He Exchanged Into Three Condos, Then Read the Governing Documents

Condominium units are popular 1031 replacement property. They are affordable enough to buy several, easy to finance, straightforward to value, and simple to rent.

The tax side is rarely the problem. A condominium unit is real property, and a unit held for investment is perfectly good replacement property. The problems arrive in the governing documents, which almost nobody reads inside a 45 day window.

What are the governing documents?

The declaration, bylaws and rules of the association. They establish what owners may and may not do, what the association controls, and what costs owners share.

They bind you as an owner whether or not you read them, and they can generally be amended by a vote of owners after you buy.

What restrictions actually matter to an investor?

Rental caps. Many associations limit the percentage of units that may be rented at any time, often with a waiting list. A cap already reached means your unit cannot legally be let, perhaps for years.

Minimum lease terms. Bans on short term letting are common, with minimum terms of six or twelve months.

Approval of tenants. Some associations screen tenants or charge fees for each new tenancy.

Owner occupancy requirements. A few require owners to occupy for a period before letting.

Restrictions on ownership by entities. Some associations restrict or complicate ownership by LLCs or trusts, which can collide with the same taxpayer rule if you planned to hold in an entity.

An investor who buys three units intending to rent them, then discovers a rental cap at capacity, owns three properties that cannot produce income.

What financial issues hide in the documents?

Reserve adequacy. Associations with underfunded reserves face special assessments when roofs, lifts or facades need work. Those assessments fall on owners.

Pending special assessments. Sometimes already approved and payable.

Litigation. Disputes involving the association can affect values and make financing difficult.

Insurance. Coverage levels, deductibles, and what is the association's responsibility versus the owner's. In some regions insurance costs have risen sharply, driving large increases in monthly charges.

Delinquency rates. High owner delinquency shifts costs to those who pay and can restrict lending.

Why does financing depend on the association?

Lenders assess the association as well as the unit. Investor concentration, delinquency, reserve funding, litigation and commercial space proportions can all make a building ineligible for conventional financing.

A property that cannot be financed conventionally has a smaller buyer pool when you sell, which affects value.

How does this collide with the exchange timetable?

Association document review takes time. Requesting the resale package, reading the declaration, reviewing reserve studies, minutes and financial statements is a real task, and associations are not always quick to respond.

Ordering the resale package the day a unit becomes a serious candidate, rather than after identification, is what makes it possible inside 45 days.

What should you actually read?

• ›The declaration and bylaws, focusing on leasing, use and entity ownership
• ›Current rules and any recent amendments
• ›Reserve study and reserve balance
• ›Two years of financial statements
• ›Two years of board minutes, which reveal problems before they reach documents
• ›Insurance certificates
• ›Any disclosure of pending assessments or litigation

Board minutes are the most useful and the least read. They show what the association is arguing about.

What about the alternative?

Investors who want condominium style exposure without association risk sometimes choose apartment property with a single owner, or fractional interests in professionally managed multifamily assets. Those interests are securities available to accredited investors only and carry illiquidity and costs, and they replace association risk with sponsor risk.

What happens if rules change after you buy?

Governing documents can generally be amended by a vote of owners, subject to the thresholds in the declaration. An association that permits letting today can vote to restrict it later, sometimes with grandfathering for existing rentals and sometimes without.

That is a genuine risk for an investor whose plan depends on rental income. Reading recent minutes helps, because proposals usually surface long before they are adopted. An association already debating a rental cap is telling you what is coming.

Does buying several units in one building help?

It concentrates risk rather than reducing it. Three units in the same building share the same association, the same reserves, the same insurance renewal and the same local market. A special assessment hits all three at once.

Investors buying several condominium units for diversification generally do better spreading them across buildings, and ideally across markets, accepting that each association then needs its own review.

What to do first

For every condominium unit you consider, request the full resale package before you identify it, and read the leasing provisions first. If the rental cap is at capacity or the reserves are thin, move on while you still have alternatives available on your identification form.

Nothing here is tax, legal or investment advice. Association documents vary. Confirm your review with your attorney before acquiring.