Condominium Investing Mastery Lesson 03

Lesson Three: Condominiums: Finding the Right Deal

It is often said that the money is made in real estate at the time of purchase. This is often true. If you pay too much for the condo or have too many rehab costs involved, this will hurt your ROI and could make the investment a negative one. In this lesson, we will focus on finding the right condo deals that will fit your investment needs.

3.1 Condo Trends

As we mentioned in Lesson Two, the location will determine a great deal in terms of price. It is important to consider what you will do with the condo units and whether a lower price, or a better location is more important. Suburban condo units may work better for selling condos; whereas, renting condo units may require urban dwellings. Having a plan for the condo units is essential before you make the investment. You need to know who the end users actually will be. Comparing price can be done by the price per square foot. You want to compare apples to apples in terms of size so you know how much you are spending for a “better” location and if the money spent will be returned because of the location.

Another trend is the market. Selling condos can be a bit more challenging than single-family homes in some areas. One of the reasons for this is because people like to have their own space and would spend a little more to have a standalone home with no additional fees. However, in larger urban areas, the buyers often want to have the amenities and luxuries of condo living. Many of these buyers like the no-maintenance living and prefer to live in condos. The same can be said for renters. Will you find renters who may pay more for more options? Again, knowing your tenant or potential buyer will go a long way in determining whether the investment makes sense or not.

Finally, you need to decide on what is most important. Remember, you cannot move these condos. You will need to determine how important location is and if a rehab is something you want to take on. The deals are available, but they either usually require work with a rehab or may not have the most desirable location.

3.2 Determining the Condo Value

When considering the condo’s value, the only way you can think about condominiums today is as apartments, and that is how everyone is valuing them. It is really hard to value them on a for-sale basis. You can buy the first trust note. You can foreclose on the mezzanine. You can do all kinds of things, but at the end of the day, you have to be thinking about this investment as you would an apartment complex. There are several ways that you can enter into a condo investment deal, but you also need to pay attention to the risks. There are risks in condo deals relating to the HOA considerations. You have to spend a lot of time understanding who controls the board and what the rules and regulations are for the condo building. Hopefully, it is you that will have the final say about what happens, if you are buying them.

At this time, it is not recommended to buy a failed condo or a single unit because you don’t know what’s going to happen to that unit or that building as a whole. If that building reverts back to rental, if they are going to fractionalize this, it is best to not think that you will buy the distressed condo building and “save the day.” It is true that you might find a good deal, but you might also have a building full of renters that is a fractured deal and the value might not be what you thought it would be in the end!

Another determination of the value is the HOA requirements. You need to look at the HOA requirements, who controls the HOA, what is the life of the HOA, all kinds of restrictions in the HOA. Key factors are year built, bedrooms, baths, ceiling heights, and finishes. That is pretty much it. Once you’ve got those categories, they all fall in line.

Condos are talked about in basis per door, basis per foot, and cap rate as a rental. As investors, you want to know the basis per door. This cost is noted as the price per square foot. Again, this helps you to compare apples to apples when considering which investment makes sense for you.

3.3 Metrics to Consider

These are several metrics to consider when considering the condo as an investment deal. The first metric is the loan to net sales. This probably would not impact you as the investor because you will not make the loans from scratch, but in the past, we had people saying they would take a $10 million loan and “sell-out” the condo building for $20 million. The investors were convinced they have a 50% loan to value and would have a huge ROI. When this did not take place, we now see the influx of condo buildings being rented out.

The second metric is the number of units sold to exit the deal. The lenders will be concerned with this metric because they want to know how much it would take to “get out” of the deal. As we have mentioned in the previous courses, it is essential to have an exit strategy. Typically, the first trust lender is going to pass on the deal if 60% to 70% of the units need to sell out at pro forma. These lenders are looking for that 30% to 40% cushion. Today, the problem is that nothing is selling out at pro forma, so it is going up. The mez on the deals were settling between 70% and 80%, so if you decrease the pro forma, you can see the mez out of the money really quickly.

The third metric is the profit margin. The Profit margin to gross sell out should be in the 20% range. You, as the investor, should make 20%, and the developer should also make in the 20% range. The final metric is the investor units versus owned units. This does not really have much impact right now because there are not too many investor units. When the market was extremely hot, everyone looked at how many of these were owned and how many of these are investors. It was not that easy to tell!

3.4 Condominiums: Valuing Them Today

Let’s discuss how to value condos in today’s market. There are three considerations that you need to take into account. First, what are the pitfalls of investing in condos? Second, what are the opportunities in investing in condos? Third, how can you still make money in a down market if you make the investment?

Let’s start this discussion with a brief introduction into distressed assets. Why do deals go bad? Basically, there are a few things that will make a deal go bad. When you’re looking at a deal that is distressed, you need to understand why? Different deals go bad for different reasons.

First, one of the main reasons that deals go bad is because of bad sponsors. Incompetence, a lack of experience, people who never should have been here anyway can make the deal fail. We have talked in great length in previous courses about making sure that you take the time to partner with the right people. This decision can literally make or break the deal and yield success or failure. When the markets are hot, a lot of people look smart because it is hard to fail in a hot market; however, now we are finding out who the smart guys are and who the lucky guys are. Falling cap rates made anybody make a lot of money if they bought real estate. You did not have to be that smart and you did not have to have that much money. You could just go in and buy the deal and you would look good. Of course, nothing that is that good will last forever,

Today, we see too much time in the real estate industry. We are seeing that now in condos. We are seeing that in new construction. Anybody that started a new construction deal did not pro forma this market. That new construction, whether or not it has taken too long or not, they are building into a market dataset that is totally different than what they anticipated. Costs were underestimated. That is an obvious one.

Here is one that you are going to see all over the place. Key leasing or sales did not occur. There is generally something that has to happen in these deals in terms of leasing or sales. In previous examples, we have used Denver, CO. and condominium buildings in downtown Denver. Presently, they have 300 to 500 units that they are delivering at the same time and they are going to have to sell all those units into the market at the same time. This is unlikely to occur because the market is saturated and the demand would not exceed the supply. The only option if these condo units do not sell is to rent them out. If this was not in the plans to rehab and hold, the investment’s ROI could take a fast negative and money could be lost in the short-term.

Assignment:

Determining the value of a condo can be challenging. Discuss how to value a condo and what attributes to focus upon. It would be beneficial to find a sample condo for sale and price out what it is actually worth in terms of ROI.

This assignment is your study guide to ensure you have learned these materials before you take the required quiz.