Let’s start with a simple approach for making that comparison, based upon an example where the difference in assessments is $100/month and your mortgage interest rate is 5%. In that case the extra $1200/year in assessments is approximately equal to the interest you would pay on an additional $24,000 purchase price ($1200/.05). In other words, for the same monthly outlay you could afford a $24,000 more expensive home or buying the home with a $100/month assessment is equivalent to spending an additional $24,000 on a home. In fact, most buyers intuitively take this into account by looking at their total monthly outlay in terms of mortgage, taxes, and assessments.

That’s the basic concept. It gets more complicated (doesn’t it always?)

First, there’s the tax benefit of a mortgage. If your marginal tax rate is 25% then the after tax cost of mortgage interest is really 3.75%. So that $100/month is really equivalent to paying an extra $32,000.

But I’m not done. It gets even more complicated. Really complicated on this round. In fact, it gets downright scary. Let’s say you believe that your assessments are going to go up because of inflation – maybe 3% per year on average. Wellllllll….now that’s equivalent to paying an extra $160,000 (1200/(.0375 – .03)!

OK. You’re not going to believe that and, while it’s accurate, it’s not totally correct so I better explain. The formula I used above is for what’s called a perpetuity. In other words, it assumes you are going to live there forever. Of course, that’s not true. In fact, you will either die (sorry, but it’s true unless you are a teenager in which case you believe you are immortal) or move before perpetuity comes. So what you really need to do is factor in the increases that will occur while you are living there using a technique called discounted cash flow, which is too complicated for me to get into right now but, in a simplified form, it’s actually the basis for all the formulas I’ve been kicking around here. Basically, it averages out the increases you are likely to experience while living in this place and it comes up with a number far closer to $32,000 than $160,000.

But here’s the point: an extra $100/month really adds up over time and the longer you live there the more of a burden it’s going to become. So think twice about buying a place with a higher assessment unless it’s a lot cheaper.

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).

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.

Effective as of March 1, Fannie Mae:

• Will not guarantee mortgages in condo buildings where fewer than 70% of the units have sold (up from the previous number of 50%
• Will not back loans for sales in buildings where there are 15% of current owners delinquent on Homeowner Assessment fees
• Will not back loans where more than 10% of units in the building are owned by a single entity (generally the developer)

Starting in April, buyers without at least a 25% down payment will have to an additional   fee at closing equal to 0.75% of their loan regardless of their credit score. As of this writing, Freddie has not followed along with the increases….yet!

2008 was uniformly higher than 2007 and really shot up over the last 4 months, hitting highs above a 20 month supply. Although inventory pulled back in January like it always does, it’s still higher than 2008 at a 17 month supply.

Meanwhile, there is a clear upward trend in the days on the market for condos that sell, though it hasn’t really broken out of the 80 – 100 day average that has existed for the last 2 years.

There is really only one way for this glut to correct itself. Prices will come down. They are coming down.

You can always find our latest statistics on the Chicago market here and we also keep inventory and days on the market data at the neighborhood level:

• Edgewater
• Hyde Park
• Lakeview
• Lincoln Park
• Lincoln Square
• Logan Square
• Loop
• Near North Side
• Near South Side
• Near West Side
• North Center
• Rogers Park
• South Shore
• Uptown
• West Town

Well, this last week Crain’s Chicago Business ran on article on the Downtown Dead Zone, highlighting the woes of condominium developers. Here are some of the highlights (or lowlights) of the article:

• In the first quarter of 2008 downtown developer condo sales were down 83% from the previous year to only 201 units. This gives new meaning to the word downtown.
• 2007 developer sales were down 54% from the peak in 2005.
• The glut of condos on the market is causing some development projects to be put on hold and other projects are converting to apartment buildings.

Crain’s also supplied this graphic that succinctly summarizes the situation. Judging from the dramatic growth of unsold condos under construction it would appear as though the developers hit the gas just as the market was running out of steam. Interestingly, based upon the fact that the unsold, completed condos have not historically grown from one year to the next, I would conclude that, in the past, most condos have been sold prior to completion. However, the question is whether or not this pattern will continue over the next year or two as these huge projects near completion. I would say there’s a good chance the developers won’t be so lucky since never before has the market needed to absorb so many units still under construction.

As buyer’s consider purchasing into these developments they have to be nervous. What would happen if the developer is left holding a large portion of the building? What if the developer starts to heavily discount the selling prices after the majority of the units have been sold at “list price”? And does the developer have the financial wherewithal to keep the association afloat with only a portion of the units contributing to the funds?

We may soon find out the answer to these questions.