I used to give a class called, "Condos, Clients and Catastrophes." I haven't given it in a while but the issues are still valuable. Many of my comments will be California specific but the issues pretty much exist anywhere in the United States.
First, these laws apply to any planned unit development. The public and media call them condos but a true condo is usually a high rise unit, where you own only the airspace. Townhomes, connected properties and single family homes with a common area (pool, clubhouse, park, etc) also fall under these laws.
There are several issues that an agent should advise their client about "before" they start showing property:
- Loss of rights: Too often, buyers don't really think through the process. These associations typically have a much stiffer list of restriciions that the local laws. These might include house colors, landscaping restrictions, parking, pet and other restrictions. For example, you might not be able to park or do car repairs in your driveway. Or, maybe there is a restriction on basketball board on front of houses. Or, there might be a restricition on the size or number of pets you might have. All of these can be very painful if the buyer doesn't investigate these issues before removing contingences. Make sure that your buyer read the Rules and restrictions carefully.
- A loss for everyone: I just heard about a case where the HOA rules, even though well intended, were catastrophic to a family. Here is what happened. This townhouse complex was a designed senior complex. You had to be 55 years old to live there. And, their rules stated there the units can not be tenant occupied, even by another senior. So, they guy and his wife, convinced his father to buy one of the units, since the complex was quite nice and was near their home. 5 years later, dad dies. Since the mortage and HOA fees were in the $2500 per month range, the couple thought let's sell. But, then the house bubble burst. So, they said, let's rent it out until the market approves. Yes, you can guess. They are being sued by the HOA for breaking the rules. Don't know how this will turn out.
- Association dues and fees - Remember, these can be quite expensive depending on what the association is offering. And, since they are an expense, it will lower how much that your buyer can qualify for. So, be sure to tell your lender if the buyer is thinking condo, when you prequalify them
- Financials: Most of the litigation and unhappy buyers come from this area. The assocaition is a business entity. In that capacity, they have a financial statement which reflects their financial strength or weakness. When a buyer buys into an association, they take on their share of the liabilities. In most states, the association is supposed to be setting aside monies for a reserve account. This account is to be used for repairs and replace of the assets in the common area and is the area that is typically the biggest red flag. The problem is that in many states, replacement reserves are supposed to use "accural" accounting, vs. Cash accounting. What that means, that instead of waiting until the expense of a new roof comes up, they are supposed to anticipate the costs and prorate it, so that when the bill comes due, they have already collected the money. In California, this is done with a reserve study. This means that they look at each component of the association that will need repair and replacement (driveways, roofs, pools, sprinker sytems or anything else the HOA is reponsible for). The first determine the life of the component, then the remaining life, then the anticipated cost of replacement. Then, they divide this number by the remaining months, then the number of units. The result is the amount of $$ they should be collecting (NOW) to make sure that they have enough money. The problem is that most boards won't raise the due to a large enough number to accomplish this task. Some just don't want to raise their own dues, while others take the position, ..we won't be here when the roof has to be replaced in 20 years. The result is that many or in some cases, most, are under-funded.
- % of Reserve funding: This is determine by determing the ratio of actual funds on hand for reserves vs. how much they should be funded. This is expressed at percent funded (example is 32% funded). What this means is that the current owners have not paid their share. The problem is that someday the residents who live there when the bill comes due will have to pay. And, if there are not enough reserves, the HOA has a legal right to do what is called a special assessment to collect the money. So, instead of collecting $1 or $2 per month for the roof from each owner for 30 years, they owners might be billed $5000 for their share of the new roof. So, it is critical that the buyer have someone qualified read the financial statements. And, if underfunded, the buyer should ask the Seller for a price discount.
- Dues are too low: This should be a red flag. If all the properties you are showing are around $400 per month and this one is $250, watch out. Either the HOA board is incompetent or is purposely keeping the dues low. Or if this is a newer unit, still controlled by the builder, it is common for them to artifically keep the dues low, to help them sell their units. Unfortunatley, this has to be made up by the owners sometime in the future.
- Litigation: there is a joke in the industry that HOA has already been sued or will be. It is common that seller disclosures require that they must disclose if there is pending litigation. This means a current lawsuit. But, there are two others that are just as important.
- If the association has a past lawsuit, you need to find out what was the problem. Then, you need to find out how much was the settlement (these rarely go to trial) and most importantly, did they fix the problem. Let me give you an example of a real case I was on. The HOA sued the builder for several million dollars. They settled for less than the amount asked for. Since the attorney was working on a contingency fee basis, he took 35% of the settlement and there was another 5% in costs and fees. Thus, they not only did not get all they asked for but only got 60% of what they settled for. Because of this, they had not done the work. No one disclosed this to the buyer. So, when the board got around to sending out the special assessment of $500 per month for the next 5 years, he was not a happy person.
- IF there is a current lawsuit: You need to find out the problem. It is posible that it doesn't affect your building but you still have financial liability. In most cases, this property will sell for less than other comps and you might have trouble getting fixed rate financing. They safest way to determine how much would be to take the total amount that they are asking for (let's say $4,000,000), then divide by the number of units. If there are 200 units, then I would discount my offer by $20,000.
- The next area is contemplated. This is rarely a required disclosure. This is a case where the board is discussing suing someone but hasn't actually done so. This can be a sucker punch to a buyer. In California, the law requires that the buyer receive a copy of 1 years worth of minutes of the board. Typically, these kind of issues are discussed months and months ahead of actually pulling the trigger on the lawsuit. Whether the HOA or the Seller has the legal duty to disclose, it is a good idea for the buyer's agent to make a written inquiry of whether there is past, current or pending litigaiton.
- Loss of value while in litigaiton: This one really frosts me. Too often, attorneys will convince the owners to file a lawsuit without looking into every other possible solution, like mediation. The problem is that the minute a lawsuit is filed, it must be disclosed to potential buyers. And, like any smart buyer, they either won't buy into a complex with litigation or they substantially discount their price. And, since it may take 3-5 years on this type litigaiton, the current owners are really stuck. If they try to sell, they lose big time. And, many may not eve be able to refi since they have lost value. Again, not a pretty picture.
- % of rentals - most lenders will not make loans, or a least good loans, in a complex with 30% or more rentals. But, in todays market, there is even a bigger problem. I have a friend who has a beautiful condo in San Jose, Ca. Unfortunately, the builder allowed almost 50% of the buyers to be investors. So, when this turndown happened, many have walked away. And, they are not paying their monthly dues, so the current owners are having to pony up extra money each month.
I had no intention for this to be as long as War and Peace but as I typed, I just thought of more and more issues that I have seen in my many years.