Q & A With America's Real Estate Professor: Condo Approval
By Leonard Baron
Condo Purchase Cannot be Financed
Q. I’m trying to buy a condominium and my lender is saying that some of the projects I like are not approved for financing. Why aren’t some condo projects financeable and is there anything I can do to work around this issue. Melissa P. Yonkers, N.Y.
A. Major lending institutions have learned over the years that certain condominium projects have characteristics that lead the project to a higher risk of default. For example, if there is a lawsuit that the homeowner’s association (HOA) is involved in, that can lead to trouble for the owners and the HOA, and often more units in that type of project default on their mortgages and then the banks lose money because they have to foreclose. So those characteristics, which also include too many renters in the community, too high a non-collection rate on HOA fees, one owner controlling too many units, etc., are higher risk and the banks are basically saying, ‘No thanks, we’ll pass on financing those because we feel it is more likely we will lose money financing those types of communities.’
Instead of trying to work around this issue, you should realize that if you buy into one of these communities, you are taking on that risk that the lending institution rejected. And you’d better make sure you have a full understanding of the problem and what could go wrong. In most cases, I would recommend buying a property in a project that is already approved for financing and that way you will avoid many of those potentially financially painful issues.
Investment Returns on Real Estate
Q. I am considering buying real estate and trying to determine how to calculate my investment returns so I can find a good deal. Can you explain a few of the calculation options and which one is best? Robert. N, Philadelphia, PA
A. There are many ways to calculate investment returns on real estate and the best way is the one that you feel is appropriate for your decision making. There is Cap Rate, Cash on Cash, IRR (Internal Rate of Return), and several others.
I use the simple Cash on Cash return. It’s easy to calculate and I feel gives you the most accurate view of how a property investment will perform. Plus it’s pretty close to directly comparable to a cash yield on a bond, CD, or dividend yield on a stock. This way you can compare it to other investments. You take the rental income, subtract a vacancy percentage, subtract your conservatively estimated operating expenses, and the mortgage payment and what is left over is your monthly cash flow. Multiply that by twelve and divide it by the amount of cash you invested to buy the property and that’s your cash on cash yield.
For example, if rents are $1,500, all expenses are ($1,200), that leaves $300 per month or $3,600 per year. If your cash equity invested was $48,000 (downpayment + closing costs + rehab costs), you have a 7.5% net rental yield ($3,600/$48,000) and that’s a really good deal. So compare that to yields on other assets to get a picture of which would be a better investment.
You also get a little bonus on real estate because you are paying down your mortgage with each payment and hopefully the value will increase over time. Google how the other investment return measures work; each has its advantages and disadvantages. Pick the one that works for you. Good luck.
Leonard Baron, MBA, is America’s Real Estate Professor® - his unbiased, neutral and inexpensive “Real Estate Ownership, Investment and Due Diligence 101” textbook teaches real estate owners how to make smart and safe purchase decisions. He is a San Diego State University Lecturer, blogs at Zillow.com, and loves kicking the tires of a good piece of dirt! Email Your Questions to: Leonard@ProfessorBaron.com