Risks of Buying into an HOA Community – Buyer Beware!
Recently Zillow blogger Brendon DeSimone wrote “Three Ways an HOA Can Screw Up the Sale of a Condo” which discussed some of the red flags a seller should learn and items they should clear to help get their property ready for sale. In addition, it’s necessary for a buyer to do an in-depth analysis of the HOA to better protect themselves when purchasing a property.
Researching an HOA is a time consuming process and very few buyers have any idea what they should be looking into when purchasing. Yet your time and effort is worth it as it is your money at risk!
Each one of these items is a significant risk issue and should be reviewed and understood, no matter how difficult it is to get the proper documentation. Some states are not helpful with requiring things like reserve studies, and some communities don’t even have or prepare what is needed. But if you understand the issues, that will help you reduce your real estate risk.
While you may be familiar with basic due diligence for HOAs, there are additional risks a buyer needs to understand to protect themselves when purchasing a home for sale in a common interest development community:
Unfunded or seriously underfunded reserve and replacement accounts: In this case, there are long-term repairs and replacements that will be needed in the future, like roofs, private streets, mechanical equipment, but the HOA has not saved anywhere near enough money to pay for these.
HOA in litigation: The HOA could spend a lot of money filing or fighting litigation and most lenders will not lend money on a project that is in litigation. This also means that you may have trouble selling your unit until the litigation is ended – which could be years – and possibly beyond that date.
Water and mold issues: Potential large dollar uninsured repairs that were not anticipated – so potential regular or emergency special assessments in large amounts.
Too many rental units: You many have trouble obtaining a mortgage or it may be more expensive (i.e. a higher interest rate) and the project may not be as well taken care of, thus making it harder to sell.
New project, few owners: Less than a majority percentage of the units are sold and the developer is in financial trouble. You need to determine who will be paying the HOA fees on the unsold units to cover the property expenses to keep the lights on, elevators working, maintenance, etc.
Insurance: This involves not being properly insured for the inherent risks you potentially incur on the interior part of the unit you own, or the exterior. Cash buyers be especially aware here.
Is the building on a ground lease? Or does the HOA own the pool, parking lots, clubhouse, streets? This may seem extreme but in some rare instances the HOA may be leasing common areas because the original developer made them separate and kept ownership. You better know for sure before you invest.
One owner controls multiple units: If the original developer or a subsequent owner has control over more than 10.0% of the units this may be an issue with financing and other issues.
CC&Rs (Covenants, Conditions and Restrictions): CC&Rs are the governing documents or rules that the HOA’s abide by. It is necessary to read them, and the bylaws, as well as the Board of Directors meetings minutes and notes. If you don’t, you run the risk of being in the dark about a possible special assessment and could be charged the week after you close escrow. I know one incidence in which a woman closed three days before a $7,500 special assessment that had been noted in the BOD minutes that she got via escrow but did not read.
Lender Condo Certification (Condo Cert) – Did your lender do one? Did you ask for it and get a copy? Did you read it and made sure you understood the items on it? If you are paying cash, you don’t have the lender watching out for you, how are you going to mitigate that risk?
Banks will not finance it, just pay cash! If a bank will not finance a unit, they are telling you something! I often hear investors say, “well, I’ll just pay cash.” What you must consider however, is that the bank, with decades of experience losing money on loans in these communities, is signifying a problem by not approving the loan. Don’t just pay cash because you have it; I suggest that you listen to the banker.
Those are the issues, and if you plan to buy into an HOA-governed community, you need to fully understand these items and how to mitigate these risks.
Leonard Baron, MBA, CPA, is a San Diego State University Lecturer, a guest blogger on Zillow.com, the author of “Real Estate Ownership, Investment and Due Diligence 101 – A Smarter Way to Buy Real Estate”, and loves kicking the tires of a good piece of dirt! See more at ProfessorBaron.com.
Note: The views and opinions expressed in this article are those of the author and do not necessarily reflect the opinion or position of Zillow.