RateWatch #218 - Condos - a Box of Air and Then Some

September 30, 2000
by Dick Lepre

What's Happening?

What is happening is that I have been spending a lot of time at baseball games this week. As an Oakland A's fan I am sweating it out as I just got home from seeing the A's return to first place. This has not deterred me from actually working and producing a revision of last year's piece on condos.

Personal Income for August was +0.4%. Consumer Spending was +0.6%. A deep introspection of this data will reveal that people are closing the tiny gap between what they make and what they spend. In other words, the savings rate has declined once again. They savings rate is, in fact, negative 0.4%. Consumers are spending more then they are making. The difference comes either from extracting money from investments or cash accounts or from credit card spending. There is a sort of bizarre irony here. Now that the federal government is taking in more than it spends consumers have taken on the role of "big spenders".

This decrease in savings may be an early warning sign for equities.


A condominium project is usually a building which looks suspiciously like an apartment building or complex. The "apartment-like" units are sold individually. Buying a condo unit give you ownership interest in the 3-dimensional space that is your unit. It also gives you partial ownership interest in the "common areas" and (if you're lucky) a parking place.

As the owner of the unit you are agreeing to be a member of the Homeowners Association. The Homeowners Association provides for the maintenance of the common areas and the structure itself. This would include open spaces, pools, roofs, staircases, balconies etc. There was a humorous X-Files episode about a homeowners association for a planned unit development in which, shall we say, folks pay the ultimate price for painting their mailbox the wrong color. While that might be extreme there are cases where the homeowners association meetings can get quite contentious. It's always ugly to fight with your neighbors.

This "common interest" has its advantages and disadvantages. The advantages are that you don't have to fix the roof, paint the outside or mow the lawn. The Homeowners Association has it done for you. The stuff inside your unit is your problem. While "their" roof may leak its "your" sink that leaks and "your" carpet that needs replacing.

The Homeowners Association provides for the insurance of the entire structure and liability insurance for the common areas. You will need personal property insurance for your "stuff". Your personal property insurance will pay you if "your" TV is stolen but "their" insurance will pay you if "your" unit burns down. If someone falls down the steps, the Homeowners Association is liable and their insurance takes care of it.

Your rights to your unit come with CC&R's (Covenants, Conditions and Restrictions), This is, generally, a gigantic document that spells out in the tiniest of details what the "rules" are. While on the surface, this may seem absurd, its purpose is to diminish the possibility of expensive litigation.

These CC&R's sometimes prove annoying because you might not be aware of the details. You may not be able to put Christmas lights around your window. You are likely unable to modify the color or hardware on your front door.

Who Are Condo's For?

Condo's are for at least 3 groups of people:
1) young couples who would like their own house but cannot yet afford one. Ownership of a condo affords many of the advantages of homeownership without the steep price.
2) a young single person who may not want the maintenance responsibilities but does not want a landlord and wants the economic advantages of homeownership. These are also known as bachelors.
3) older folks who no longer need their 4-bedroom home and the maintenance problems associated therewith.

Special Case Condo's

In addition to the usual "apartment building" condo there are some areas that have what one might call "urban condos". I live in a residential neighborhood in San Francisco. The building that I own has two units. The buildings on either sides are 3 unit buildings and, in the last 10 years, each has been made into condo units.

These "small condo projects" also have their CC&R's. They also have "arbitration agreements" that specify what is to be done in case their is a dispute among tenants.

Other urban areas have condo-like units. New York City has many buildings that were build for manufacturing, commercial or warehousing purposes. During the '80's it became apparent that they were no longer economically valuable for commercial purposes but that younger people wanted to live in them. A friend that I went to high school and college with has one on the top floor of a building on 32nd Street. When sleeping there I am treated to a very-impressive view of the top half of the Empire State Building. NYC framed a "loft law" to specify how these units would be converted to residential use.


Another type of property is the townhouse. Generally, townhouses are similar to condos but are not stacked. You own the land under your unit. Many are attached on one side to another unit.

Problems With Loans on Condos

Sometimes there are some problems with getting mortgage loans on condos. Lenders feel that there is greater economic risk associated with condos. Lenders are not as secure with a condo as collateral for a loan because there have been times in the past when condos have depreciated in value faster than single-family homes.

Insurance on Condos

Make sure that you are absolutely sure what you own and what the Homeowners Association owns. Make sure that between you, you have insurance on the whole darn structure.

Read these words of advice from a faithful reader who filled me in the last time I wrote about this topic.

"You have to be careful here. My brother is a personal lines underwriter at an insurance company, and he advised me to dig into the condo documents and get a handle on precisely what I own. Many condo docs are drafted to shift the risk to the individual unit owner and not the association. That way the association's insurance premiums are lower and so is the condo fee. I read the documents with care and sure enough, in my case I own everything out to the outermost surface of the joists that are below, behind and above the walls, floor and ceiling of my unit. That means I own all the drywall, all the wiring, all the insulation, all the hardwood floors and all of the invisible framing structure that supports it. In other words, I own about 95 percent of what I would in a conventional fee-simple home. Given this arrangement, in the event of a big fire that destroys the entire building, me and the other individual unit owners are going to bear the overwhelming majority of the loss.

If everybody understands what's going on and the individual owners purchase the appropriate insurance, this is not necessarily a problem. The problem is that insurance agents don't really understand that different condos have different legal descriptions of the dividing line between the individual owners' interest and the association's interest. When I contacted an agent, he obviously believed that I owned only the proverbial "box of air." So he recommended "paint and paper coverage" of about $5,000. I patiently explained to him why I needed more coverage, but believe it or not he said that "the computer" would flag that number as excessive. After much wrangling, I finally got the amount of coverage increased to a level of about $150 per square foot, which is what it would cost to rebuild my unit.

I've raised this issue at owners' meetings, but I don't think many of my neighbors have gone to the same trouble as I have. So in the event of big loss, I suspect that there just wouldn't be enough insurance coverage to rebuild. In my case, I'd take my money and go elsewhere. But the owners of the underinsured units would be out of luck and their lenders would be left holding the bag."

(That is the end of the note from fanatic follower PMB.)

There are four issues for lenders:

1) LTV - loan to value. There are, in some cases, slightly tighter restrictions on loan-to-value ratios on condos.
2) Owner-occupancy ratios. If the percentage of owner-occupied units in a condo project falls below 70% you will not be able to get a FHLMC or FNMA conforming loan. This will translate into a higher interest rate.

This may, in the future, result in restrictions on the sale of your unit. The Homeowners Association may see that the owner-occupancy ratio is in danger of falling below 70% and decide that you can only sell to someone who will occupy the unit as their principal residence.

3) New projects - it is a big pain to get the first few loans on a new condo project. Generally, we need to go to a local S&L and even then that S&L might only give a limited number of loans on a given project.

4) litigation - some lenders are tough on this and some are easy. There are two areas of concern: "slips and falls" and builder defects. "Slips and falls" may give the lender a concern if there are too many personal injury suits against the project. The issue is that the Homeowners Association may not have enough insurance and the individuals may become liable. Builder defects usually result in lawsuits where the Homeowners Association is the plaintiff and the builder is the defendant. The most common things that I have seen are: leaky roofs and faulty decks. These are typical problems that might not be evident until the building has been out of the hands of the developer for a couple of years.

The problem with these is that they indicate that something is wrong with the building. If the Homeowners Association makes the repairs and sues the builder it may be to its legal disadvantage to indicate that all is fixed.

Words to the Wise

Find out these things about a condo project before you make an offer on a unit:
1) what is the owner-occupancy ratio?
2) is the Homeowners Association involved in any litigation either as plaintiff or defendant?  Among things that can hurt are too many "slips and falls" lawsuits or, worse yet, litigation where the condo project is suing the builder for defects.
3) make sure that you can live with the CC&R's. If you need to put a Metallica or NRA poster in your window to be able to sleep at night and the CC&R's prevent it, you will regret it later.

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