Assessing the Association
I was recently talking with a first time buyer about the assorted contingencies that she'll have to fall back on if she puts in an offer on a property. For those of you not accustomed to real estate lingo, contingencies can be thought of as "escape routes" - they're reasons you can use to get out of your purchase contract. If you're working off of a standard Chicago area housing contract to purchase a condo, you'll usually be able to use the following reasons to get out of your purchase contract:
- Inspection contingency (Major problems with the property found by a licensed home inspector)
- Lawyer review contingency (Problems in the purchase contract language)
- Home sale contingency (If you have to sell your current home first before you can buy a new one)
- Loan contingency (No loan, no property.)
- Condo association contingency (Problems with the bylaws or financial status of the condo association.)
I mentioned that buyers often do not see the bylaws, financial statements and meeting minutes of a condo association until just a few days before closing.
"Isn't that really late in the game to be finding out that kind of information?" she asked. "Shouldn't you know the financial health of the association before you make an offer?"
Personally I agree. You should have that info before you make the offer. Condo association info is reviewed by not only the buyer but the mortgage lender. The information isn't only a matter of peace of mind, but the outright survival of the deal. Fannie Mae, Freddie Mac and Ginnie Mae have issued guidelines for what makes a good or bad condo development. Good ones make it pretty easy to obtain your loan. You might be stuck with a cash-only purchase if you want to buy in a poorly-managed one.
Unfortunately, since that kind of information could also seriously harm the property values of the other residents in the community, most HOAs hold the 411 about their business dealings close to the chest. They're entitled to do so, just as any other privately held business can keep their books out of the public eye.
Many condo developments choose cheap, ineffective property managers as a way to save money. Or they try to self-manage, even though the owners may have very little experience in taking care of a building and handling finances. It's no wonder that a lot of condo projects are in trouble. The best a would-be buyer can do going into a condo purchase is to ask as many pertinent questions as possible before writing the offer. That way, when the docs finally come through it's a matter of quick fact-checking as opposed to original research.
Perfect Domain or Parliament of Dunces?
Here's a rundown of what you should ask about when you're thinking about buying a condo in Chicago, especially if you'll be borrowing money to make your purchase. If you're putting down less than 10%, this information becomes even more critical, as the association will be subject to more intense scrutiny from your lender.
- Reserves. The reserve accounts are the building's savings accounts. If the building needs major work done, like a new roof, the regular operating account won't have enough money. A good development should be contributing at least 10% of its monthly assessments into the reserve account. Newer communities may not have a high reserve balance yet, but they should still be making an effort to build their funds.
- Lawsuits. A pending or recent lawsuit involving the condo association will kill your loan application immediately, with very few exceptions.
- Delinquent assessments. Are more than 15% of the residents behind on their assessments? Has the building evicted a large number of condo owners for non-payment of dues? If so you will have trouble getting a loan.
- Special assessments. When a condo association has to pay for a very expensive project without the funds to do so, they may levy what's called a "special assessment" to pay for the excess. This means that everyone's monthly payments go up - sometimes by a lot - until the debt is paid off. Sometimes the seller will pay the full balance of their share of a special assessment as part of the sale contract. Other times the buyer inherits those payments.
- Completion. If this is a new conversion, how many of the units have been sold? Banks don't like to take risks on empty developments.
- Owner to renter ratio. Faced with a slow sales market, many homeowners have chosen to rent out their condos until the activity pics up and prices aren't so low. However, too many renters in a building can mean more work for the remaining owners, not to mention lower property values in general. If you're buying with at least 20% down and planning to occupy the property in question, the ratio won't be a problem. Folks with lower down payments and investors need to be cautious, though, as too many renters in the building will kill the loan application.
- Residential to commercial ratio. It's easy to forget that storefronts on the ground floor of condo buildings are part of the association too, usually as renters. Rent from lots of commercial space is great for building up the association's reserves. It can be awfully convenient to have a dry cleaners in house. However, the square footage devoted to commercial use counts against the owner-occupancy percentage.
- Environmental hazards. Is the property in a flood zone? Are there buried oil tanks? Is it in compliance with local building and fire codes? If not, your lender may consider it likely that a lawsuit or worse may be coming down the pike and shy away from backing your mortgage.
- Is it really a Co-Op? Cooperatives are covered by entirely different underwriting guidelines, as you do not actually purchase property in a co-op. You purchase shares, and in exchange for those shares the coop rents back to you the portion of the building in which you'll live. I'll do a big article on Condos vs Co-ops in the near future, so don't stress if this is all pretty opaque right now. Suffice to say, if it's a co-op, you want to know that before you make an offer.
- Is it part Hotel? Lenders get really jumpy about issuing loans when a condo development uses part of its inventory for vacationers and temporary visitors.
- Property management responsiveness. If the building is managed by outside property managers, are they responsive? Many loans fail to close because of delays in receipt of necessary documents. A disorganized or overloaded property manager could leave you out in the cold. Check into the property manager's reputation via the BBB, Yelp and Angie's List before jumping in with them.
There are certainly other issues that may affect your comfort living in a community. Is the association active or hands-off? Do meetings run peacefully or are they rowdy like a CTA town hall meeting? Do they charge exorbitant move in and move out fees? Are you only allowed to move in on alternate Tuesdays in June? All of these questions are important, certainly, but the ones mentioned in the bullet list above are the ones that can keep you from closing.
Wednesday we'll be talking about the breakdown of a homeowner's monthly payment. See you then!