As part of my ongoing rant about the high condo assessments in Chicago I’d like to revisit a topic I covered a while ago – what is the appropriate tradeoff between price and assessments? In that previous post I got into some fairly esoteric finance details about discounted cash flows and perpetuities that may have made the decision process seem a bit unreal. However, in discussions with a current client, I came up with a more concrete analysis that looks at what the impact of different assessments might be for a typical buyer with a finite time horizon.

In the example below I look at a theoretical high income buyer facing a choice between two condos, with one condo having assessments that are $100/month higher than the other. Given that the buyer is only going to live there for 5 years, the question is how much more can the buyer spend on the condo with lower assessments and still have the same monthly expenses, if the mortgage rate is 5%. In addition, are there any other economic considerations?

I factored in the buyer’s tax bracket because of the deductibility of mortgage interest. The impact of the deductibility is to make mortgages more attractive relative to assessments for high income buyers than for lower income buyers. I made a few simplifying assumptions as well: that assessments and the value of the condos would go up with the rate of inflation, assumed to be 3% per year and, that for purposes of this analysis, we could just look at an average of the monthly interest and assessments.

The conclusion is that you could spend an additional $41,000 on the condo with the lower assessments, have the same monthly after tax monthly expenses, and end up with an additional $6,580 of appreciation at the end of 5 years. In other words, think long and hard before signing up for a condo with high assessments.

Another South Loop condominium development is looking to clear their unsold inventory via an auction. On November 15, 2009 Michigan Avenue Tower II will auction off 41 units in one hour at the W Hotel, starting at 1:00 PM. Check out the link above for information on the building, floor plans, and some historic sales data. The building is located at 1400 S. Michigan Avenue and offers nice views from the north (above the 10th floor or thereabouts) and east facing units.

Here is the list of condominium units up for auction:

These units are being auctioned off without parking. Indoor, heated parking spaces can be purchases separately at a flat fee of $35,000. Notice that most of the units being auctioned off have the less desirable exposures. Units are available for previews daily through November 14. Every time I’ve been to the building it has been swamped with potential bidders so I’m thinking there aren’t going to be any bargains at this auction. Then again, all these people could be bottom feeders, who will drop out once the bids rise $20K above the minimums.

Bidders will be required to register in advance of the auction and should check in by 12:00 noon on the 15th at the W Hotel, located at 172 W. Adams St., in Chicago. Bidders must bring a cashier’s check or the usual substitutes for $5000 along with a blank personal check, which will be used in combination to leave a 5% deposit (of the winning bid amount). A separate cashier’s check is required for each property that the bidder is approved to bid on. It sounds like they won’t let you into the auction without presenting the checks.

Bidders can work with realtors but their realtor must be present at the bidder’s first visit to the building and all must register in order for the realtor to earn the 2% commission.

There will be a practice auction at 7:30 PM on November 14, also at the W Hotel. Interested bidders would be well advised to attend this event as it will provide an opportunity to find out what the bid increments will be, whether or not you will be able to understand the auctioneer (why the hell do they talk so fast?), and get a feel for the overall process.

When shopping for a condo or a townhouse in Chicago buyers are often confronted with comparing units that have assessments that are significantly different. So how do you make this comparison?

First, the simple part which almost everyone intuitively knows. Check to see if heating and/or air conditioning is included in both. If not, then estimate the value of this and subtract it from the assessments that include this. Now you have the equivalent cost of the assessments as if there were no heating and air conditioning.

Second, are there amenities included in one that are not included in the other – e.g. fitness center, pool, etc…? If so, you could impute the value of that amenity to you and subtract it from the assessments. Some people place no value on a doorman but it’s possible that a really good fitness center would allow you to cancel your $100/month health club membership.

The third piece is a bit more complicated and is really only practical for people familiar with reading financial statements. You have to figure out how much of the assessment is going towards operating expenses vs. building reserves. Let me explain. Suppose you have two identical buildings with identical expenses but different assessments. How could that be? Well, the building with the higher assessments has decided to build up their reserves. They’re really not spending the money but they are saving it for a rainy day (when the roof starts leaking). The other building will have to impose a special assessment, so, in the long run, the cost of living in the two buildings is exactly the same. Therefore, when comparing the two assessments you should subtract out that portion of assessment that is going towards building the reserves. If you don’t know how to determine this you could always ask your realtor (good luck with that one).

There is a too-often ignored field in the MLS for condos which is abbreviated in the system as POO – percent owner occupied. In the current environment this number has become critical for buyers seeking mortgages since lenders see a low number – less than 70% – as a sign of trouble. In other words, a building with lots of POO is a good thing.

Unfortunately, as I alluded at the beginning, this field is rarely filled in by the listing agent. So, what happens? Buyer and seller enter into a condo sales contract and when buyer tries to get a mortgage the mortgage company balks and the buyer has to get another mortgage – except now mortgage rates have risen and the buyer’s cost goes up. Worse yet, the deal falls through.

The implications are clear for both buyers and sellers of condos. If you are buying a condo you have to know if you have enough POO before you pick your lender because, given your down payment, not all lenders will be willing to lend. According to Tom Fishwick of Guaranteed Rate, you will certainly have an easier time getting a mortgage on a low POO building if your down payment is at least 20% because then some lenders only require a limited review of the condo building and don’t even ask how much POO you have. “The reason you would have trouble getting a loan approved without 20% down is because the Mortgage insurance companies may not insure the loan. Lenders are willing to lend up to 90% but they require mortgage insurance and it is those guidelines that have been changing.” Curiously, an FHA loan, with only 3.5% down, will allow up to 49% renters in a building. Of course, you pay a higher effective total rate for an FHA loan.

If you are selling a condo in a low POO building then you better line up a lender who will be willing to finance the purchase and make sure any potential buyer can qualify for their program. Alternatively, you can sell your condo 3 times before a deal actually takes.

Just to give you an idea of how serious this problem can be consider Millenium Centre at 33 W. Ontario in Chicago. This building has some $1 MM + condos/townhomes in it. It also has 63% renters or 37% POO. (As a side note, this is an American Invsco building and they often actually assisted investors in buying and renting units in their buildings.) You have to wonder if the low POO is contributing to all the problems in that building. Aside from the fact that many lenders wouldn’t touch that building, I would personally be afraid to put a buyer there. Of course, I would be extremely cautious about any building in the South Loop. Just walking through some of them you can tell that they don’t have a lot of POO. And as I recently learned, even nice buildings in the West Loop might have too many renters for some lenders.