Watch Out for Evil Homeowner’s Associations and Fees
When buying a condominium, it is important to take care when making a purchase that includes conducting due diligence on the Homeowner’s Association (HOA) and the monthly fees charges for maintenance of the public areas and facilities, such as swimming pools. There may be HOA fees for some gated communities of single-family homes as well.
Due Diligence on HOA Fees
Many buyers do not conduct proper due diligence regarding the homeowner’s association and the HOA fees. Most simply rely on the statements about the monthly fees and leave it at that. There are other important things to consider, such as the possibility of a community tax assessment that is charged to the HOA and not paid by the builder of the property. These taxes pass- through to the members of the HOA by increases in the HOA fees.
Another consideration is the policy and procedures for increasing the HOA fees. Some HOA’s have an annual review of expenses and use this as a basis for adjusting the HOA fees. Other associations have automatic annual increases.
Rarely do HOA fees decrease. Significant charges, such as insurance for the entire facility can suddenly increase. For example, if there is a natural disaster that damages the public areas of the HOA, and an insurance claim is made to cover the cost of the repairs; it is likely that the insurance premiums will increase.
There is a significant negative impact on the financial returns over an extended period of time caused the erosion of profits due to the HOA fees. Here is an example:
Property Location: Houston, Texas
Purchase Price – $150,000
Down Payment (20%) – $30,000
Amount Financed – $120,000
Annual Loan Interest Rate (APR) – 4%
Monthly Payments for 30-yr. Loan – $656
Annual Property Taxes and Insurance (1.81%) – $2,715
Annual Home Insurance – $1,000
Average Annual Appreciation Rate (1980 to 2015) – 4%
This period includes a major downturn from 2008 to 2010.
Using the 4% annual appreciation rate shows the future value in 30-years to be $486,509
Sale Value in 30 years – $486,509 assuming an average annual value increase of 4%.
Deductions:
Loan Payments Made – $206,243
Property Taxes Paid – $81,450
Insurance Payments Made – $30,000
Return of Down Payment – $20,000
Gross Profits Remaining – $148,816
Here is the impact on investment returns caused by monthly HOA fees at various levels:
HOA fees $100/month for 30 years = $36,000.
This creates Profit before Capital Gains taxes of $112,816
HOA fees $200 per month for thirty years = $72,000.
This creates Profit before Capital Gains taxes of $76,816
HOA fees $300 per month for thirty years = $108,000.
This creates Profit before Capital Gains taxes of $40,816
HOA fees $400 per month for thirty years = $144,000.
This creates Profit before Capital Gains taxes of $4,816
This simple example shows how HOA fees erode profits.
Due Diligence on HOA Rules
Even though many HOA rules are lengthy, complex, and come printed in books that look like an old telephone book, it is still important to drink plenty of coffee and read them thoroughly. Look for things like restrictions on property use, how the HOA directors are chosen, and if there are proper annual audits of the finances that are available to the HOA members for their inspection.
Summary
HOA rules and HOA fees have the ability to create a strongly negative effect on investment returns, reduce the ability to enjoy the use of the property, and impact resale values. A wise investor or buyer takes the time to understand them.