Last month we took a look at the different segments of our market for resort condos and my research indicated that sales have been strong in recent months but uneven. Large condos and condos eligible for conventional financing have been selling better than smaller condos and condotels. One of the potential reasons for this discrepancy is the unusually large gap in interest rates between conventional financing and condotel financing.
Before getting into the data I collected on this, here’s a short course in the differences in “condos” (eligible for conventional financing) and “condotels” (must use specialized condotel financing).
Condotel: These buildings typically have one or more “Hotel” type characteristics such as an onsite rental office, onsite commercial space(s) such as restaurants, day spas, convenience stores, numerous onsite amenities such as pools, lazy rivers, whirlpools, indoor water parks, exercise rooms, etc, high-level guest services such as 24-hour check-in, golf packages, show packages, daily maid service, concierge, valet parking, etc. Condo buildings often have some of the same types of amenities but generally not the services.
Conventional Financing: This type of loan is the one most familiar to many people but it is actually different from any other type of loan. An explanation for how and why “conventional” financing” came into being requires a short history lesson. Before the 1920’s, homeownership was only for the rich (around 5% of the US population). Since banks were very limited in how much they could lend as well as the amount of risk they were willing to accept, loans were short term - five years or less. The monthly payment amounts were prohibitively expensive for most people. To make home ownership affordable, quasi-governmental entities now known as Freddie Mac and Fannie Mae were set up to oversee a secondary loan market. Banks were now able to package and sell their loans, collect a profit and then write more loans. This enabled lenders to offer 30 year mortgages - making home ownership far more affordable. The program has been very successful and now aout 65% of Americans own their own homes.
Why don’t condotels qualify for conventional loans? The conventional secondary loan market was always intended for residential properties only - primary residences and second homes - and there are guidelines in Fannie Mae and Freddie Mac to determine which properties qualify. If a property doesn’t qualify, the lender cannot sell the loan to one of these entities. Lenders can still make money on loans they can’t sell (such as commercial loans). However, since they tie up assets for potentially long time periods, the returns (interest rates) generally must be higher to justify the risks.
Is there anything wrong with condotels? No, just as there is nothing wrong with restaurants, hotels, office buildings or any other properties that could typically be described as “commercial” in nature rather than residential and also don’t qualify for conventional financing. As previously stated, many of their characteristics actually may make them more desirable to some second home owners than condos or detached houses.
Interest rates for condotels vs. condos (see below for current comparison): Condotel rates are always higher than rates for condos and sometimes a larger down payment is required. Also, 30-year fixed rate financing is typically not available for condotels. The primary reason for the difference in interest rates is that, since condotel loans are typically not sold, any profit the lender makes is based on the “spread” between the interest rate charged to the borrower and the interest rate available to the lender during the entire life of the loan. Therefore, to protect their investments, lenders want the rates either to be able to adjust as prevailing interest rates change or they want shorter loan terms - usually 15 years or less.
Q. Why would I buy in a property that does not have conventional financing when others are available on the Grand Strand that are eligible for conventional financing?
A. First, the very features that make condotels ineligible are attractive to many buyers (and renters). Onsite restaurants, extensive amenities, convenient on site hotel-type front desks, daily maid service, room service, etc.
Second, rental incomes are often higher than with other properties, again due to these very features that create the financing difficulties.
Third, the financing situation is already built into the price because the pool of buyers for these is smaller. For this reason, condotels can often be bought for significantly less than comparable condos in developments that don’t have these commercial-type features. I’ll cover this in greater detail below.
In summary, a prospective buyer should weigh the benefits (price, amenities, rental income, etc.) against the drawbacks (less favorable financing terms) when choosing between a condo and a condotel.
OK, now that you have a basic understanding as to why the interest rates differ from condos to condotels, let’s take a look at the reason the current exceptionally low conventional interest rates are resulting in conventionally financed condos selling better than condotels over the past 18 months.