The Wall Street Journal

By Dan S. Barnabic, November 26, 2014

To many buyers and unit owners, condominium ownership may still be ambiguous and convoluted. Since condos aren’t based on the same ownership structure as street-level traditional (freehold) homes, comparing condos to traditional homes is like comparing apples with oranges.

Why condos can be a poor trade-off to traditional homes

By Dan S. Barnabic

Condo ownership is based on a two-tiered ownership system. One tier pertains to the individual unit itself, and the second, to the prorated and undivided interest of all the common elements in the condo complex, including the land underneath the complex. Even though the unit owner receives an individual deed to their unit, it is at all times contingent and subordinate to the master deed of the second tier ownership, represented by the common elements of the condo complex.

Conversely, a traditional home, structured by its fee-simple title ownership, gives its owner an absolute and exclusive ownership of both the land and the dwelling erected on it.

The major distinction here is that the individual unit owner isn’t the absolute master of the condo property. Sharing a common roof and the rest of the condo complex with the other unit owners makes them an intrinsic part of the joint ownership commune. Therefore, the value and destiny of any condo unit depends on all owners electing competent leaders (HOA board members) to govern their condo complex diligently, and on their prompt payments of realty tax, monthly maintenance fee and special assessment, as they become due.

The traditional homeowner’s loss of property doesn’t adversely affect any of their neighbors. Conversely, the condo owner’s loss of their unit automatically affects all the other fellow unit owners in the same condo complex, by increasing their financial obligations to maintain the complex. The more losses of the units, the heavier financial burden on remaining unit owners to maintain the complex.

Many financially weak condo buyers purchase their units with very small down payments, facilitated through insured high-ratio, aka monster mortgages, mostly guaranteed by tax payers. Quasi-government formed insurance agencies such as Fannie Mae and Freddy Mac, have been approving and encouraging such (subsidized) purchases to stimulate the economy for quite some time.

During times of a healthy economy and vibrant real-estate markets, the condo scene — providing it is not overvalued — might be a viable alternative to traditional housing for which it was originally designed from its inception in 1965. Its volatility comes into play in times of overinflated prices, oversupply, unemployment and interest spikes, as was the case in the early 90s and from 2006 to 2011.

Financially weak unit owners are the first to succumb during economic adversity. Their units get liened and sold out by forced sales. If adverse conditions persist, over time, the strain on the remaining unit owners to shoulder the financial burden of maintaining the whole complex may start a domino effect. More unit owners may then succumb to financial pressures, especially when there are no readily available new unit buyers on the market. This phenomena doesn’t affect traditional homes as one failure of financially weak owner doesn’t affect the other owners on the same street or neighborhood.

To realize what may happen to condos in the extreme, one has to look at what happened to cooperatives or “Co-ops,” a very similar concept to condominium-like ownership. The Great Depression of the 1930s caused scores of co-op owners, unable to cope with their financial woes, to default on their maintenance fees and common co-op mortgages, precipitating the catastrophic failure of co-ops on a massive scale. Should the economy tank again, condos, many of them financed to the hilt, may end up meeting their demise just as co-ops did some eighty years ago.

Government regulators and policy makers should take note that condominiums are the most volatile of real-estate products due to the financial diversity of its inhabitants. At the next major market correction, the trade-off of stimulating the economy by inducing financially weak buyers to buy condos with little or no down payments may backfire badly. Taxpayers would again foot the bill for defaulted insured mortgages.