Have some spare money, should we buy a condo to offer as rent?

July 31, 2012 12:12 PM

Married, and have some savings. Does it make sense buying a condo just for giving it out as rental? Caveat - I may have to sell it off in about 3-4 years though so I'm wondering whether it'll all be worth it.

We're recently married and are renting from a private condo owner in a very good home-owners condominium community. We love the location and the amenities offered by the housing association and were thinking whether it makes sense to buy a condo just for rental purposes.

We currently pay a rent for a similar condo at about 1% of the approximate price of the condo. (say 1000$ if the condo price is $100k). We have enough savings to outright purchase the condo in the next two years if we wanted to. The prices have been pretty stable for condos in this community and we've seen a 5% total increase between prices of say 2008 and now - so buying the condo doesn't make sense just for appreciation purposes. A 15 year mortagage would come to about 70-80% of the price we expect to make via rent each month so that should take care of the mortgage money.

I work nearby but my wife is looking for jobs; depending on where she gets it - we may end up moving to up to 30-45 minutes away from this location so she can travel light and I'll commute by public transportation to my workplace so we're not keen on making this our home and would prefer renting for ourselves and becoming landlords for the condo we're thinking of buying.

We're considering leaving the U.S. in 4-5 years so we won't be buying a home or condo as our primary home.

So we're wondering whether getting into being a landlord, buying this condo, dealing with tenants will be worth all the hassle or not. We're responsible people but have read quite a few terror tenant stories on ask me :)

So theoretically if all works out well: Say we buy this place paying a 10-20% downpayment. The rent should take care of the mortgage costs so we don't expect major changes to our current lifestyle except for the occasional maintenance, and hopefully the annual tenant lease signup/renewal. In 4-5 years, we should have paid off about 40% of the mortgage cost just with the the rent we earn so we should make an approx 30% profit when we sell this in about 5 years?

Also - how much is the normal home owner's association fees? We've heard the fees are higher here than in other places but don't quite know how to compare.
What's the typical home owner's insurance cost?
Are there companies who can take care of managing renting the place etc for a fee, say for when we leave the country but don't sell the condo.
Are there tax consequences we're not considering?

Thanks so much!

posted by bbyboi to home & garden (12 answers total)

All of the usual caveats about getting major financial advice on the internet ought to apply here.

But let me encourage you to take a step back. You're considering a financial investment that might net you a 6% return per year by your math. But it has a lot of obvious financial risks-- a problem tenant could ruin you; fluctuations in your local real estate market could ruin you; even just a few months of vacancy here and there as you're looking for a non-problem tenant could eat up a lot of your planned returns. And you'll be learning from your mistakes as you go.

In the alternative, you could invest the money in a diversified portfolio of interest-bearing assets (there are lots of threads here about the best kinds of assets, I have my views, but that's another question). Unless you have some particular skills at being a landlord, or some other reason that this is an unusually cost-effective investment for you, or a strong affinity for gambling, you will almost certainly have a lower risk-adjusted return if you put your money in some kind of investment portfolio. If creating the portfolio seems daunting, I assure you that the finances of making money off of individual real estate parcels are worse.
posted by willbaude at 12:24 PM on July 31, 2012 [5 favorites]

Home owner's association fees can vary drastically. I had a 2/2 condo in Florida, my mortgage was $450 and my HOA dues were $150 per month. This covered my share of insurance on the building, grounds keeping, maintenance and electric (for the building common areas, not my unit), trash and water. My friend's condo charged $500 per month in a high rise. It really depends.

Another thing that's an issue with condos is assessments. If the place needs a new roof, the association will send each owner a bill for their share of the expense. You don't get to vote on it either. Assessments can go into the thousands, depending on what's getting fixed.

As a condo owner, you'll have a cross between homeowner's insurance and renter's insurance. You'll need some liability for the inside of your unit, but the actual building and exterior will be covered under your HOA. You'll need your own insurance for the contents of your unit.

I was responsible for my HVAC and Hot Water Heater. It just depends on how your facilities are run. Do you have a boiler or is each unit on a separate system?

If you ask me, given the question marks in your plans, I wouldn't buy a condo. The small appreciation in value will be eaten by the closing costs on your purchase, about 5% of the purchase price, and if you sell, the realtor fees will suck any other profit you may have seen. Realtors typically charge 6% of the total purchase price.

Many mortgages at optimal rates are for owner/occupants, not for investment property. Also, the deductions for mortgage interest aren't as good as they would be for an owner occupant.

I don't think this is a very good idea. You won't realize the profit you're anticipating and if any one portion of your plan doesn't work out, you'll be out money and you'll have a condo to deal with.

It's better to bank the money than to risk it on this kind of investment.
posted by Ruthless Bunny at 12:29 PM on July 31, 2012 [1 favorite]

Variations of this question are asked on a regular basis, and I always think it's a bad idea. People seem to think that "becoming a landlord" is something you can do once by filling out some forms and then you just get free money without doing any work after that ("can we pay someone to manage it?").

Being a landlord is a lot of work and long hours, it opens you up to a lot of legal requirements and liability, it can very easily become a money sink rather than a profit, nightmare tenants are nightmares, on and on.
posted by kavasa at 12:42 PM on July 31, 2012

My siblings both have a substantial number of rental properties, and I've got some friends who would love to be out from under their rental condo.

The thing about owning a condo is that it only takes one unscrupulous law firm to convince a gullible condo board that they need to sue about some defect, which, at best, leaves the law firm with 2/3rds of the settlement amount, the condo board without enough money to cover the now disclosed repairs, and the owners on the hook for the rest of the bill.

The thing about owning rental properties is that rental/leasing management is a lot of work, and so far as I can tell the only way it's really profitable is if you get enough properties that you can start to build your own maintenance and repair team. That said, there are property management companies that do this.

And the only people I know who actually made money with condos did so during the real-estate bubble, and sold 'em before 2008.

To your questions:

"how much is the normal home owner's association fees?" - That's not important, you're looking at this condo. Look at the board minutes, figure out how the money is being spent. Remember, you're about to buy a building in common with a whole bunch of other people, you should know what they're spending the money on and why they're doing so.

"What's the typical home owner's insurance cost?" - call your insurance company and ask them. My insurance company has been really good about helping me with speculative questions.

"Are there companies who can take care of managing renting the place etc for a fee, say for when we leave the country but don't sell the condo." - Absolutely. There are property management companies that do exactly this. Call 'em up and ask them about the details.
posted by straw at 12:53 PM on July 31, 2012 [2 favorites]

If you actually wanted to live in the apartment for several years I could imagine buying it, but not as a rental property. Buying real estate is a big deal. I wouldn't do it just to make some hypothetical extra money, especially if you may have to be a seller/landlord while living in another country! Based on my own experiences, it's hard enough to get through the whole purchase process when you're really invested in living in the place. There are all sorts of fees (lawyer, bank, application costs, and maintenance costs later in addition to the mortgage). Plus, once you've bought the place you have no guarantee you will find a good tenant, or a tenant at all.
posted by mlle valentine at 1:24 PM on July 31, 2012

Renting out real estate is not a hobby. It's a job. It takes time and money.

In 4-5 years, we should have paid off about 40% of the mortgage cost just with the the rent we earn so we should make an approx 30% profit when we sell this in about 5 years?

No. Absolutely not. Several reasons.

First, you aren't actually paying off 40% of the mortgage. Interest is real. Say the property costs $100,000. Say you put 20% down. Say you pay 4% interest. In five years, you'll have paid $35,505 towards the mortgage, but over $14,000 of that will have been interest. The balance on the mortgage will still be over $58,000. So you'll only have realized an equity gain of $22,000. That's 22%, not 40%.

Second, just because you aren't living in the place doesn't mean you won't be spending money on it. Property taxes and insurance are real things, and they're just as high as if you were living there. Possibly higher; don't know about how rental premiums compare with owner-occupied premiums. There's a few thousand dollars of expenses right off the top.

Third, you will have vacancy. You just will. Maybe only a month or so per year, but it's going to happen. Nationally, the vacancy rate is about 8.6% as of last month, i.e., 8.6% of the rental units on the market are vacant at any given time. That's almost exactly the equivalent of one month out of the year. Which makes a certain amount of sense. Most leases are for one year, and it takes about a month to clean up after the old tenant and get a new one. You can maybe turn it around faster, but that's a pretty decent assumption. So plan on eleven months of rent per year, tops. At 1% of the total property, that's $11,000 a year.

So let's take a look at the numbers. At that price point, you can really only count on $11,000 in revenue per year. But your mortgage expenses alone come to about $7,100. A good chunk of that is principal, but we'll get to that in a minute. It's still money going out the door every month. Call it another $2,000 or so for taxes and insurance. Now we're at $9,000. You'll also need to set aside money for maintenance and repairs. Not much, probably, but $1,000 a year is not impossible, especially on average. One visit by a plumber can easily set you back a few hundred bucks, and you'll need to spend money on the place every time you get a new tenant. So we're at $10,000. Throw in your condo fee, which could be anything from $50-150 a month, and we're right at the point where you're breaking even on a revenue basis. There will likely be other expenses, but let's stick with that.

So the odds of actually making a profit on a revenue basis seem low. That leaves us only with your equity contribution of $22,000. Only you're probably going to have to pay closing costs at least once, either buying or selling, so there's $5,000 right out. Down to $17,000. Over five years. A 17% gain, call it 4.25% on an annual basis. If everything goes right.

That's not a terrible return, especially these days, but it's a far riskier and work-intensive way of going about getting a return than just dropping the money on muni-bonds. And an extra month or two of vacancy will radically decrease your return.

Of course, you'll do a lot better if you charge more than 1% of the purchase price in rent. Even 1.5% would radically change those numbers. But you may not be able to command that price on the market. That's just another aspect of the risk.
posted by valkyryn at 1:26 PM on July 31, 2012 [7 favorites]

TL;DR version: if making money renting out property was as easy as you think it is, everyone would be doing it. But in reality, a landlord is a labor-intensive, fairly risky thing to be unless you've got an enormous amount of capital. An apartment complex is, in many respects, a safer investment than a single residence.
posted by valkyryn at 1:39 PM on July 31, 2012

What valkyryn said! It is really tough to turn a profit on a property in such a short timeframe.

Also, depending on where you're from, the HOA fees that valkyryn uses may be low. I paid $625/month in HOA fees in a high-cost-of-living area (as a reference, my mortgage itself was only $950/month).

If I were you I would definitely invest this money to save up for the down payment on your future home, assuming you're already maxing out tax-advantaged savings like retirement accounts and that you have an emergency fund. I have been a landlord. Your situation does not sound like a worthwhile investment to me.
posted by treehorn+bunny at 3:08 PM on July 31, 2012 [1 favorite]

There are also substantial closing costs that you will not recoup (around 7% of the mortgage amount? something in that ballpark), that, and if you sell in a few years, you get to pay transfer tax again (plus a 6% commission). There's a rule of thumb that if you're going to sell in less than 5 years you should hold off on buying, because the closing costs on either end make it so not worth it.

You would also be marrying a condo association, their fees, their whims, and their collective liability. You might be better off getting a duplex or something, renting half and living in half, but that might be my control freak side coming out. Condo and HOA fees seem, to me, like paying a mortgage and renting at the same time with the negatives of both.

Don't forget what your time is worth! If you are squeaking out 3-5k a year in profit/ equity, is all the time you'd spend managing the place worth it? What about the risk of a horrible/ deadbeat/ hoarding/ million cat/ super-litigious/ meth-cooking tenant? (World's Worst Tenants). Just buying a house is hard work. The paperwork, meetings, phone calls, inspections, appraisals, and haggling take a lot of time. I estimate I've spent around 100 hours actively buying a house, and probably another 100 of internet research. Times that by your hourly rate and it's not insignificant, and just like closing costs on either end of your ownership you are very unlikely to recoup that in whatever value you extract from renting the place.

I'm no expert at all, though. If you run the numbers, and are very conservative in your estimates, and it makes sense to do it, I'm not one to stop you. I asked a real estate question on AskMeFi a few months ago, and it was almost unanimous that I should not buy real estate. Now I am two weeks away from moving into a beautiful house, in a great neighborhood, with a 3.25% interest rate and a mortgage payment around half of what renting would cost.

Do your homework, ask everyone you know, and be overly conservative. If it makes sense it makes sense, and if it doesn't it doesn't. Also, if, after researching the crap out of everything you possibly can you are still on the fence, hold off - don't pull the trigger unless it is obviously the right choice for you two. As with almost everything else, ask the important questions that you know you might not like the answers to.

Good luck!
posted by amcm at 8:34 PM on July 31, 2012

Also worth bearing in mind: condo financing has become much more stringent since the housing crash, and doesn't look like loosening up any time soon. Probably doesn't impact your purchase, if you're putting 10-20% down, but it does impact the ability to resell in the short term, unless you can find a borrower who also has a substantial amount of cash to put down. I think the only way I'd be inclined to buy a condo I didn't intend to live in for the next 7 years is if I was absolutely certain I wouldn't have to resell it - (maybe I'd run it as a vacation rental??)
posted by tinymojo at 10:29 PM on July 31, 2012

How much "spare money" do you have? Do you have six months of income set aside in savings? Have you maxed out your 401(k) contributions at work? Do you have money set aside for emergencies? Do you have life insurance? Do you regularly contribute to an IRA? If you can say yes to all (or at least most) of these, then you may have "spare money" to further invest. But based on the responses here, I wouldn't advise investing it in a condo that you're not going to be living in.
posted by Nathanial Hörnblowér at 11:10 AM on August 1, 2012

Wow - that's a lot of information, thanks so much! There are so many things we hadn't considered - we just looked at the best case scenario, which as you have described, may not necessarily be worth looking at the expected return on time/money invested.

We're going to step back and think on this a lot more. Thanks again for all your input.
posted by bbyboi at 10:14 PM on August 3, 2012