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| The Basics | Is a condo a money pit?
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Dont let the surge in prices fool you: The condo craze is all bubble. Worse, living in a condo can be maddeningly complex -- and costly.
By Liz Pulliam Weston
Any time speculators tell you that things are different this time, you should beware.
Yet that's exactly what some investors and experts are saying about the condominium market. They insist the wild upsurge in condo prices can be attributed to changing demographics.
Don't you believe it. This is the tech-stock bubble all over again. Consider:
Condo builders are on overdrive. About 800,000 condo units were built between 2000 and 2004. Between 2005 and 2006, the National Association of Home Builders expects another 525,000 new units to come on line. Regulators and rating agencies have expressed concerns about potential overbuilding in several markets, including Las Vegas and Miami, as speculators snap up new units in hopes of flipping them for quick profits.
Condo conversions are running amok. In 2003, investors bought about $3 billion worth of apartment units for conversion to condos. A year later, that volume had soared to $13.3 billion, a 350% increase in 12 months. Another $7 billion was snapped up in the first six months of 2004. The pace is so frenetic that Fitch Ratings predicts widespread defaults in the next three to five years as inexperienced investors combine with oversaturated markets to devastate many projects.
Price increases are losing momentum. It was big news when median condo prices outstripped those of single-family homes for the first time. But after four years of double-digit gains, the rise in condo prices recently slowed dramatically while single-family home values continued to charge ahead.
| Median value of single family homes vs. condos | | Year | Single family | Change | Condo | Change | | 1990 | $92,000 | 2.8% | $85,200 | -0.9% | | 1991 | $97,100 | 5.5% | $85,800 | 0.7% | | 1992 | $99,700 | 2.7% | $86,000 | 0.2% | | 1993 | $103,100 | 3.4% | $84,400 | -1.9% | | 1994 | $107,200 | 4.0% | $87,200 | 3.3% | | 1995 | $110,500 | 3.1% | $87,400 | 0.2% | | 1996 | $115,800 | 4.8% | $90,900 | 4.0% | | 1997 | $121,800 | 5.2% | $95,500 | 5.1% | | 1998 | $128,400 | 5.4% | $100,600 | 5.3% | | 1999 | $133,300 | 3.8% | $108,000 | 7.4% | | 2000 | $139,000 | 4.3% | $111,800 | 3.5% | | 2001 | $147,800 | 6.3% | $123,200 | 10.2% | | 2002 | $158,200 | 7.0% | $142,200 | 15.4% | | 2003 | $170,000 | 7.5% | $165,400 | 16.3% | | 2004 | $184,100 | 8.3% | $193,600 | 17% | | Sept. 2005 | $212,200 | 14.3%* | $213,600 | 9.0%* |
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*Compared to September 2004; Source: National Association of Realtors
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A litany of drawbacks
By the way, it's not that your average single-family home costs less than a condo in the same market. Most condos are located in expensive big cities along the coasts, while the single-family home data reflects prices throughout the country. In San Diego, for example, the average new condo costs $450,000, but the average new house costs nearly $650,000.
The reality is that condos will never replace single-family homes as the real-estate investment of choice. Condos simply have too many drawbacks and too limited appeal for most buyers:
- Older units suffer from the shoddy construction that plagued the last condo boom in the 1980s.
- Condo conversions are still apartments in drag, with all the noise and shared-space issues that plague rental units.
- Even the newest, most upscale projects are eventually turned over to resident-run condo associations, which often do a poor job of keeping up with maintenance and repairs. One out of three associations, according to Calabassas, Calif.-based Association Reserves, doesnt have enough money in the bank to pay for needed upkeep.
And that affects your bottom line. If your fellow residents let the complex go to pot, your units resale value will suffer.
Your investment is in your neighbors hands in another way. If enough of them become landlords, you could have trouble selling your unit. Lenders often balk when renters make up more than a third of a condo complexs occupancy.
Condo owners in hard-hit Southern California and Boston learned about this potentially vicious cycle during those markets' last real-estate recessions. As prices started to drop, those who couldnt sell their units for what they owed on their mortgages often decided to rent them out instead. That made it harder for those who remained and wanted to sell. The more values dropped, the more renters appeared and the more lenders refused to offer mortgages to potential buyers.
That's among the reasons why condo values fell more, and took longer to recover, in those markets.
Demand likely to rise
Now, the new condo cheerleaders aren't entirely wrong when they say demand for these multifamily units is likely to increase as retiring boomers downsize and buy second homes. This is especially true in the high-end market, where more wealthy folks are trading in luxury homes for luxury condos, according to Lawrence Yu, research director for the National Association of Realtors.
These upscale condos offer quiet, exclusive luxury with none of the maintenance hassles that come with owning a stand-alone house. A rising number of better-off baby boomers likely will continue this trend, keeping the upper end of the condo market strong.
But anyone who expects vast numbers of boomers to shift to condos is delusional. Like their parents, 80% of whom "age in place," most boomers will stay in the houses where they retire. Familiarity and family ties will, for most, trump Arizona golf courses and Florida early-bird specials.
The projected influx of first-time echo-boomer buyers may be exaggerated as well. Cheap mortgage rates in recent years brought homeownership within the grasp of many renters, who bought what they could afford -- which, in expensive cities, was condos.
What interest rates giveth, though, interest rates can taketh away. Every uptick from now on will exclude more potential purchasers. With fewer entry-level buyers, the market will cool for the typical condominium.
If youre still determined to buy a condo, take the following steps to protect yourself:
- Read the codes and covenants. These outline whats allowed and whats not. Many restrictions are designed to preserve the complexs value, but you may find the lack of freedom stifling. Make sure you know what youre in for.
- Talk to other occupants. A high number of renters or complaints about the condo association should be red flags.
- Ask about the associations operating budget and reserve fund. Bad signs: more than 10% of owners are late paying their condo association fees, and more than 50% of maintenance liabilities arent funded.
Liz Pulliam Weston's column appears every Monday and Thursday, exclusively on MSN Money. She also answers reader questions in the Your Money message board.
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