There’s something about owning real estate that gets folks going all ga ga. On a primal level, we humans crave to see, touch, even smell (ya, odd, but hey, we’re a diverse species) our investments, and real estate offers the chance to do just that and more.
The more part? Well, there’s the Sunday drives where you may visit your property for inspection or simply wave hello, and feel good about a particular piece of wood, brick, steel or stucco belonging to you. And you may show your friends and say things like, ‘hey, lets meet at my investment property before we go for dinner’. And all that will give you the warm and fuzzies like no stock ever could.
But, putting on my investor cap, aside from being a source of the occasional feel goods, does it make money sense to buy a condo for investment purposes?
Talking This And That
Alright, first off, I can’t give you a blanket yes or no to that question. There are just too many variables, too many ‘it depends on this and it depends on that’ scenarios such as: the particular neighborhood where you buy; is property demand growing owing to neighborhood/town/city growth; is the condo structurally sound or will the building need major repairs in the near future; did you lock into a smoking hot deal, like those on offer in 2008-2009 in many parts of the USA; what are your financing terms; did you hire a property manager or will you be responsible for dealing with maintenance, repairs and tenants; do you enjoy being a landlord? do you understand that property ownership is a business in itself, requiring your commitment of time and energy if it is to be successful …
All of these issues will affect both your income stream (i.e., rent) and whether or not the condo’s value increases over the years to come.
Uh Oh, I Didn’t Think About Those
Look, I’m not trying to dissuade anyone from investing in a condo. But I am saying there’s a good chance that it may not be all your friends say its cracked up to be. And I’m saying that you have to look at downsides and potential pitfalls, you have to fully inform your self as to what you’re getting into, before starting any business or venturing into any investment.
Working For A Living
Running your own property investment gig takes commitment, skill, and energy. And to do so successfully, you need to know how the game works. In this regard, consider the following Need-To-Knows:
- Condo Fees
You’ll pay a monthly fee, akin to a maintenance fee, that goes toward keeping the building in good working order. When you’re budgeting expenses, be sure to factor this into ownership costs. And count on the fee increasing at least as much as the rate of inflation.
- Who’s Running The Show?
Owners are elected to the Condo Association, which is usually made up of between 5 to 9 people. When owner-occupiers serve on the Condo Association, they typically take better care of the property. Landlords not so much as they’re more concerned with keeping monthly fees to a minimum so they can maximize personal cash flow.
- Condo Rules
This condo rule thing, it’s fairly wide open as far as what may or may not be permitted. Common examples include: uniform colors throughout the building, no pets, and even no kids. For the potential landlord, well, it goes without saying that you need to ensure that the rules do not prohibit renting.
- Joy of Assessments
Let’s say the building needs a new roof or owners vote to replace single pane windows with double pane. To pay for it, the Condo association has the power to assess a special levy on all owners. Meaning, you’re obligated to pay your share of repairs whether you want the repairs or not.
Typically, it will be a lump sum payable by a certain date. In the Pacific Northwest, during the past twenty years or so, many buildings constructed of wood in the 1970s or 80s needed to have the entire building enveloped and repaired owing to structural water infiltration. The cost per owner? Somewhere in the ballpark of $30,000 to $60,000. Not pocket change.
And once in a while, a rebel owner would put on their complaining pants, state their objection, and refuse to pay their share of the Assessment. What happens then? The Condo Association has the right to put a lien on Rebel Owner’s unit that may prevent future sale of the unit. Okay, all fine and good and just and fair but, in the meantime, funds need to be raised for repairs. Who shoulders the extra cost? The other owners.
- Condo Association Finances
Before buying, you absolutely must review Condo Association finances. Even better (and highly recommended) is if you have an experienced condo lawyer review the books because they will know exactly what to look for, and what to flag.
Common issues include:
Financial Reserve. Does the Condo Association maintain a financial reserve? If so, how much is the reserve? If the reserve is on the teeny tiny side or there is none, don’t be surprised to receive occasional assessments for major repairs.
Condo Fee Steady. If the Condo fee hasn’t risen for several years, expect an increase soon. And if the fee was recently raised, find out why. It’s possible that an increase reflects a need to raise more funds to pay for repairs.
If The Purpose Is Investing, Think About A REIT Or Two Or Three, Instead Of A Condo
If you’re not too keen on expending the time and energy required to run your own property investing business, i.e., manage repairs, attend to tenants, fill vacancies, arrange a mortgage, and pay property taxes, then consider investing in REITS.
A Real Estate Investment Trust (REIT) is a company that owns or finances income-producing real estate.
Many REITS are publicly traded so owning shares is a simple matter of paying under $10 to your discount broker and making the buy. Yup, it’s that simple. And you get to keep your evenings and weekends free (instead of fixing the toilet in the condo or meeting with the bookkeeper) while earning a monthly dividend of anywhere between three and ten per cent (the dividend yield depends on the particular REIT) and reaping the benefits of any share price increase.
So what’s not to like about a well managed REIT? Well, before I blather on about the benefits of REITS, here are two potential downsides when compared to being a property owner:
- First, you’re not in control of the property. Instead, you’ve outsourced control to the REIT management team. Personally, I don’t see an issue here, to farm out management to people who are skilled and experienced in the real estate investing game. That said, property owners enjoy doing business their way, they want control.
- Second, REIT share prices don’t zoom to the moon. So, if you own property in a neighborhood where prices are skyrocketing, then your property investment will likely perform better than a REIT.
For those of you who do not wish to speculate on property prices, are not built to be a landlord, and prefer a virtually stress free property investment vehicle, choose REITs because …
REITS offer diversification in that they hold many properties situated in different geographical locations. And they operate in all sorts of property related businesses including: office, industrial, healthcare, shopping centers, mortgage/finance companies, student housing, hotels, self-storage, and apartment buildings.
A solid REIT provides stable monthly income and annual dividend growth. Think of each dividend increase as a rent increase charged to tenants – the beauty of it is that you don’t deal with any tenants.
Instead of you taking care of buying, managing and selling property, with all its attendant costs and demands on your time, REIT owners are investing in the company’s property management expertise, and their ability to effectively run a public company, including improving its share price and cash flow.
Every month, the REIT drops a dividend payment into your investment account, and occasionally you check the share price. Stressful? As much as a day on the beach.
On any given day that stock markets are open for business, you can sell shares in your REIT for a total transaction cost of under $10 (assuming you’re using a discount broker). Not so with real estate. Rather, it takes time to find a buyer. There is a waiting period up to ninety days before closing. And you need to hire a lawyer and real estate agent, at a minimum, and often pay a government land transfer fee in the thousands. Typically, closing costs run anywhere between four and eight per cent of the sale price.
What Works For You
If you haven’t guessed by now, I’m more of a fan of owning solid REITs instead of income producing property.
REIT ownership is simple, and I don’t have to bother with (re: stress) buying, managing and selling property; which leaves more time for life outside of investing such as hanging out with my kids, going for a walk with my wife, hiking and yoga. Balance.
Still, it’s not a matter of one being ‘better’ than the other. If you enjoy being a landlord and all its responsibilities, and are committed to making your own property investment business a success, then go for it. For those who want exposure to real estate but do not have the time and/or inclination to be a landlord, REITs are an excellent alternative.
ps. huge thanks to American Advisors Group for their permission to use the image introducing this post!