AskDong

I recently obtained a few quotes for renovations to my current residence, and my rental property.  I had been thinking about renovating the kitchen and bathroom.   After receiving the quotes, I’m not so inclined.  The renovations would have cost at least 50k for each apartment.   At that cost, it just doesn’t make economic sense.

Most people do not recoup renovation costs at the time of sale (unless you’re developer).   I had planned on renovating not as an investment but because I wanted a nicer kitchen and a deck.   I wanted to renovate the rental property as a matter of maintenance.  However, at a cost of nearly $50k for each apartment I have to question if this tack is one I want to take at all.

I live in 1 bedroom condo.  I’m unlikely to live in this condo more than 2 years, and likely less than that.   I have to ask myself what is the value of that renovation for me over that two years along with the inconvenience of a month of being sans kitchen?   Studies have shown in the past that kitchen remodels recoup 90% of the cost.  Effectively I would be paying 5k to have a nicer kitchen for two years, assuming the 90% return on the remodel.   I do not believe that assumption holds in the current housing market.  I think I would be more likely get back 60% of my cost.   Assuming a 60% return, the price of nicer kitchen is 20k.   I would be willing to pay 5k for having a nice kitchen for the next two years; I’m not willing to pay 20k for that privilege.

So what about my rental unit?  My original plan was to hold onto the unit for the forseeable future.  However, now that I’ve decided that I’m willing to move, my whole game plan is up in the air.  I might sell the rental unit to put towards a new place to live.  That uncertainty means I need to scrap any renovation plans.  Why spend money on renovations that might not be cost effective?

On Sunday, Federal Government officially took over Freddie Mac and Fannie Mae.   Secretary Paulson had previously called this possibility, firing the bazooka in the pocket.  Fannie and Freddie had been under intense financial duress as result of the U.S. housing slowdown/meltdown.

For those who don’t know what Freddie and Fannie are.  Let me first describe them as best I can.   While Freddie and Fannie are two different entities, they serve an identical function.   Both are Government Sponsored Entities (GSE) charted to buy and securitize mortgages.   Both corporations buys individuals mortgages and then sell bond like securities that backed by those mortgages.  Each collects small fee for guaranteeing the principle and interest payment of those securities they sell.   While explicity those guarantees are only as good Freddie and Fannie themselves, it has always been assumed standing behind the curtain was the full faith of the U.S. Government.   It has been widely and correctly believed that Federal Government would not allow either Fannie or Freddie fail.

Why have Fannie and Freddie at all?  Can’t private corporations serve the same role?  They have and they do.   Commerical banks routinely securitize mortgages.  Bear Stearns certainly got into alot of trouble doing that.   The benefit of having GSE serve that role is that a GSE can do so more cheaply because of the government guarantee.  Fannie and Freddie pioneered the mortgage back security industry, creating a viable liquid market.   They still own or guarantee over half of the 12 trillion U.S. Mortgage market. Most people who have any kind of mortgage can thank Fannie and Freddie, and implicitly the U.S. Government for making borrowing cheaper.   And until now, that implicit rat subsidy had no cost.

So what does the bailout meant?

Because Freddie and Fannie have been under such duress as of late, neither entitity had been able to do much of what they were created to do, buy mortgages.  With the bailout, the cloud over their business should lift.  The conventional wisdom is that mortgage rates will be lower as the implicit guarantee on the bonds issued by Fannie and Freddie has become explicit.  Personally, I’m doubtful how large that impact will be.  Some speculate that it might be as much as 1% decline.  I find that hard to believe as that implict guarantee was almost universally accepted truth.   That said I do think there will be some loosening.  Fannie and Freddie were capital depleted previous to this move and were unable to do as much business as they probably should’ve.

Who Gets Bailed Out?

It’s still early, but the intial evidence indicates that shareholders will be wiped out as it should be.  Bond holders should benefit. Taxpayers in the end will have the foot the bill for delinquent homeowners.   While unfortunate that many of those responsible for current problem will have pay for the excess of thew few (greedy bankers, greedy home flippers, uninformed homeowners), I guess I believe in the end we are our brother’s keeper even as much we may choose not to be.   If things work perfectly, responsible taxpayers will fair OK.   The federal government is actually taking an ownership stake via preferred shares and even has a right to buy  common shares.

Gabriel Ask

Dong, I am debating whether to sell my house or rent it. I purchased my house late 1999. Then, two years later I refinanced my house to obtain a lower interest rate thinking that this would be my last house. I owned 109,000 and my house is currently valued at approx. 147,500 with an equity of aprrox 35,000. I have 13 more years to paid off the house./
Should I see the house or rent it?
Thanks.

Gabriel

Gabriel, I had similar decision to make about 3 years ago when I decided to move from my old Condo. I quickly decided that I wanted to rent it out. That was the right decision for me, but not necessarily the right one for you. I made the following considerations.

• The property was in area that is very easy to rent out. It’s in the city, and there many many renters every year looking for a place in the area I owned my condo.
• I was able to cover most of my costs through rent. My conservative rule of thumb is that annual rents should be at least 10% more than annual expenses. To be honest this is not true for me.
• I had decided long ago that I wouldn’t mind the burden of being a landlord. I don’t mind answering calls, and making arrangements for repairs as they come up. This last point is the most important one to consider. I have had great tenant, and the apartment has been mostly trouble free. Yet, at the same time I have to acknowledge the mental burden of being a landlord has been greater than I thought. Because it’s not my full time job, the added stress of knowing that something can come up is actually more acute. And, I have a great tenant. I can’t imagine what it would’ve been like had the condo had major problems or if I had a tenant that was unreasonably demanding.
• Part of my long term investment strategy is owning property. I knew from 1st day I purchased my condo that I would someday convert it into a rental property. That’s what I did after 4 years.

Was it the right choice financially? If I were evaluating the decision right now, the answer would be no. Had I sold three year ago I would’ve sold into a better housing markett. However these decisions should not be evaluated purely on the basis of investment timing. Timing is always a game better played in hindsight. The more important question financially is how it fits in one’s overall investment strategy, and cash situation.

• Do You Need the Money? If you need the money to finance another home purchase, then you should sell. It’s not a good idea to put yourself under more financial duress than you can handle.
• What else are you invested In? Are you already well invested in the stock market? I’m not believer that Real Estate is the only place to make money. I think it’s great place to do so, but so is the stock market. It’s best to have eggs in different baskets.
• What’s the current Interest Rate Environment vs. your Mortgage? If you’ve been able to lock in a great rate that is well under current market rates, this is when renting can make a great deal of sense. Let’s say for example Gabriele locked in a 5% 15 year Loan, and current rates are over 6.5%. By selling, Gabriel would give up that rate. If Gabriele can rent out his place, and earn a healthy amount over 5% then that’s “free” money Garbriele would be leaving on the table. Unlike companies, individuals are generally not in a position to borrow money at competitive rates except when it comes to property, especially property originally purchased as a residence. This borrowed money gives leverage which magnifies both losses and gains.

Crunch the numbers. Make sure you’re ROE (return on equity) is more than acceptable. Above is simple example of s such a calculation. Play with different scenarios. I also can’t stress this enough, if you do want to rent out the property make sure you want to be landlord. While it’s possible to hire a professional property manager, this is likely to eat most of the profits associated with having a rental property. Landlording isn’t for everyone. Hope this helps.

Hello Dong, I’m a condo owner in Washington DC and could really use some advice.
Here is a very quick run down of my situation:

• there are 12 total units in our condo association (3 buildings side by side
  with 4 units in each)
• 3 units have been bought and are being lived in. 1 other unit is finished, and
  the 8 remaining units are approximately 75% - 85% finished.
• our developer has notified our acting property manager that they do not have any funds available to pay for upcoming insurance premiums (covering all three buildings) and repair costs for fixing our water heater a couple of times and possibly replacing our sump pump. The developer also said their lender would not give them any more money. Since I moved into the condo in March there has
  been no work done on the 8 unfinished units.

Since there are only 3 of us condo owners (25% occupancy) the developer is still in charge of the condo association, which, to me, seems to leaves us with few options. There has been talk with our property manager about doing a special assessment (for the 3 homeowners) to cover the insurance and repair costs. However, is it possible to have a special assessment that only applies to 3 homeowners? The developer still technically owns the other 9 units and I don’t believe they should be excluded. But if they are broke then what? We can’t try to foreclose on the unoccupied and unfinished units because we don’t control the condo association.

I guess some of our options could include suing the developer, making our building where the three of us live a separate condo association, or doing the
special assessment and then recouping costs later down the road when (or if) the developer finishes and sells the remaining 9 units.

Are there more options out there? I’d like to hear opinions from anyone willing to share them. We are in the process of getting a lawyer and I know that might be our only option, but I thought it would be interesting to see if you guys have any other suggestions or anything further to add. If anyone needs any more information please let me know.

Thanks,
Patrick

Patrick has quite a situation, and one which I’m not very qualified to answer. It’s clearly a legal issue more than anything else. This is not to say I don’t have any thoughts. I even took a little time to get some quick legal advice from actual lawyers. The first thing that Patrick needs to do is review all the documentation associated with the property. This includes the Condo Association bylaws, the Master Deed, and Purchase and Sales agreements. There might be something in those documents to hold the Developers accountable and or specify a predetermined remedy.

The bigger problem is not so much holding the Developers accountable, but what then. The problem with the developers is that they probably don’t have any money. I think Patrick and his fellow homeowners should exact what they can from the negligent developers, but it’s unclear how much of anything the developers have to contribute. Given that the developers is not paying dues and being a responsible member of the condo association, they may forfeit some of their voting rights as a member of the association. It’s unclear to me if this would be the case as the laws vary state to state. In the least the Condo association should begin the process of getting a lien against the properties so that they are in position to be paid.

As for having a special assessment that applies only to small subset of the unit owners, apparently in Massachusetts this is the de-facto course of action when more than 50 percent but less than 75% of the condo owners agree to the improvements. In Patrick’s case, actual owners only have a 25% interest. However, it might be different in Washington DC.

At the end of the day in this situation as in many other situations in life, it’s important to acknowledge common interests and not just take the opposing position. It’s in the best interest of both the current Condo Owners (Patrick and his compatriots) and the interests of the Developers to make the required fixes. The more work that’s done on the property, the better off the developers are. Ultimately all the developer wants to do is to sell the properties, and if the property is in disrepair his chances of doing so are diminished. With that in mind I think it’s important to both talk a lawyer and talk to the developers about coming to an agreement. I wonder if there’s opportunity for Patrick and the other owners to help developer sell the remaining units to owners who have the money to finish up the property and pay the assessment? Hopefully everything works out for a Patrick, and if anybody else has any thoughts please share in the comments. Both I and Patrick would appreciate it, especially if you’re a real estate lawyer

Is there any disadvantage selling your home in a buyer’s market if you are going to buy in the same market? In reality, isn’t a wash if you sell and buy in a slow market?

How would you go about finding comps for a condo? Does it cost to ask a realtor to do a price analysis and are you bound to use them when you sell your place?
-stevie

I’ll answer the 2nd question first. Unless you sign a contract you’r not bound to do anything. When a realtor does a price anaylsyis, he or she’s really making a sales pitch. Getting a price analysis is not a obligation to work with that broker. That said, you should be clear on your position. Always deal in good conscience. Don’t tell a broker that you’re definitely going to work with him or her if know you won’t. As for finding comps, the Internet really has really made things much easier. Websites such as Zillow not only give it’s estimate on prices, but will also report the last sale. I find the best way to get a sense of comps is to start monitoring listing in the area you’re interested in. That way you have all the info from the listing, and then it’s easy enough to determine what those properties eventually sell for.

As for selling your home in a buyer’s market is trickier question. In buyer’s market, buyers have more leverage and that makes selling harder. In a perfect world buyers would only buy in buyer’s markets, and sellers would only sell in a seller’s market. In this non-perfect world of ours, we usually buy and sell homes not because of the market but because of life. The best you can do is try to manage the process smoothly.

You do bring up a good point about selling and buying once you already own a place. Given that you’re selling and buying into the same market, the changes in price is less relevant. If anything if you’re looking at upgrading, it’s most likely that you’re better off, all else the same. Let’s say your home is worth 200k, and you want to buy a place that’s worth 400k, and the market comes down 10%. In absolute terms your house is worth 20k less but the house that you’re buying is 40k less.

The far bigger difference that people often lose sight of is that the housing market is incredibly inefficient, and non-objective. Outside of the cookie cutter developments, homes are unique. One person may pay 300k for a house that I wouldn’t think of paying more 250k for. So if you’re looking to make a change, I would spend time on thinking about how you want to sell your home, and carefully assessing the market rather than worrying about timing.