Q: We’re interested in purchasing a condo as investment property. It’s a condo hotel property and our lender told us that we could not purchase the unit as a second residence, and so we cannot get a 30-year fixed rate loan at today’s low interest rates.
The condo hotel has an excellent financial track record and rental history. We love the complex and location.
But the best loan terms we can find is for an adjustable rate mortgage (ARM). The loan is a 7/1 ARM at 6.5 percent with a 25 to 30 percent cash down payment.
We’ve always been afraid of ARMs but if worse comes to worse, we could pay off the total amount of the loan in 7 years with borrowing from our 401(k) or doing a 1031 exchange at that time. Any thoughts on this loan or investment property plan?
A: The first thing that comes to mind is to wonder why you’re buying a condo hotel.
Condo hotels became extremely popular as the frenzy over traditional timeshares faded. The hook is that you’re buying a specific unit, which the hotel will rent out for you when you’re not there and share the income after expenses. It’s a recipe that might be fraught with problems. Some real estate investors consider condo hotels to be a good deal for the initial developer and the condo hotel manager, but probably not a good investment for the individual condo hotel unit owner.
Hotel occupancy is down dramatically and in some areas of the country there is even a glut of rooms. What if the hotel isn’t rented out quite to the level that was promoted during your sales pitch? And, what’s your exit strategy? Is there going to be a long line of people just waiting to pick up your unit from you when you’re tired of paying maintenance fees?
You say that you would do a 1031 exchange in order to sell the condo hotel and use the exchange to buy another investment property. But what if you can’t sell your condo hotel at that time?
If you play around with the numbers, it might be less expensive to simply rent a hotel room in the nicest hotel in town rather than buy and finance a condo hotel investment. I’ve run the numbers on a few of these deals and once you factor in the fees, maid service, repairs and upgrades, the only one that does well is the developer.
Have you run numbers to determine what your breakeven will be and how many days you must rent out the hotel condo to come out ahead? Also, don’t forget to budget for improvements that may be required by the manager to your hotel condo in the future.
But back to your question. Do I think you’re getting a good financing deal? I don’t know. It sounds reasonable for what you’re getting. I like the fact that you can pay off this purchase in 7 years. I don’t like that you’d need to use cash from your 401(k) to do it.
As far as financing goes, it’s tough to finance investment properties at the moment, and you might pay somewhere around 6.5 percent on a 30-year fixed rate loan if the property could qualify. The fact that you have a 7/1 ARM means you’re safe for the next 7 years – and hopefully you’ll have figured out what you’re going to do with this property – and if it’s a moneymaker – by then.