Is Buying a Condo a Good Investment?
Here's What You Need to Know Before You Decide to Buy
Are you looking at buying a condo as an investment? If so, how do you know if a condo is a good investment? There are several calculations you can go through, and questions to address, to determine the answer.
When considering a condo as an investment, you must accurately estimate:
- the annual rent you may receive, and
- the annual expenses you will incur, including such things as:
- real estate taxes
- maintenance and repairs
In addition, you have to factor in the occasional expenses you may occur, such as:
- legal fees if an eviction is required
- advertising costs to get tenants
- repair costs if a tenant damages the property
Let's Do the Math! An Example of a Condo Investment:
Let’s look at an example. If You find a condo selling for $55,000. You can pay cash. It will rent for $750 per month ($9,000 per year). You think that represents at 16.4 percent yield ($9,000 divided by $55,000). Before you get too excited, you must factor in these expenses:
- Real estate taxes are $1,000 per year
- Insurance is $300 per year
- You estimate about $300 per year in maintenance and repairs
- You figure the condo will be vacant about one month per year (you factor in this as a cost of $750 a year)
- You figure each time it is vacant you’ll need to spend $250 on advertising costs, and you estimate this as a once a year expense
- You also factor in that maybe one out of every five years you might have a bad experience and incur legal costs and additional repair costs of about $5,000 (which would be about $1,000 a year).
Those costs total $3,600 a year (or about $300 a month).
Your net rent is now $5,400 ($9,000 minus $3,600), which represents a net rental yield of 9.8 percent, which is still an attractive return. In addition to cash flow, you will get to participate in the appreciation of the value of the property. If you expected real estate to go up about 3 percent a year, in the first year your condo would appreciate from $55,000 to $56,650, a gain of $1,650.
If you cannot pay cash, and must finance the property, you’ll also have to factor in the interest cost. For investment property, plan on putting 25 percent — 50 percent down to qualify for the loan. In the scenario above, let’s say you put 30 percent down ($16,500) and finance the remaining 70 percent ($38,500) at a 7 percent rate over 30 years. Your payment would be $256 a month.
When you add your payment of $256 a month and the estimated expenses calculated above, of about $300 a month, you get $556 a month of estimated expenses. With expected rent of $750 a month this property would still deliver positive cash flow, and based on these numbers would likely be a good investment.
Other Factors: Condo Assessment and Association Fees
You’ll also need to find out if the condo you are considering has association fees and how often you may need to pay assessments. Assessments are expenses incurred to cover the common areas of the condominium property. Assessments could include landscaping, parking lot and parking garage repairs and maintenance, improvements to the exterior of the building, and expenses associated with any common areas such as a main lobby or entrance way. These expenses should be factored into your expense estimate before you calculate the estimated return on your condo investment.
Before making any real estate investment you must also assess how realistic your assumptions are. Here are some additional questions to consider in determining if a condo purchase will be a good investment:
- Is your condo in an area where rental properties are in demand, such as near a college?
- Is it in an area that is getting less popular or more popular?
- Could a major employer in the area close down and cause rental demand to decline?
- Could a new condo development be built nearby, leaving yours in need of expensive improvements to compete?
It takes knowledge of an area, and experience, to assess these types of risk. For a great book on the subject check out John Reed's How to Get Started in Real Estate Investing.