Whether you are a Realtor or a home buyer, it pays to investigate the financial condition of condominium home owners associations before taking a listing or making a purchase bid. Failure to do so can lead to a rude awaking with jolting financial consequences.
Most people buy condominiums without a real understanding of the financial burden to which they are committing themselves. They have a vision of “care free condo living,” not realizing that active participation in the homeowners association (HOA) is necessary to protect their investment. Worse yet, many are not aware of pre-existing financial conditions which may require them to write big checks shortly after moving in.
In today’s market many condominium complexes have several units in foreclosure. Plus, there may be more units that are behind in dues and are likely to tumble into foreclosure in the near future. What this means to a potential buyer is that HOA monthly dues are likely to increase because fewer paying units will have to cover fixed operating expenses.
Perhaps the scariest situation for a potential condominium buyer is inadequate financial reserves to cover required maintenance. Many HOAs have adopted an attitude of avoiding special assessments or increase in monthly dues because owners would not approve these. Consequently, many (and maybe the majority) of condominium complexes have a reserve account balance way below where it should be. This is a big red flag for buyers because they are likely to get hit with a hefty special assessment in the future. Deferring maintenance to keep monthly dues low and avoid special assessments is a self-defeating strategy that always boomerangs on condo owners.
Many States now require a full disclosure of HOA reserve funds status as part of the purchase process. This involves a formal reserve study which determines the life cycle of major complex components (roofs, pool, etc.) and then determines how much reserve monies should be set aside each year to ensure adequate funds are available when repairs or replacements are due. California, for example, requires unit owner access to their reserve study and full disclosure of reserve fund status on an annual basis. Obviously, these documents are an important part of the escrow process.
Most condominium complexes are waking up to the fact that their units are not marketable if reserve funds are grossly inadequate, and special assessments are beginning to happen to make up the difference between existing reserve balances and recommended funds. For example, I live in a condominium, and my HOA has levied specials assessments totaling almost $20,000 per unit over the last two years. It hurts, but it is necessary. And there are strong rumors that California will soon require that reserve funds comply with levels recommended by a formal reserve study. What California does, the rest of the nation often follows.
When reserve funds are inadequate, the financial impact on condominium owners can be severe. In fact, it often leads to double “wammy” because special assessments can force some condominium owners into foreclosure which means fewer units are paying monthly HOA dues. So, not only does foreclosure ultimately mean forfeiting a portion of anticipated reserve funds (to senior liens), it also means less revenue coming in to the HOA for six-to-nine months during the foreclosure period. And there is only one solution for an HOA to stay afloat – a monthly dues increase to cover ongoing operating expenses.
What are the most dangerous situations? Small, older condominium complexes are ripe suspects that require close financial scrutiny. Next, any complex that had a number of sales backed by subprime loans should raise eyebrows. A lot of these have 100 percent financing, no equity and are tumbling into foreclosure.
Hence, it behooves Realtors and buyers alike to carefully review condominium reserve fund studies and balances, as well as the number of units in foreclosure and additional condos that are behind in their dues. For Realtors, this is essential to ensure compliance with full disclosure laws and avoid legal ramifications, and buyers can circumvent situations that come with a hidden price tag. In other words, it is time to start doing your homework to avoid stepping in condo “do-do!”