  As we know, buyers pay ridiculous premiums for updates (thanks HGTV), and a few thousand dollars worth of upgrades can mean tens of thousands in value.