By Deborah Goonan, Independent American Communities
A reader contacted me with a suggested topic for IAC. He posed an intriguing, tongue-in-cheek question: what if condominiums came with a “sell-by date?” Today I share my thoughts on why HOAs tend not to plan for the future.
Q: I’ve got a brainstorm for an article! And it just might be a kernel for a meaningful push for legislation. What about a legislatively-mandated “condo sell-by date”?
Think milk. Now think the huge personal homeowner investment and the real limitations of a condominium’s physical lifecycle. And now think the typically huge disconnect between the immediate personal pocketbook issues motivating a volunteer condo board… and the needs articulated by a reserve study.
— Brian
A: Brian, if you’re saying that condominiums gradually approach obsolescence, I agree with you.
However, the HOA/condo industry already knows that their built structure and environment will not last forever. Frankly, I think that’s part of the plan.
Just as with any other American product or durable good, there must be planned obsolescence to create future demand for a new, improved version. Common interest housing is no exception. The HOA-industry relies upon perpetual demand for more modern homes and communities.
As you point out, every component of modern home and multifamily construction has a shelf life. The structure of a common interest community not only requires regular maintenance, but its components will eventually need to be rebuilt or replaced.
HOAs showing their age
Unfortunately, many condo and HOA-governed communities are showing their age — and not in a good way. The combination of deferred or inappropriate maintenance, plus under-funded reserves causes all sorts of problems for owners and residents as the decades slip by.
Leaky roofs. Wood rot. Termite damage. Mold. Worn out plumbing and sewer lines. Old or hazardous electrical wiring. Non-functional heating and air conditioning equipment. Dangerous decks and balconies. Broken elevators.
All of these are common defects in aging multifamily communities.
In many older planned communities, it’s not uncommon to see crumbling private roads and poor storm water drainage. After several decades, amenities such as swimming pools, playgrounds, tennis and basketball courts, club houses, and common landscaped areas can become unusable eyesores or, worse, safety hazards.
Traditional homeownership vs. ownership in a condo – HOA community
By contrast, homeowners in traditional neighborhoods (no common interest, and no HOA) have the freedom and motivation to maintain and preserve their property. They keep their homes well-maintained , not only for their own use, but for the benefit of future generations.
Each new generation tends to breathe new life into older neighborhoods by updating and renovating existing homes.
That’s why, in the United States, we have many millions of older homes, most of them still in relatively good shape.
But in HOAs and condominiums, homeowners lack personal connections to property owned in common. Housing consumers are sold on the expectation that someone else (their HOA) will take care of the commons in exchange for the fees they pay.
The higher the fees, the more service homeowners expect from their HOA.
Likewise, the more strictly an HOA enforces covenants and restrictions, the more homeowners are discouraged from upgrading or personalizing their house or condo.
Keep in mind that a developer or sponsor is only motivated to maintain the common property in the short term — for as long as it takes to sell the units or parcels and hand over the reins (and financial burdens) to the homeowners in the mandatory membership association.
Why we’ll never see a “sell-by” date for condominiums
So Brian, you seem to be saying that, after turnover of the condo or HOA to homeowners, the “housing product” might as well be openly depreciated each year — much like a rental car is depreciated as a business expense. That way, everyone involved in the association knows when it’s time to sell and redevelop.
It’s an interesting suggestion, and one that has been embraced in Japan, where housing units are routinely torn down and rebuilt from scratch when they reach 30 years of age.
However, I doubt we’ll ever see a “sell-by” or “use-by” approach to housing here in the U.S.
After all, the real estate industry counts on churning out resales — and they prefer to sell buyers on the potential for ever-increasing property values. Of course, the idea that HOA protect property values is know a myth, (according to recent research) but most housing consumers fall for it.
Besides, real estate investors and developers are only interested in buying and redeveloping desirable condominium or HOA assets that happen to be well-located. And, even then, investors prefer to time their buyouts before infrastructure is too far deteriorated.
Let’s face it. A poorly-located or a severely blighted building doesn’t support profit potential.
So when the community is well past its prime, we rarely find buyers willing to bail out the poor owners of housing units in multifamily buildings. Likewise, developers won’t buy real estate in a flood zone, or in an isolated location, in the bad part of town, or close to the landfill or airport or county jail or whatever, unless the local government offers substantial tax breaks or incentives for redevelopment.
So, I think we’re better off to enact policy that rewards homeowners for preserving existing residential housing and communities.
That’s going to be a huge challenge, if we must continue to operate within the HOA box.
Perverse incentives for HOA-industry
The HOA industry includes planned communities with HOAs as well as condominiums and co-ops.
By now, it’s common knowledge that HOAs habitually underfund their reserves. Everyone prefers to keep condo, co-op and HOA fees as low as possible, for as long as possible.
The process starts with real estate developers, and often continues with homeowner-led association boards.
In the early years of a community’s life cycle, while new homes are being built and sold, developers tend to set artificially low condo and HOA fees. Lower fees make ownership seem more affordable. Predictably, in the short run, this strategy sells more homes.
By the time owners figure out the scam, the developer is long gone.
After the developer hands over control of the HOA to volunteer homeowners, many continue to keep fees lower than they should be to fully fund reserves for the future. Why?
It’s important to realize that the HOA-industry has many other perverse incentives for its failure to fully fund reserves. Here are a few of them:
Investor-owners look at the bottom line
In communities with a high percentage of investor owners (landlords who rent their units), lower HOA or condo fees reduce the cost of doing business, which results in a higher profit margin. It’s a simple equation:
High rent minus lower carrying costs = more net revenue for the investor.
Redevelopment creates opportunities for profit
Conversely, we see some investors who target under-performing communities with profit potential. They buy up units at low prices, gain control of the association, then force the long-time owners to pay for massive renovations and capital improvements to increase their potential for future rent payments.
More often than not, this business strategy culminates in a termination or deconversion.
Bailing out
Forward thinking condo boards, who see the association is headed for insolvency, decide it’s better to sell the entire project to a developer/investor on their own terms.
Once that decision is made, the association has no incentive to increase reserve payments or engage in big construction projects. It makes sense. Why throw away money that owners won’t get in return upon a sale of the community and deconversion?
HOA management is big business!
Management companies and vendors provide an array of services in major renovation projects. The HOA industry is now saturated with its own HOA banks, HOA lending, HOA collections, etc.
Money-making opportunities abound when a homeowners association defers maintenance.
Owners’ associations that fail to fully fund reserves years also tend to defer maintenance. Eventually, major repair and replacement projects become unavoidable.
At that point, the HOA management company steps in to “save the day” with referrals to engineers, contractors, lenders, insurers, reserve specialists, and more.
Each link in the management-contractor-financial services chain gets a piece of the action. As documented here on IAC, owners often face inflated costs in the form of hefty special assessments and regular fee increases.
The kick-the-can-down-the-road-until-there’s-a-crisis HOA management model disproportionately affects owner-occupants, especially seniors, the disabled, and other homeowners living on limited incomes.
But, there’s no question that stakeholders in the HOA-industry are making a lot of money as a result of irresponsible management, dysfunction, and corruption in HOA-and condo-ville.
The dirty little secret is this: the HOA industry actually benefits from the dysfunction it creates.
To be fair, not all HOAs are irresponsibly managed. But too many are.
Self-managed associations, conflicts of interest
HOA boards of self-managed associations face different challenges.
IAC has observed that many of these association boards consist of self-interested leaders in the real estate biz.
For example: real estate brokers, insurance brokers, owners of property management or lawn maintenance companies, etc.
In small communities, the original Declarant (developer) creates perpetual revenue streams for itself and its family.
That’s the game plan from the beginning.
Owners don’t agree on priorities
In any given HOA or condo association, there will be a fundamental rivalry between the owners who want to preserve the housing community for the long term, and those who only care about their monthly expense-to-revenue ratio in the short term.
Add into the mix the rise of the short-term rental, and you have a recipe for disaster for the owner-occupants in HOA-governed communities. The common interest housing model tips the scales way in favor of investors.
That’s why, in my opinion, common interest doesn’t work for the majority of housing consumers. Most owners don’t know it’s time to sell, until it’s too late. ♦