Thinking about investing in a condo to rent out for cash flow? We don’t want to rain on your parade, but it’s probably a really bad idea. Joe, an investor from New York, was forced to sell after he relocated for work and his HOA wouldn’t let him rent out his unit.
His story is not unique. Chicago realtor, Brie Schmidt of Second City Real Estate says that in Chicago, it is very common for condos to prohibiting renters. She says it is a constant struggle for investors who bought condos as investments without looking into the guidelines.
If you’re thinking about investing in a condo that you might not live in, go through our due diligence list first.
Beware the Condo HOA
Ultimately, your condo will live and die by the quality of your HOA.
While many single-family housing communities also have HOAs, they are much less powerful than condo associations. That’s why it is an important risk factor to consider if you’re thinking about investing in condos.
Condo associations can increase your fees, issue special assessments, select contracts, etc. Most importantly, they can prohibit you from renting out your unit. These rules are laid out in legally binding documents called “CC&Rs” — Covenants, Conditions and Restrictions.
Bylaws May Prohibit Renting
The odds that you can rent out rooms on Airbnb are slim to none. Condo associations’ bylaws typically prohibit short-term rentals. This means you won’t be able to rent your place out for less than 12 months. Most bylaws explicitly state, “under no circumstances can a unit owner permit unit to be used for a hotel or transient purposes.”
Condo Associations Don’t Like Renters
Associations also don’t look kindly on long-term renters either. There’s a perception that renters won’t take care of the building the way an owner would. Some associations want to foster a close-knit community with long-term owners, not transitory renters.
But the biggest reason that condo associations often prohibit renting is, they want to stay on Fannie Mae and Freddie Mac’s good side.
After the mass defaults in 2008, lenders tightened up their standards. Condos were the highest-defaulting type of real estate in 2008, in large part due to rampant speculation. Unsurprisingly, the units that were actually owner-occupied (versus purchased for the sole purpose of being flipped) fared the best.
Buyers who purchased their condos as investment properties were 30% more likely to default than buyers who purchased a condo to live in.
Having learned their lesson the hard way, the FHA and Fannie/Freddie imposed restrictions on the number of renters that a condominium can have. For a condo to be warrantable, meaning for Fannie/Freddie to purchase the loan, no more than 50% of the tenants can be renters. This threshold was recently relaxed to 35%, provided the association meets all the other guidelines.
Buyers can still line up financing for unwarrantable condos by going to a portfolio lender. But since this shrinks the buyer pool, condo associations prefer to stay under the 50% threshold. This way, when owners list their unit, they know that their building qualifies to FHA/Fannie/Freddie loans.
If there’s a high ratio of renters in your building, you’ll have to wait until the renters are out before you’re allowed to open up your unit.
Fees, Waitlists and Other Headaches
Even if the condo board doesn’t prohibit renting outright, they can make it extremely inconvenient and cost prohibitive.
One common practice is charging the unit owner a rental fee on top of the association fees. This happened to Washington Post columnist Douglas Hsiao. Despite the fact that David rented out his Dupont Circle condo for 18 years without incident, his condo board debated banning rentals completely. After two hours of debate, the board decided to double his rental fee instead.
Hsiao writes, “The outcome was not perfect, as it will put me deeper in the hole on my cash flow, but I felt some relief that something more drastic did not pass which may have effectively required me to sell my apartment.”