When Tim was starting out as an investor, he purchased a townhome as one of his first investments. This unit did well for him and was a great rental. Over time, Tim would buy up other units in the same community, which was easy since he knew they performed well and made maintenance easy since they were all close together.
As Tim grew, he looked at townhome rentals in other communities, but quickly realized many cap the number of rentals permitted in the community to be less than 50% with no other one owner owning more than 10%.
The primary community Tim purchased in did not have a restriction on renting units, so he kept to what worked for him and grew over time.
Eventually, Tim owned almost half of the community, with 55 of the 120 units under his ownership. Opportunity beckoned one day, and he got an offer to purchase all of his units. However, the buyer encountered issues with their financing, and the deal fell through.
What went wrong? Tim wondered.
Let’s dive in to the conditions around owning rentals in a condo or HOA today, and what investors need to be aware of.
First: Define Condo or Homeowners Association
Many investors may hear the term “Condo” or “HOA” used interchangeably.
- Technically an HOA or ‘Homeowners Association’ is a group management of a community of homes, which each property within the association is located on its own parcel of land. They may be sharing common walls. Sometimes the association may cover ‘Common Elements’ like a walking path, pool or other recreational space, and may cover maintenance to the exterior of the units.
- In contrast, a Condominium is legal structure where the property owner owns the air space inside of the walls, with the Association owning the land, roofs and exteriors of the property. Property owners own a right in the Association related to their property ownership.
Because of this, Condominiums typically cover much more in their ‘Common elements’ while HOA cover less of the exterior components. Naturally, Condo fees are typically higher as they cover more items in their maintenance requirements.
Warrantability: How Investor-Concentration Kills Owner-Occupant Financing
Fannie Mae and Freddie Mac, the agencies that purchase the vast majority of conventional residential mortgages in the United States, impose strict eligibility requirements on condominium projects and HOAs. A project must be “warrantable” to allow individual unit buyers to obtain conventional financing. Among the most consequential of these requirements is the owner-occupancy ratio.
Under current agency guidelines, a condo project generally must have at least 50% of its units owner-occupied (or under contract to owner-occupants) to remain eligible for conventional financing. When investor ownership — meaning units held as rentals or second homes — exceeds 50% of the project, the project becomes non-warrantable.
The practical consequences are severe. Buyers seeking conventional 30-year fixed financing are locked out. Lenders who will still lend on non-warrantable condos typically do so through portfolio loan products at higher interest rates, lower loan-to-value ratios, and shorter terms. The pool of qualified buyers shrinks dramatically, which suppresses resale values and extends marketing times when owners want to exit.
Investors should consider two options when investing in group ownership communities:
- Own only a small percentage of units in a community mostly owner occupied. This ensures that on a sale, the buyer could be an owner occupant who can obtain warrantable financing and pay more for the unit.
- Own the vast majority of rentals within a community that does not limit rentals, which then allows investors more economies of scale and potentially control of the HOA/Condo association. The best sale exit here is described below.
The Association Factor: Where Investor Interests Collide with Community Rules
Not all condominiums or HOAs are investor-friendly, and that tension is one of the most important factors to evaluate before acquisition. Many associations — particularly those in owner-occupant-dominated communities — cap the percentage of units that can be rented at any given time at a lower number than financing rules would dictate.
- Common thresholds run from 20% to 30% of total units. If the project is already at or near its rental cap, a buyer who intends to rent the unit may find themselves legally prohibited from doing so, or placed on a waiting list that could stretch for years.
- Even in associations without formal rental caps, investors should scrutinize the governing documents for minimum lease terms (typically six or twelve months, which effectively bars short-term rental platforms), approval requirements for tenants, and the association’s right to fine or pursue remedies against investor-owners whose tenants violate community rules.
Investor Financing in a Fractionized Condo
A separate but related problem confronts investors who seek to accumulate multiple units within the same project — a strategy that is particularly common in smaller condo developments where an investor hopes to control a meaningful share of the asset. These projects are sometimes referred to as “fractionalized” condominiums when a single investor or a group of related investors owns a disproportionate share of total units.
- If an investor accumulates a large amount of units in a community, the price point could get to a point where Agency Multifamily loans could become attractive. Typically Fannie Mae or Freddie Mac multifamily loans start to make sense above the $2 million range.
- However, the guidelines for these types of multi-family loans, there are requirements that if an investor is financing a group of rental units within a fractionalized Condo Association, then they should own 80% or more of the community in order to be able to exercise control over what happens in the community. Over 50% ownership could be considered, but less than 50% is not eligible for Agency financing.
- An investor in this situation would likely need to look for a bank loan or DSCR loan which are at higher interest rates and shorter amortizations than Agency loans.
This is why Tim’s deal fell through. A buyer had been expecting to get agency financing, which helped to make the deal’s cash flow returns much more attractive. With less attractive financing terms, it did not make sense at the price they had offered to pay him.
Consequently if an investor is looking to maximize the pricing they can obtain for a portfolio of rentals within an association, they should work to obtain at least 75% or more ownership within the association. This will allow the buyer to obtain better agency financing, which can result in a better price point.
Strategic Takeaways for the Condo Investor
Condos and HOAs can be excellent rental assets, but investors should conduct careful due diligence.
Before committing to any condo acquisition for rental purposes, an investor should request the current owner-occupancy ratio, info on any active litigation, delinquent HOA dues as a percentage of the budget, and the association’s financial reserves. These figures tell the story on the health of the Association.
Understanding the general conditions on rentals in the community is key to ensure that your investment in larger associations will be a solid long term play.
For investors who find themselves in well managed communities, rental investments within HOA or Condo Community can find them well- performing, low maintenance investments.
Many investors we work with have diverse strategies for success. Working with diverse strategies gives us insight into multiple pathways for investment success. If you would like some friendly input on your investment strategy, CONTACT US today to take your next step towards being a smarter, more informed investor.
Sources:
-https://www.lument.com/
-https://www.multifamily.loans/hud-multifamily-loans/
-https://fhareview.com/fhacondoapprovalguidelines/
