How HOA Payments Reduce Your Buying Power

buying powerIf you buy a condo or town home, there is almost always a homeowner’s association (HOA) that charges a monthly fee. What the fee buys you varies, but typical benefits are exterior maintenance, water, trash, and sometimes amenities such as a pool, tennis courts and club house.

The issue with HOA payments is they reduce your buying power, which is the amount of house you acquire for your monthly payment.

How You Lose Buying Power
Most people have a total monthly payment (TMP) they can afford, say $1200. If your HOA fee is $335, it takes $335 from the TMP. This leaves $865 for the rest of the TMP. If your HOA fee is $167, it leaves $1,033 for your TMP. Obviously you can borrow more with $1,033 a month than with $865, so that’s how the HOA fee impacts how much house you can buy.

Impact On Buying Power
What can you buy for $865 per month with a $335 HOA fee?

  • A $155,000 condo with 3.5% down and 4.5% interest creates a monthly payment of $840.18 (Principle + Interest + Mortgage Insurance)
  • You also need $77.83 for taxes and about $20 for insurance
  • $335 HOA fee
  • TMP = $1264

What can you buy for $1,033 per month with at $167 HOA fee?

  • A $175,000 house with 3.5% down and 4.5% interest creates a monthly payment of $948.55 (PI + MI)
  • You need $88.92 for taxes and about $20 for insurance
  • $167 HOA fee
  • TMT = $1,165.87

As a seller with a high HOA fee, you are competing against properties that are 11% higher priced, most likely with more features, more square footage, perhaps newer, or in better locations. As a buyer, you are bypassing properties that are 11% higher in price.

Another consideration is property appreciation. Since HOAs tend to increase over time, they put a drag on appreciation as they rise.

That being said, when a property is RIGHT for you, then that is your major consideration, not the HOA fee; it becomes something you live with to have the house you want.

Appraisals

Real-Estate-AppraisalWhen you buy a house, your lender will require an appraisal on the property before they will complete your loan. Why is an appraisal necessary? Because the bank wants to know that they are not loaning more than the property is worth.

What’s an Appraisal?
Appraisals are completed a week to ten days before the closing. Even though lenders require appraisals, you get to pay for them. The cost is $400 to $500.

Appraisals are conducted by – believe it not – appraisers! These are professionals who specialize in determining the “actual value” of properties. The actual value is based on past sales, features, condition, location, and other factors. Appraisers attempt to remove biases and simply look at facts and numbers.

Appraisers vs Real Estate Agents
Instead of “actual value,” real estate agents determine the “market value” of properties. Market value is the price that buyers will pay for a house in the current market. Market value is based on supply and demand, marketing plans, buyer emotion, and market trends. If a market is active and buyers are frenzied, they will often pay higher prices than past sales appear to support.

What to Look For in an Appraisal
From a buyer perspective, your objective is for the appraised price to be at least as high as the purchase price; anything higher is a bonus. You don’t want it to come back lower than the purchase price. The reason is that lenders loan you money based off the appraised value.

For example, if you are buying a $200,000 house with an FHA loan (borrow 96.5%), and the appraisal comes back at $195,000, then the bank will only loan you $188,175 not $193,000.

If the appraisal comes back too low, you have a couple of options. First, make up the difference out of your own pocket. In the previous example, that means you come up with $11,825 down payment (5.9%) rather than $7,000 (3.5%). Another option is to have the seller lower the purchase price to match the appraised value. Your third option is to terminate the contract and walk away.

Summary
Think of your appraisal as a reality-check on the price you agreed to pay the seller. It’s nice when a third party agrees that your new home is a good value – or warns you that the house is over-priced.

Homeowner’s Insurance: How Much Coverage Do You Need?

insurance-agentWhen you buy a new home, you are required by the lender to have homeowner’s insurance (aka “hazard insurance”). The question is, how much coverage do you need?

Daryl Alexander, an agent in Fort Collins with State Farm, recommends that you “make sure your home is insured for at least 100% of its estimated REPLACEMENT cost. “

What does Daryl mean by “replacement” cost?

The Difference Between MARKET VALUE and REPLACEMENT COST
Market value is the amount a buyer would pay for a home. Replacement cost is the rebuilding cost necessary to repair or replace the entire home.

Over the years, the cost of materials and labor increase, sometimes faster than the market value of a property. If you have a fire, water leak or hail claim, and you’ve owned your house for many years, the cost to repair your house could be really high.

Cost of Premium
It sounds like replacement cost is the way to go, right? Then why would anyone get market value insurance?

The premium for market value insurance is lower than replacement insurance, which is why many homeowners buy it.

That’s being penny-wise and pound-foolish, as the expression goes. For the minimal increase in cost, replacement insurance gives you the coverage you’ll need in case of a disaster. Remember, you are buying peace-of-mind that your family and possessions are protected.

Review Your Policy Occasionally
As the years go by, it’s a good idea to get together with your insurance agent to ensure you still have the right coverage for your home. This is particularly true if you have remodeled bathrooms and kitchens, finished basements, or added on rooms or living spaces.

The worst time to find out you DON’T have enough insurance is when a disaster occurs. Avoid the heartache and trauma of insufficient coverage; find a trustworthy, reputable insurance agent, listen to his/her advice, and buy the coverage he/she recommends.

If you would like a referral to some trustworthy insurance agents, please contact Gary Clark.

Fair Housing Act

Equal Housing OpportunityIf you rent residential property, you must comply with the Fair Housing Act. The act, passed in 1988, establishes seven protected classes of people. Therefore, you cannot discriminate on the basis of race, color, religion, national origin, sex, handicap status, or familial status.

Because of the protected classes, landlords are not allowed to take any of the following actions:

  • Refuse to rent or negotiate for housing
  • Make housing unavailable
  • Deny a dwelling
  • Set different terms, conditions or privileges for rental of a dwelling
  • Provide different housing or facilities
  • Falsely deny that housing is available for inspection or rental
  • For profit, persuade owners to sell or rent
  • Deny anyone access to or membership in a faculty or service related to the sale or rental of housing

Prohibited actions are threatening, coercing, intimidating and interfering with prospective renters. You cannot advertise or make statements that indicate you do not rent to protected classes.

You can still be “discriminant” with who you rent to, just not in violation of the Fair Housing Act. So on what basis can you discriminate? On things like credit history, work history, and rental history.

The Fair Housing Act is an excellent ideal to strive for. In practice, it’s not always easy or  straight-forward and, should someone file a complaint against you, there are serious consequences.

The good news is that if you treat all people with equality and respect, and use common sense, you’ll be fine.

Mortgage Debt and Inflation: An Investor’s View

Inflation-rateInvestment advisors are nearly unanimous in saying that inflation will hit the USA in the next few years. So what is the thinking on mortgage debt in inflationary times? Overall, debt should be avoided whenever possible, in my opinion. However, a manageable, intelligent mortgage on your residential rental property can be good.

Remember that debt on a rental property isn’t paid by you; it’s paid by tenants. (As long as you made a reasonable down payment, such as 20-25%, and your payments and maintenance costs cash flow.) But what happens to your debt if the inflation rate hits 10%?

Rents would presumably rise with inflation. Your mortgage payments, on the other hand, would remain fixed (assuming you have a fixed rate loan). Certain costs, such as maintenance, utilities, insurance and taxes, would all go up too. All in all, your cash flow would probably improve. You could either pocket the extra revenue or use it to pay down your mortgage faster.

What about your loan principle? Let’s say you borrowed $150,000 at 5% fixed rate, prior to inflation taking off. Your payment would be $805.23. Now let’s assume that interest rates climb to 8%. The payment at that rate would be $1,100.65. In five years that makes a difference of $1,477.10. Suddenly your 5% loan seems like pretty cheap money.

Now consider that the value of your property would also rise with inflation. If you bought your property for $200,000, before inflation took off, it would likely increase at the 10% inflation rate. In 5 years your house would conceivably be worth $292,820.

Investment advisors say solid inflation hedges produce income, allow prices to rise along with costs, and increase in value along with the inflation rate. Rental property meets all these criteria.

Every way I evaluate rental property against inflation, it comes up favorably. You have to compare it against own investment criteria, of course. And you have to want to be in the business. But if it’s the right thing for you, I think you’ll find that rental property will protect your wealth when inflation hits.

What Type of Investment Property Should You Buy?

house-for-rentOver time, investors develop a certain type of property they prefer to own. Some like single-family houses, others like duplexes, townhouses or condos. It’s simply a matter of taste.

For new investors who don’t have the benefit of experience, what is the best type of property to buy? There’s no right or wrong answer, all properties have advantages and disadvantages. Let’s look at the merits of each type, based on a few criteria.

Profitability. Properties without Home Owner Association (HOA) dues tend to be more profitable than properties with HOAs.  To be fair, if you don’t pay HOA dues, you still have repairs and maintenance costs so you’ll need to set aside money in a reserve account. The difference is that HOA dues include administrative expenses and profit, which you save by doing it yourself.

Management. Townhouses and condos are easier to manage than houses. That’s because associations maintain townhouses and condos, while owners maintain their houses. (To be clear, by “maintain” I’m referring to the exterior.) Newer houses are easier to manage than older houses because they take less maintenance. The easiest form of management is to hire a property management company.

Ease of Renting. When it comes to rentability, my experience is that people like to rent houses the best, townhouses second best, and condos third (depending on the condo configuration). Why? Privacy, personal control, noise.  In today’s world of 2% vacancy rates, however, you’ll find you can rent practically anything without much effort. Who knows how long that will be the case, however.

Multiple Properties. If you plan on owning several rentals, management time is your biggest consideration. If you are busy and time is an issue, townhouses and condos are your best option. If you have time for management and want to maximize profit, look for newer houses without HOAs, but have very efficient management systems in place.

The best advice I ever got was: think about the tenants you want to deal with and buy housing they want to live in. The caveat to that statement is to stay within the boundaries of fair housing laws. Do you like working with college students, professionals, section 8 folks, or factory workers?  Then buy properties that are ideally located, priced, and set up for those prospective tenants.

If you would like to explore investing in rental property, please contact me. My company, Rooftop Property Management, owns one of each type of property and I’ll be glad to share what I’ve learned over time.

John Mosley: CSU’s Civil Rights Trailblazer

ImageA few years ago I had the honor of meeting a man who is a living piece of history. His name is John Mosley, and his list of “firsts” and accomplishments is remarkable:

  • National Merit Scholar in 1939
  • First African-American athlete at Colorado State University (then Colorado A & M) in 1939
  • Member of the Tuskegee Airmen in 1945
  • Helped form the Head Start program
  • Member of CSU Sports Hall of Fame in 1998
  • Member of Colorado Sports Hall of Fame in 2009

As much as Mosley accomplished, however, his life was also defined by what he couldn’t do. For instance, Mosley originally wanted to be a veterinarian. At that time, you couldn’t enroll in the program unless your father or grandfather was a veterinarian.  As a football player, he couldn’t go to movies or stay with the team in hotels. As an undefeated wrestler and winner of conference championships, he couldn’t compete in national tournaments because blacks were banned. And he had to live off-campus because residence halls and fraternities were white-only.

As humiliating and degrading as life was for Mosley, it was not without some merit; it prepared him to become a pilot and join the Tuskegee Airmen, a famous and well-decorated unit of all-black pilots in WWII.

“It was an experiment designed for failure. Anything you did, like not shining your shoes, not making your bed – things not related to flying – and you were washed out of the program,” Mosley said of the Tuskegee training program. “I completed the program because I had the experience at CSU and in high school, how to face similar challenges. I know what I had to do to succeed: be twice as good as anyone else in order to be considered average.”

I never knew about John Mosley until I attended a luncheon hosted by the CSU Alumni Association. Mosley was the speaker that day. At that time he was 86 years old and had to be helped to the stage. Yet, as he told us about his life, I became more and more mesmerized by him, what he had gone through, and what he represented. He was so much more than I expected when I signed up for the program.

At the end of his presentation, I decided I had to find Mosley and shake his hand, as a gesture of respect. I also wanted to tell him how moving his speech was, and how much I appreciated him sharing his life with us. To this day, I tear up when I think of that handshake.