Wednesday, March 7, 2007

Condos versus Co-ops

For my first discussion, I want to talk a little bit about co-ops vs. condos. Co-ops are a very ,misunderstood piece of the real estate market. The basic difference is this: Co-ops are corporations in which you buy shares, in exchange for which you are given the right to occupy a unit. Condos are units that you buy, along with an undivided interest interest in the common elements (like hallways, courtyards, pools, and other amenities.) Though it may seem like a small difference, the implications are actually huge. You can see a further discussion of the differences on my web site here.

First, a disclaimer: I am just not a fan of co-ops. Something about having to get approval of a Board before you can buy property just rubs me the wrong way. And the captive financing--by which I mean you can only use the one or, if you're lucky, two approved lenders, who certainly know that if you want the unit you have to go through them (guess what that does to your rates?), well, it's just not in keeping with the capitalist spirit. The MBA in me bristles at it. Co-ops are almost always cheaper than comparable condos, and for good reason.

The financing is one disadvantage, but the biggest drawback I've learned of is the "land lease" co-ops. Here's how it works: when the co-op is formed, they only have a lease on the land that the buiding is on. It's usually very long term, say 99 years. River Place in Rosslyn is like this. Guess what happens when the lease is up? Everyone gets kicked out, and the building and all its improvements (that means your unit too!) revert to the LAND owner. You get nothing! It's just like having an apartment that you pay to remodel, but when the lease is up, your landlord gets it all at no cost. River Place's lease is up in about 50 years. That 's why the units there are so darn cheap compared to condos...they decline over time as the lease end approaches. I wonder whether people within the 30 year window at the end will even be able to get a loan? It will sure stink to be an owner in that window. Good luck trying to sell!


CN said...

Yes but before 2052 arrives, you can rent out your unit at market rates. Conservatively, let's say you get $1,000/month or $12,000/year. In 40 years, that translates to $480,000 in rent!

Right now studios are selling for less than $150,000 and you can definitely get more than $1,000/month for them in rent (and rents will definitely go up in the next 40 years).

So, the disadvantage of the ground lease is already priced into the purchase price.

Katie Wethman said...

CN, thanks for your comments, but I disagree that these units make a good investment for most buyers. If you're paying all cash, then perhaps you could turn a small profit since you don't have the interest expense. BUT if you're putting, say, 25% down (which most investors have), then the P&I is roughly $587 at today's rates, then add the co-op fee of approx $257/mo for a studio, then add your landlord's insurance, and even just one week of vacancy between tenants and now you're producing a net loss of roughly $400/year, not counting any repairs or maintenance throughout the next 40 years (appliances, hvac, painting, carpet, etc...remember tenants are often hard on properties). And that doesn't factor in any transaction costs to buy (approx 3% in our area) or sell (approx 6-8% for most sellers). Even a cash buyer would produce only about $6500/year, a return of about 4%. As an investor, I would much rather leverage that $150,000 by buying a larger property in an appreciating area, rather than a depreciating land-lease, and create income not only through monthly cash flow but also long term appreciation (which is where the real money is over 40 years).

Another fear with these land leases is that eventually, of course, the association is going to have to negotiate that lease, which likely means a new huge blanket mortgage which will be assigned pro-rata to each owner at the time. Too big a risk for me as an investor.

Anonymous said...

Also, I hear that the only types of mortgages available for River Place, even with 30% down payment, are 1 to 5 year ARMs, so add the mortgage rate as an additional unknown, unless you plan on reselling within 5 years i.e. by 2017, and good luck with that.