In most real estate markets across the US, condominiums are the poster child investment property of choice. The reasons are obvious: They are small, easy to rent, usually well located and priced lower than their single family counterparts. So when our out of town clients come to Houston to view investment properties, the question never fails to arise: What about condos? What follows are three strong reasons why investing in condos in the Houston market does not make sense.
Higher operating costs hurt or eliminate cashflow
The primary reason why investing in condos does not make sense in the Houston market is their higher operating costs relative to the income they produce. Here’s what I mean in a simple example. Let’s compare two properties: The first is a single family home in a suburb of Houston and the second a Galleria condominium both priced at $135k. Let’s assume that they both rent out for $1200/mo to level the playing field. The single family home will have operating costs of about 40% of the incoming rent or $480/mo which covers property taxes, insurance, annual HOA dues etc. In comparison, the condo will have operating costs of about 60% or $720/mo. The reason: Houston condos typically have $300 per month in maintenance fees. Put a different way, a condo that costs $135k has similar costs to a $160-170k single family home. What does this mean? If you were to invest in the condo by putting 20% down, your positive cashflow would be wiped out by those higher costs and you would have a break even property at best. In contrast, if you invested in the single family home, there would be $3600-4000 annual positive cashflow – a 10-12% cash on cash return on your invested capital.
When you take cashflow off the picture, appreciation is all that’s left
So if your investment property isn’t producing positive cashflow then where will that return you hope for come from? All that’s left is appreciation. In other words, you would purchase an investment property that pays it’s own bills while waiting for its value to go up as your tenant pays your mortgage. Small problem with that plan: Houston has never been a high appreciation market. Even in the peak of the market, we were barely scraping 5% annual price growth. And besides, have you seen what happened to markets that did have that steroidal appreciation? I’ll take Florida condos for a third of the price, Alex. An investment plan that relies solely on your property appreciating in value in Houston Texas is two rungs above buying a Texas Two Step lotto ticket on the sound investment scale.
But what about location, location, location?
Condos have proven to be sound investments when they allow the real estate investor to acquire property in a sought after location and the tide of popularity of that location has made values across the board rise. Example: If you want to live in the city, chances are you can’t afford a single family home but a condo will get you all the benefits of that location at a much lower price tag. The Houston market is different in that it’s very de-centralized. Houstonians don’t mind commuting for 35-45 minutes each way if that means they can have all the space and amenities that a great home can offer. Certainly there’s a subculture of people that would never live outside of the Inner Loop, but that’s not the majority. Most people would rather live in the suburbs where schools and amenities are better and work Downtown or in the Galleria. This commuter culture results in a lack of land shortage that is a necessary ingredient for value appreciation. For instance, if you want to live in Manhattan, you have to pay the price as they’ve run out of land long ago. In contrast, in Houston you could get twice or three times the size of home if you just go out 15-20 miles. And if you don’t mind the drive, it’s a no brainer. And it’s bad news for condos as investment properties.
Bonus Reasons: Age and control issues
Some additional concerns with condo investments are the age and the lack of control in certain circumstances. Let’s tackle them one at a time. For the most part, condos priced low enough to break even on the incoming rent tend to be built in the 1980s. Age may do great things to wine but all it does to investment properties is cause the operating costs to creep upward which makes rent increases a necessity. Besides, if you are a long term investor think about the age of the property 10-15 years from now. Is it smart to own a property that when you want to sell it will be hitting the half century mark? I know some out of towner’s eyebrows might be raised right now, but you should know that in Houston, 50 year old properties are considered “historic”! Last but not least, condos present some unique control issues. What happens when a hurricane damages a condominium’s roof? Well you might be hit with an unexpected “special assessment” bill from the homeowner’s association that’s trying to offset the large deductible on their master insurance policy. Oh, and what happens to your tenant when the roof is leaking profusely but the Landlord can’t fix it right away because she has to wait for the homeowner’s association to reach an agreement with the insurance adjuster? Like the title said: pretty much out of control.
I’m a firm believer in taking what the market gives you when investing in real estate. And in Houston Texas the market gives you new (or 5 years old or less) single family homes in good neighborhoods with great schools between $125-$150k. Anything else, you’re sacrificing something you shouldn’t.
Side note: This analysis addresses condominiums as pure investments. If you’re looking into purchasing a condo as a residence, it may make sense as an investment because you have to consider the fact that you have a cost of living to contend with everywhere you go.