Great investment, but zero HOA reserves. Show stopper?

Question

After a very long search, I am days away from signing a P&S on a condo investment. This is in Boston. It is a residential unit in a 12 unit complex. 9 are residential, 3 commercial. The cash flow and IRR are fantastic, not even close to anything else I've looked at. The current tenants are strongly interested in renewing their lease in September. Having 16 months of assured cash flow is golden.

The first concern is a rodent infestation. The property manager has engaged a pest control company the last 3 years yet the problem remains. Not really seeking advice here. I'm assuming this is a solvable problem, but it still bugs me that my tenants (4 girls) still have to live through this.

My greater concern is the interelated combination of three things: HOA has ZERO reserves, the Board is providing minimal oversight/leadership, and the property management company is lousy. There are three trustees that are pretty checked out for various reasons. The president and only real decision maker permanentlly lives out of town in Arizona. The Board has never met face to face! They correspond via email. There aren't even meeting minutes. All 10 owners (of 12 units) are investors. Due to the history of this building and original condo origination, many of them are out of state and some (like the President/trustee) have lost lots of money on this investment (from historical events). The good news is that I was just able to speak with the President. He's a good guy and would more than welcome me joining the board (even becoming president). I would clearly be able to exert powerful influence in turning this situation around. Actually be local and stay on top of what's going on. I do have a full time job and two young kids, so a big concern is how much time this might suck up. But having gua.ranteed tenants, and the unit requiring minimal maintenance (inspection revealed it to be in great shape), puts me more at ease.

On to the property management company. The first order of busines needs to get them out and find somebody new. They have a reputation for being lousy, and clearly there's nobody around to keep them honest. I'm sure with a reputable company, the budget can be trimmed of fat.

MY BIGGEST QUESTION IS ON THE ZERO RESERVES. Should this be considered a show stopper, or is this, while undesirable, not uncommon (especially in a 100% investor owned complex)? To some degree, as a trustee I'll be able to start improving this situation. And good chance that more units will start to sell and fresh blood will be injected into the HOA. Philosophically, with the greater reward comes a greater risk....here in the form of a weak HOA and no rainy day fund.

I feel a bit of pressure to move forward. It's a huge sellers market here and pickings are slim, multiple offers very common, prices are high. It may be many more months before I find another suitable investment, or I'll have to compromise on lower ROI. Time is no longer on my side because this would be an all cash deal -- and the money is a cash out refinance/loan from another property. I'm starting to pay the mortgage as of today, so every month that goes by without any cash flow...well you get the picture.

Hoping cooler heads prevail -- I welcome all opinions!

Vlad

Theresa K. · Answer

Vlad Selsky:   Is the common area in good condition?  If there are bad roofs, plumbing issues, pot holes in the parking lot, etc then you might need to put in money for a special assessment soon.  If there is deferred maintenance and the rest of the owners don't have money or don't want to put in money for reserves or a special assessment, then the condition will continue to deteriorate.  But if the rest of the property/common area look to be in generally good condition then you might be ok with the lack of HOA reserves for now.  You can start working on building reserves once you get on the board.

Also - what is the HOA responsible for maintaining?  Some HOAs maintain a bunch of stuff like exterior building maintenance, roofs, landscaping, pool, parking lot, water, hot water, snow removal, etc.  On the other hand some HOAs are minimal and only maintain stuff like common area landscaping.   If the individual property owners cover the big ticket items for their unit and the HOA is only responsible for small amount of maintenance, then I wouldn't be worried about the lack of reserves.

Jeff S. · Answer

Vlad Selsky it probably has more to do with you then and your financial ability to withstand loss if everything falls apart. Also, a strong financial player can swoop in and buy out less financially able people. If you are there then the risk would be smaller relative to your financial situation. If everything going sideways would wipe you out then this deal may not be for you IMO.

Your best bet is to gain control either financially by buying others out or by having a majority of board members on board that can straighten things out. In any case it is going to cost money and with investor owned properties that can be tough. Good luck.

Vlad Selsky · Answer

I believe that many owners are out of state and are financially tight. I can't contact every one, was barely able to contact the single trustee. I'm at least trying to get details on HOA fee collection, see if there is any in arrears/delinquency. I am heartened that one of the owners tried to make an offer on my unit, so as an insider he clearly has faith and sees the upside.

Ziv Magen · Answer

Not to be taken as benchmark, because we operate in Japan and not the USA, but dealing mainly in condos, we generally only accept empty reserves if they're backed up by a long and verifiable history of repairs/renos etc. of course, if you're local as you say and have interest in turning this around, that's a totally different goal and approach. Personally, I prefer minimum hands-on, so I can spend my time on the next deals, so can't comment on that one.

Vlad Selsky · Answer

The HOA covers all the major stuff, and the inspection was very sound. Expenses run $40K a year and they just about break even. I calculated that a 17% HOA increase will build up a $10K reserve in less than 2 years (25% of operating expenses).  I will be speaking with the pest management company on Monday.

Dyna J. · Answer

How much do you trust your inspector? Because if a "lousy" PM company hired a lousy Pest Control company and considers that acceptable then what other lousy repairs have been made?  Are you getting a smoking hot deal on this place? Zero reserves would be a showstopper for me but I exclude condos as a rule anyway.

Jeff S. · Answer

If all the owners are cool then you might be fine. Have heard of projects where the owners chose to not have reserves and just write a check when needed. This group of owners were pretty well heeled so all was ok according to him.

Sounds like something that will require lots of research as you are going into a RE deal with a bunch of strangers where the rules aren't well spelled out. Would try to contact every owner.

Great investment, but zero HOA reserves. Show stopper?

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