What Landlords Need to Know About HOA
Updated January 1, 1 . AmFam Team
If you’re considering the purchase of a rental unit in a community governed by a homeowners association (HOA), you’ve got a lot to think about before signing. Because many HOAs are committed to enforcing their bylaws, you need to know their rules. To get you up to speed on HOAs, we’ve put together these tips on what landlords need to know about homeowners associations.
Get Familiar with the HOA’s Covenants, Conditions and Restrictions (CC&Rs)
When buying a home within a “planned community” like a condominium, single family home or a townhouse, you may find the benefits seem pretty great at first. For a monthly fee, many services are performed across the shared property — from mowing the lawn to removing the snow. Plus, you may get to use exercise facilities and other amenities.
As much as the HOA fee may be a downside, those costs may not be as big of an issue as their restrictive rules and regulations. Before you put in an offer for an HOA-managed rental property, dig deep into those CC&R details and learn about their corporate culture to verify that they’re managed in a way that works for you.
What You Need to Know About HOA Fees
HOAs are much like a property management business. They have been charged by the HOA board of directors to keep the common areas of the property well maintained. Like one business to the next, they're each a bit different — and the fees they charge are no exception to that rule. Here’s what you need to know about HOA fees:
Understand how the HOA limits occupancy. This is a key detail for real estate investors that will be renting a space out. The CC&Rs may outright prohibit your ability to rent, or the homeowner association laws may allow it, but with very specific and strict guidelines. Also inquire about short-term leases now. If your tenant leaves in the middle of a lease, will you be able to work with a subletter?
Pay attention to any HOA fee. Even if an HOA fee of $1.00 is stated, you need to be aware that bylaws and restrictive policies may be in play.
Learn about HOA fee trends. Because a number of factors can impact the cost of the HOA fee, it’s important to understand how the fee had been trending in the past few years. If they’ve been scheduled to go up by 3% annually, they’ll be 30% higher in ten years.
Get the details on what you’re buying. Inquire about what is covered and what’s not paid for with your monthly fee. If landscaping and snow removal are included, that doesn’t mean garbage collection and cable TV is. Request a full list of all products and services that the HOA pays for.
Compare and contrast. Once you’re more familiar with the offerings of HOAs, you’ll be able to better look at similar properties and see the differences between them. Make a list of pros and cons for each property. In addition to the cost itself, you’ll soon be able to see where the best deal for your money is.
Inquire about hidden costs. Some HOAs charge a fee that only covers the cost of the work they’re required to perform or outsource to contractors. Ask about how the HOA plans to afford big-ticket items. You may wind up with a big increase in dues when the parking lots are slated for replacement.
Get Details on the HOA’s Business Operations and Board of Directors
Once you have an understanding of the cost structure of the HOA, it’s time to dig deeper into the business side of the HOA. Because your property will be dependent of the financial decisions the HOA will make, you need to know that the group’s making good decisions. And if there are any upcoming projects that will require additional funds, you’ll want to take that into consideration too.
Ask about the HOA’s financial reserves. Financial solvency will also vary from one HOA to another. By requesting banking details from the HOA, you’ll see how healthy the business-side of the HOA is. If you see that they’re having trouble keeping a positive cash balance, they may be looking to increase fees soon to make up the difference. Consider bringing on a CPA to audit the HOA’s numbers.
Find out about the board of directors. Learn about the number of years the board of directors has been active. Inquire about term limits and look for trends between board member turnover and financial issues.
Review the HOA’s special assessments. Costs for special projects are usually spread evenly across all members of the HOA. But depending on the reserve fund amount, the monthly fee and the number of households contributing, the assessments can impact communities to varying degrees.
Suppose an HOA is proposing a $600,000 special assessment to cover the cost of replacing a swimming pool and its solar panels. That cost distributed across 2500 members is $240 per member. But if the HOA’s only got 500 members, that cost climbs to $1200 per member household.
Financing Your Loan With an HOA
Your bank will take a close look at your financial records when you apply for a loan. If the home you’re considering is part of an HOA, your bank will also consider that as well. Here are other ways that financing your loan with an HOA–property can impact your underwriting.
The bank will review the HOA fee. You know that the HOA fee can make a big difference on your bottom line and so does your mortgage group. Be sure you’re able to prove that you can afford the additional expense for HOA fees by using a mortgage calculator with an option to input the HOA fee.
HOA fees are not necessarily a bad thing. Depending on the age of the property, an HOA fee can mean a decrease in overall costs. It may actually be less expensive to live in an area where an HOA manages much of the day to day operations of a property. Underwriters like to know that out-of-pocket expenses will be absorbed across a large and solvent HOA, and that can be a good thing.
HOA fees will impact your maximum approved amount. Because mortgage lenders are all different, it pays to shop around and compare deals. The way underwriters calculate monthly expenses and incorporate HOA fees into that math will also vary between lenders.
HOAs with high tenancy rates may be an issue. It can be difficult to get a loan on a property that’s saturated with tenants. When a certain percentage of units are rented out, lending groups worry that if HOA fees escalate, tenants will flee the property. This can impact resale value and you may have a hard time securing funds for the purchase.
Learn About the HOA’s CC&Rs
Here’s where a little online research can help you get HOA codes, covenants and regulation details. Do a search for the name of the HOA and look for their published CC&Rs. There’s a lot you can learn from a well-appointed HOA website.
Get up-to-date CC&Rs. If your internet search resulted in outdated CC&Rs, request a current set of documents before making any decisions. Board members change and sometimes new management decisions aren’t readily accessible.
Explore the limits and allowances of the HOA. Many HOAs will define the ways you can decorate, paint, garden and park certain types of vehicles on your property. Be sure that you can live with these requirements before you buy.
Identify the way the HOA handles conflict. If you install the wrong type of blinds on your windows, how does the HOA go about resolving the issue? Some will go so far as to place a lien on your home in order to force compliance. Will you be able to work and live within the limits that the HOA requires?
Explore the HOA-imposed penalties for violations. Be sure you’re able to live with the HOA’s fining structure process and learn about how fines are imposed. When rules and regulations are broken what is the first course of action the HOA will take?
Get historic details on HOA legal actions. Most HOAs keep publicly-available notes on issues and resolutions that resulted in fines or other legal actions. Have a large number of property owners been taken to court, and has the HOA ever been involved in lawsuits? Also inquire if the HOA has ever violated state law of federal housing laws.
Review HOA-imposed foreclosures. It may be worthwhile to explore how the HOA deals with its biggest issues. By resorting to foreclosure, HOAs may be working against their own best interests. In other circumstances, the move may be justified. Some HOAs have bylaws that allow the board to foreclose on a member for nonpayment of HOA fees. Look into the reasons and ways in which foreclosures occurred to gain insights into the culture of the HOA.
Explore the Reputation of the HOA
By learning about the HOA’s reputation, you’ll have a better idea of how its employees and staffers manage their operations. Here are other considerations when exploring the reputation of the HOA.
Inquire about the business structure of the HOA. Many HOAs are group of volunteer board members that were voted into their position. Others are run more like a property management company — outsourced and without local members able to advocate for their needs. Learn about frequently used sub-contractors and their reputation too.
Study up on the Community Associations Institute (CAI). Get online and look at the CAI’s website (Opens in a new tab) to learn about HOAs and all the benefits they provide. Their online Learning Center is a great way to introduce yourself to HOAs if you’re new to the process. With details on trends, current legislative advocacy and training opportunities, this website has a lot to offer. You may find information on your state’s HOA Chapter where you can inquire about the property you’re considering.
HOA Compliance and Your Property
Sometimes, residents may have to move when they can’t afford to update or upgrade the property. Ask the HOA for a full inventory of property issues that are in violation of HOA CC&Rs. If you purchase the property without understanding the extent of the violations, you’ll be held responsible for bringing the property into compliance, which could get expensive.
Be sure to ask about your options for resolving problems. The board may be willing to settle and make an exception to their rules in order for the property sale to go through. They may also increase the time limit for you to make the necessary changes.
Understand the HOA’s Insurance Plan
One benefit of living in a planned community is that many of the costs independent homeowners would incur on their own are carried by the HOA. And because states frequently mandate the ways HOAs are required to carry insurance, you’ll have some understanding of what insurance your HOA is covering and what you’ll be responsible for. Here are a few other points to keep in mind when it comes to understanding HOAs and insurance plans.
HOAs cover common areas. States usually require HOAs to carry policies for areas that the homeowners community has access to.
Homeowners will need their own policy. The purchase of a homeowners or landlord policy will usually be the responsibility of the individual real estate owner in HOA-managed properties. However, most HOAs cover the exterior structure of the building but your own personal property won’t be included in that policy. You’ll also need your own personal liability protection for accidents that occur within your home.
While you’re considering properties and comparing HOA offerings, remember to check in with your American Family Insurance agent (Opens in a new tab). You’ll find great coverage that’s easy to understand. And your agent can help you to build a policy that fully protects everything you’ve worked so hard for. With that kind of coverage, you’ll find the peace of mind that can help you to focus on growing your business.
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As a landlord, you know that an investment property has great potential. When everything goes according to plan, it can be an exceptional source of income. But seeing a consistent return on investment means you’ve got to keep a close eye on the numbers before you close on a property.
Although there’s a fair amount of risk involved in making a purchase, you can lean on a few key rules, formulas and indicators to help guide your decision. Next time, when you’re wondering “Should you invest in this rental property?” refer to these important purchasing tips to help make the right choice — and quickly rule out real estate that may not be worth the investment.
Start with the “One Percent Rule”
Answer a simple question: Will your monthly rent for the space equal at least one percent of the purchase price? If your answer is yes, then your place may be able to turn a profit in the years ahead. Congrats, you’re off to a good start. Be sure that the rental’s priced competitively for spaces of similar design. Here are few other factors to consider:
Understand the formula
If the total purchase price of the property is $200,000, rent should be no less than $2,000 per month or one percent of the total cost. Likewise, a $600,000 purchase price for a multi-unit rental property should meet or exceed $6,000 per month in total monthly rent earnings.
Get the purchase price right
When factoring in the purchase price, remember to include closing costs, property taxes and insurance. One way to better estimate these costs is to use an online closing costs calculator which can approximate appraisal fees, home inspection fees, application fees, prepaid interest among a host of other out-of-pocket expenses that can up your purchase price, sometimes by thousands.
Factor in repair costs now
Because real estate investing as a landlord requires the space to be “habitable” upon tenant occupancy, you may need to make certain repairs or upgrades before renting the property. As a result, you’ll want to add the total cost of these repairs into the purchase price.
Consider the “Class” of the Neighborhood
Neighborhood classifications help buyers understand the potential return on investment in a given area. If you’re new to being a landlord, you’ve got to pay close attention to what the neighborhood’s telling you.
One good way to check out an area — specifically if it’s an investment that requires some traveling — is to use Google map’s street view. Is trash left out on the front lawn? Do neighbors maintain their property? What can the cars parked on the street tell you about the demographic? Here are details on the four distinct neighborhood classes real estate agents use to classify a region:
Class A neighborhoods
High income neighborhoods, combined with a home that is move-in ready will usually get an A class rating. Because homes are expensive in these neighborhoods, and their higher than average tax burden, real estate investors usually won’t buy a home there because the one percent rule fails the test. Tenants in these areas tend to be very reliable, high-quality renters.
Class B neighborhoods
Typically populated by those earning a moderate-to-high income, B class neighborhoods are frequently considered a good investment for landlords and fertile ground for tenants seeking rentals. Purchasing “as is” properties that can be cheaply updated and rented above the one percent factor is typically possible here with minimal risk. These areas will usually experience increased turnover and vacancy rates.
Class C neighborhoods
Because the risk is a little higher in neighborhoods that land in the C class category, the opportunity to see a high rate of return on fixer-upper places is good if you buy a For Sale by Owner property, or one not listed on the MLS (multi-listing service for real estate sales). Populated with blue collar workers with relatively low-to-average income, C class areas typically have higher crime rates and under-performing schools. Landlords should expect less-than-optimal tenants and periods of vacancy.
Class D neighborhoods
Areas riddled with crime, properties damaged upon a tenant’s exit and high costs for property upkeep can be anticipated in D class neighborhoods. Buyers usually consider these types of purchases high risk. It should be noted that many property management companies are reluctant to accept properties to service in these areas because the risks associated with the area. Investors tend to seek properties in more stable neighborhoods.
Use the Capitalization Rate as a Predictor of Value
Another key way of understanding the rate of return on an investment is the capitalization rate or “cap rate” for short.
What is a cap rate?
A cap rate determines a profit ratio that a property can generate. It’s best used as a quick way to compare investment opportunities to determine which one is the better value. Start by dividing the total of one year’s rent by the current market value of the home which should include costs and upgrades required to get the space habitable — you can’t rent the place if it’s not livable, right? The resulting percentage is your cap rate. The higher the rate, the better your annual profit margin.
How to Calculate the Cap Rate for an Investment Property
Although the cap rate’s a useful tool to quickly analyze the relative value of comparable real estate opportunities, it’s used as a rough guide to qualify properties for consideration, given the state of today’s current market climate. First, estimate your property’s overall purchase price:
Figure the acquisition value
Simply put, this is the total purchase price. It should include all upgrade costs, closing costs, taxes, business insurance, fees, points, etc. Let’s assume a property you’re considering has a total purchase value of $200,000.
Calculate one year’s rent
If you’re collecting $2,000 per month, you’ll have twelve payments at the end of the year, or $24,000. This figure is your gross annual income.
Account for half a month’s vacancy
Because turnover typically requires some painting and repairs, it’s fair to consider that half a percent (two weeks’ worth of rent) of your total annual income will be deducted to cover the mortgage payments. Assume that your new tenant will cover the remaining pro-rated rent for the other half of that month. Once the vacancy amount is deducted, the result is your gross operating income.
- Gross annual rental income: $24,000
- Less the cost of vacancy: -$1,000
- Gross operating income: $23,000
Factor in operational costs
These costs will include money required to keep the property habitable, like paying for trash collection, making repairs, fees from property management, and landlord insurance. Let’s put that cost under fifty percent of the gross operating income, or $9,300. Some years it will be more, some less.
- Gross operating income: $23,000
- Less operating costs: $9,300
- Net operating income (NOI): $13,700
Divide the NOI by the total value of the property:
$13,700
--------------------- = 0.0685 or 6.85 % - That's your cap rate.
$200,000The capitalization rate for this investment is 6.85 percent annually. If another property under consideration returns a higher cap rate like 8.23 percent for instance, you may want to explore opportunity with the higher annual yield in order to maximize your profit potential.
What is considered a good cap rate?
Generally, a cap rate between 8% and 12% is considered good. However, an optimal cap rate is really going to depend on several factors including location, risk and current rental income. For example, in high-demand like big cities, a cap rate of 4% may be considered good.
Reach Out to Your Agent Today
With so many different ways to look at profitability when determining where to invest in rental property, it’s important you do your homework before you decide to buy. And while you’re making that big decision, remember to contact your American Family Insurance agent and discuss your upcoming purchase. When it comes time to close the deal, you’ll have peace of mind that your property’s insured carefully.
This article is for informational purposes only and includes information widely available through different sources.
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Potential revenue stream. “The big thing about the Internet of Things is that it can be a model for recurring revenue every month,” says Reid. For example, a small business can put sensors on a product that it installs and “offer to monitor it for customers for a monthly fee.”
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