Buying an Investment Condo
When buying an investment condo, there are many factors to take into consideration. Investment condo buyers can face special financing requirements, rental restrictions, and management issues. It’s important to look beyond the rental income when making this decision. As a potential buyer, you should also consider expenses (both regular and occasional) when calculating the potential return on an investment condo.
So what are the issues and expenses when buying an investment condo? Let’s break them down.
SPECIAL CONSIDERATIONS WHEN BUYING AN INVESTMENT CONDO
Before buying an investment condo, undertake some due diligence on the condo building, the condo association, and the neighborhood.
You’ll want to ensure that the condo management and finances are strong. You’ll also need to review the condo association’s rules, restrictions, and convents (AKA “condo docs”) very closely. Look for any mention of a “rental cap,” a limit set by the condo board or HOA, that restricts the number of condos in a building or community that can be rented out (vs. owner occupied). As an investor, you’ll want to confirm that the condo you’re considering can, in fact, be rented.
You’ll also need to do some extensive research on the neighborhood. Is the condo in a high-demand area for rentals? Is there a major employer nearby? Are any employers expected to move in (or out)? Are there a lot of competing rental properties? Is there a solid source of potential renters, perhaps local college students or millennials?
If you’re planning to finance the condo (vs. a cash deal), keep in mind that most lenders require a 20-25 percent down payment on loans on investment properties.
Some lenders even require the investor to live in the condo for one year before renting it. The lender must also approve the condo association. As a general rule, lenders won’t finance an investment condo in a building facing any sort of litigation.
Given all of these special considerations, you should plan on the condo being a longer-term investment (holding onto it for at least five years).
CALCULATING THE RETURN ON AN INVESTMENT CONDO
So how much can you expect to make on an investment condo? The expected return can vary depending on the expenses. You’ll have regular expenses such as taxes, insurance, and association fees (and a mortgage payment if you’re financing the purchase which would likely include the taxes and insurance, but not the association fees). You will also have intermittent expenses such as repairs, special assessments, and vacancies (it’s financially wise to plan on the condo being vacant one month each year).
Other potential expenses include property management fees (if you don’t plan to handle the day-to-day management) and advertising costs for finding a tenant.
Now for the income. Of course, the main source of return when buying an investment condo is the monthly rent it will generate. Additionally, you’ll enjoy the annual appreciation of the value of the property. Keep in mind, however, that condos appreciate in value more slowly than single-family homes due to the fact that the owners do not own the underlying land, only the unit.
To calculate your yield on the unit, divide the annual rent the condo could provide over a year by purchase price. For example
$2,500 rent x 11 months / $ 225,000 purchase price = 12 percent yield
It’s very important to also calculate net yield, which accounts for all of the expenses outlined above.
A good rule of thumb when buying an investment condo is the “One Percent Rule.” If the expected monthly rent equals at least one percent of the purchase price, the condo is a wise purchase. For example, a $300,000 condo would need to rent for $3,000 per month to be considered a good investment under the One Percent Rule. Keep in mind, investors may have difficulty reaching this ratio in our market, but it’s wise to keep this guideline in mind.
THE BOTTOM LINE
Buying an investment condo can be a good financial move — if you do your research and have realistic expectations. Be sure you look closely at the condo association, its rules, and also the neighborhood and local rental market before making an investment in any condo unit.
If you are considering buying an investment condo please let us know. We’ve helped many clients purchase investment properties — with great results!
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