Income properties make excellent long-term investments. But as a new investor, deciding between a condo vs apartment can be difficult.
Let’s look at the pros and cons for each to determine which investment is better for you.
Condos are single units that may be part of a larger residential building. The units may be owner-occupied or rented to a tenant. And these units usually share amenities. Condos are subject to HOA bylaws and must have decisions affecting the entire complex made collectively. Often, there is an elected board of directors that oversees investments.
Apartments are a suite of rooms forming a single residence. Most apartments are in a single building containing many similarly structured units. An apartment is a type of multi-family property investment.
Multifamily is a rental apartment building where the entire building is under the same ownership. Multifamily buildings are very common in the United States, but less so abroad. Think of it this way – it’s a single building designed to accommodate more than one family living separately.
These types of properties can range from duplexes to homes or small apartment buildings.
What’s a commercial property? Commercial properties are buildings with more than four units.
When institutions like private equity, pension funds, or endowments invest in apartments, they almost always buy multifamily.
When individuals invest, they usually buy condominiums. That’s because in cities like Manhattan, the average apartment costs $2 million or more. An apartment building often costs upwards of $10 to $20 million dollars, beyond the reach of nearly all individual investors.
Condo vs Apartment – Understand the Difference
Condos versus Multifamily – Why a condo is a better investment for new investors
The cost of ownership for condo units is traditionally more expensive than multifamily dwellings but is better suit entry-level or first-time investors. Condos are easier to acquire than multifamily dwellings because investors can put down as little as 10% to acquire the asset. Additionally, the overall cost of the initial investment is materially less for the condo in comparison to the multifamily apartment complex.
Apartment complexes are generally more expensive to maintain than condos. Because of the ease of maintenance, condos don’t necessitate hiring a property manager to manage your investment. Investors can use condo fees to cover ongoing maintenance costs. These fees depend on the size of the unit, types of amenities, and annual expenditures. These fees create added value for the investor.
I like the fact that investors can leverage amenities to attract potential renters to their properties. Most modern condos today have gyms, pools, spas, communal gathering rooms, business centers, etc. All these features are attractive to renters. Condos also offer additional benefits such as on-site security and front desk concierge services.
Benefits of Condos
Condos also offer other benefits: 1) appreciation and 2) liquidity (compared to other forms of real estate). They also tend to appreciate more rapidly than apartment complexes. All things being equal, however, they tend to appreciate more slowly than single-family homes.
With the market being red hot lately, a condo may offer you better investment value than a single-family home. Especially, if you are single and making your first investment. Condos tend to be tens of thousands of dollars cheaper than a single-family house.
Condo units are easily transferable. The ability to sell or flip a condo is really a function of the market you live in. Certain areas like Manhattan and San Francisco make a sale easy – even post-pandemic. But a condo situated in a market with a higher average DOM (days on market) will logically take longer to turn over.
Here’s an example DOM graph for homes across the US from 2017 to 2022. You can see that the average number of days on market has decreased substantially, indicating a high level of demand. It is a seller’s market.
Here’s a list of the ten cities in the US with the lowest outstanding DOM.
Why would a smart investor invest in condominiums?
1. The ability to capitalize on supply and demand inefficiencies. Demand is determined by a combination of economics and housing needs. Currently, the for-sale market and the rental market are both hot. When the sale market is softer than the rental market, there exists more supply than demand for condos, so the price will reflect that imbalance. There are opportunities to take advantage of over-supply on the buy-side and under-supply on the sell-side.
2. Arbitrage opportunities. Condos will reprice more quickly in both rising and falling markets, which creates opportunities for arbitrage. This means that investors can capitalize on price inefficiencies. Remember that volatility creates arbitrage opportunities.
3. Pick the low-hanging fruit. Certain units within a building are more desirable. They likely rent more quickly and sell for higher prices than other units within the very same building. By investing in individual units, the investor can build a diversified portfolio comprised solely of units that are most likely to outperform.
4. Liquidity. As discussed above, individual condos are far more liquid than multifamily buildings.
5. Management is on-site. Condos are full-service buildings that have on-site maintenance staff. Owners do not have to deal with repairs and maintenance to elevators, roofs, boilers, HVAC systems, and other mechanicals.
Condo Fees, HOA Fees, and Special Assessments
Every condo owner must pay a condo fee. Condo fees are monthly fees that cover maintenance, repairs, and basic ancillary services like security. These costs are split amongst condo owners. There is a board of directors that determines the total budget and expenses that condo owners will be responsible for each year.
Every owner of a condo is also responsible for paying HOA fees. HOA fees also cover maintenance and property improvements that are within the HOA’s jurisdiction. These fees cover the common areas, exteriors, and public structures.
Is there a difference between condo fees and HOA fees?
Most individuals would say no, but there are some differences between the two. The difference has to do with the extent of ownership when it comes to HOAs and Condo Associations. In a condo, each member individually owns their unit but has joint ownership of the common areas. This isn’t the case when it comes to the HOA. Homeowners individually own their units, but the Homeowners Association is the one that owns the common areas.
Condo fees support maintaining the common property, while HOA fees support maintaining the property that’s in another’s holding.
Condo fees tend to be higher than HOA fees since all condo owners are responsible for paying for the repairs associated with the whole condo building and common areas. As an investor, you may also be forced to make a special assessment payment. This is an additional payment that condo owners must pay when regular condo fees are insufficient to pay for a large repair. When an assessment is levied it is an indicator of poor management. The HOA board is guilty of being poor stewards of your money, as HOA fees and the reserve fund are not adequate to cover expenses.
I should note, however, that readers have pointed out that sometimes a special assessment is better than the alternative – higher average HOA fees over the long term. This is a valid point. But I believe that reserves for major maintenance events should be more carefully planned for and the use of these special assessments will be mitigated, while still keeping costs down.
The HOA or Homeowners Association establishes and enforces rules for the properties that exist within its jurisdiction. HOAs are made up of owners or a group of outside investors. A potential downside (depending on how you look at it) of owning a condo is having to deal with the Homeowners Association (HOA). HOAs usually meet on a monthly or quarterly basis to discuss property-related issues.
The HOA is also responsible for collecting fees each month that will be used to handle maintenance and repairs for key items like roofing, parking, on-site amenities, exterior and interior maintenance, etc. Now the HOA could do a great job in managing contributions, costs, maintenance, and upkeep. Or… they may do a terrible job.
They may inadvertently poorly manage costs and big repairs. Key repairs may be neglected for long periods of time and end up costing large sums of money. Condo fees that are too high may indicate poor money management.
As an investor, you are not in control of your HOA rates or how much they go up year to year.
Before you make an investment in a condo you want to do your due diligence on the HOA and understand the rules and how well the organization is managed. You will want to check into the status of features like the age and condition of the roof, the HVAC system, shared amenities, etc. You are entitled to see a complete record of maintenance and repairs on a historical basis.
Remember that when you own a condo, you may not have certain liberties such as changing plumbing or electrical yourself. You may also not have control over “common property,” which includes areas such as windows, patios, and balconies. It is important to understand how condominium ownership works and what you, the investor and owner, are ultimately responsible for.
Condos can appreciate, especially if you plan on renovating. And when you are renovating you will be able to get higher rental rates used to recoup the cost.
As an investor, you want to check your owner-occupancy rate. You want to look at properties that have a higher owner rate. Ideally, 75% of the occupants will own their condos.
You will need to consider the location and understand the market and the neighborhood where you are purchasing. Make sure that the property is in a prime location.
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What about a Co-Op?
Co-Ops aren’t popular everywhere. Half of all the co-ops in the U.S. are in New York City, there are also in urban areas like Chicago, Atlanta, and the Detroit metropolitan area, Miami, Kansas City, Washington, and San Francisco. Co-Ops are less expensive, though more exclusive, than condos. The purchase approval process and building rules tend to be stricter and they make up a larger percentage of New York City’s housing stock.
In a co-op, you do not own your unit. The entire building is owned by a corporation and as an investor, you buy in, you purchase shares in the corporation. These shares give the investor a designated unit along with access to common areas of the building. Unlike a condo, the current co-op shareholders usually have the right to veto any sale of shares from one owner to another interested buyer. This differs from a condo where unit owners may sell their condo to another without a vote being taken by the HOA.
Buying a Condo and Making the Numbers Work
Let’s walk through an example or two.
In this model, you are purchasing a luxury 2-bedroom, 2-bathroom condo in a high-end waterfront development in Jacksonville, Florida. Note that this is a buy-and-hold scenario and there are more affordable options that would further benefit from renovations made by the investor. See Scenario 2 for a more affordable investment.
The investor puts 20% down, or $104,980, on a $524,900 unit. The investor is able to secure a 30-year fixed mortgage for 3.25% for $419,920. The monthly payment, including principal and interest, totals $1,828. Yearly property taxes are equal to $1,695. Yearly insurance is equal to $2,625.
On to the monthly fees. HOA fees equal $250 plus additional condo fees of $50 total $300. The investor sets aside $50 dollars a month in special assessment reserves, as well as $100 to be put toward maintenance and repairs. Your breakeven rent is $2,882. A high-end unit like this could be rented for $3,500 a month. Using this analysis, you produce $587 of monthly cash flow or roughly $7,000 per year.
If the property appreciates at 3% per annum over a ten-year period. And the investor looks to sell, assuming 5% commissions paid for both closing costs and selling costs, the investor will profit $183,376 at the time of sale. Plus, the additional $70,000 in cash flow earned during that period.
In this model, you are purchasing an affordable 2-bedroom, 2-bath condo in Jacksonville, Florida.
The investor puts 20% down, or $39,000 on a $195,000 unit. The investor is able to secure a 30-year fixed mortgage for 3.25% for $156,000. The monthly payment, including principal and interest, totals $679. Yearly property taxes are equal to $630. Yearly insurance is equal to $975.
On to the monthly fees. HOA fees equal $100 plus additional condo fees of $50 total $150. The investor sets aside $50 dollars a month in special assessment reserves, as well as $50 to be put toward maintenance and repairs.
Your breakeven rent is $1,224. An affordable unit like this could be rented for $2,000 a month. Using this analysis, you produce $737 of monthly cash flow or roughly $8,847 per year.
If the property appreciates at 3% per annum over a ten-year period. And the investor looks to sell, assuming 5% commissions paid for both closing costs and selling costs, the investor will profit $68,124 at the time of sale. Plus, the additional $88,470 in cash flow earned during that period.
Download the Condo Investment Analysis and Mortgage Calculator to run your own sample analysis.
Why consider investing in a multifamily property?
The answer is greater passive income. Multifamily properties are a great way for more experienced real estate investors to buy real estate. Owners of multifamily properties can either live in one of the units and rent out the others or live elsewhere and rent them all out. Owners can use the rental income from the property to help them 1) qualify for a mortgage and 2) qualify for a higher loan amount. The income the property earns from renters can be used to offset the owner’s mortgage and other housing expenses. Owners of multifamily properties can write off much of the home maintenance and prorate a portion of the mortgage interest payments.
Buying a multifamily property is going to cost more upfront than it would a single-family home. And if units go vacant or tenants are late with rent, the owner is responsible for paying the mortgage. Therefore, owners will need a reserve fund to cover discontinuities or shortfalls in cash flow. Multifamily units, like condos, can appreciate with the appropriate renovations. And these costs can then be passed to the renter. It is recommended that investors utilize property managers to manage their investment.
Owners can use property managers who typically charge between 5% and 12% of the property’s overall gross rent. While property management services are expensive, a good property management company can reduce expenses and increase income, improving the property’s profitability in the long run.
Property management services often include:
Leasing and marketing
Service and dispute resolution
Tenant billing and rent collection
Management of utilities
Bookkeeping and accounting
It is all about the Capitalization Rate
Multifamily buildings trade on the basis of capitalization rates. A cap rate is a measure of investment yield.
If you take the gross rent a building earns and subtract all of the expenses, you would calculate the property’s net operating income.
A cap rate is equal to the net operating income, or NOI, divided by the purchase price or assessed value.
The higher the cap rate, the higher the current income from the property.
For example, if a property has $200,000 in NOI and sells for $2 million, that is a 10% cap rate. If it sells for $4 million, that’s a 5% cap rate.
Cap rates can vary widely. But, as a rule of thumb, apartment buildings will trade with cap rates between 5% and 12%. That means that a building generating $100,000 in NOI would be worth $1,250,000 at a cap rate of 8%. Take the $100,000 in NOI and divide by 8% to get $1,250,000.
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