Can A Condo’s Value Ever Drop To Zero?

I always like to compare the real estate market to the stock market, in many different contexts.

We look at the amount of “shares” traded in real estate, the frequency, the acquisition/disposition costs, the “dividends” for investment properties, and of course – appreciation!

But whereas a stock can drop in price all the way to zero, a piece of real estate, it seems, can not.

Let’s take a look at the problems at 40 Panorama Court in Etobicoke, and ask the question that is today’s blog post, one more time…

40PanoramaCourt

I don’t want to be accused of adding fuel to the fire here, but I do want to bring this topic up before it passes us by.

The woes at 40 Panorama Court were reported on about a month ago, as stories appeared in The Huffington Post and CBC.ca, among other outlets.  It’s a very interesting, and exceptionally unique case, and it warrants discussion.

As the story goes, the owners at 40 Panorama Court are seeing their maintenance fees increase by an unfathomable 66.67%, with $1,200 fees going to $2,000.

The building has apparently had $8,000,000 in repairs over the last decade, but still needs another $600,000, and potentially more.

The story made headlines, and as with many headlines, it did so for both the right reasons, and the wrong reasons.

When I see a story like this, as a real estate agent, a condo-owner and investor, and a person with common sense, I ignore the “We need justice” quotes, and look to find out what’s really going on in the building.

I understand that residents are frustrated, and I would be too.

I understand that many people in the building won’t be able to afford the increase in maintenance fees, and I sympathize.

But if a condominium is an “investment,” and condo fees are a variable expense that comes with the investment, then perhaps “needing justice” isn’t the right turn of phrase.

Of course, if we’re going to compare real estate to the stock market, then we should consider every accounting scandal (Enron, Worldcom, Nortel) or fraud (remember Bre-Ex?) that had a major impact on share price.

It can happen, both in the stock market, and the real estate market.

But many of the owners were quick to cry foul and make accusations about “kickbacks” and “embezzlement,” and after a cursory review of what’s going on in the building, and back in 2011 (previous media coverage), it looks to me like this building is just falling apart.

It’s awful, but it’s not necessarily anybody’s “fault.”

If a stock can go from $100 per share to $0 per share, based on intrinsic value, and where the company is heading, then can the same happen to a condominium?

It was four-and-a-half years ago that the Toronto Star published THIS article about 40 Panorama Court, and detailed the major financial problems in the building.

The 2011 article explained that previous condo boards in the building had neglected repairs, and tried to keep condo fees low, making problems worse, and eventually necessitating a court-appointed administrator to deal with the condominium’s finances.

I’m sure it’s a matter of opinion as to whether previous condo boards were “neglectful,” but think about the ugly hallways of your condo, and how the board doesn’t want to spend money to modernize them.  That’s more of a discretionary expenditure, but one that you can relate to.  So what if your parking garage was crumbling, and every day, another piece of concrete fell from the ceiling?  Would you want the board to fix that?

In any event, I’m amazed by the fact that, despite that media coverage, and despite the awful, miserable shape the condominium was in, FORTY-TWO condos have sold in that 200-unit building since May of 2011 when that article came out.

Forty-two people looked at this building, literally crumbling and falling apart, with massive budget shortfalls and major repairs still scheduled, special assessments being handed out like candy on Halloween, and said, “I think I’m going to buy in that building.”

So if you purchased some penny-stocks, and they became worthless, who is to blame?  The company, for going bankrupt?  Or you, for buying penny-stocks?

The owners in this building are upset, and “demanding answers,” but is it fair to say that many of them didn’t do their homework?

Is this a case of “you get what you pay for?”

Consider the case of one particular unit, that was sold in 2003 for $146,000.

This unit was re-sold in 2012 for $43,000.

That’s an awful loss, right?

I mean, had you bought just about any house or condo in the city of Toronto in 2003, it would have likely appreciated 50% at a minimum, and some properties might have doubled in value.

But the person who purchased in 2012, after the reports about the major problems in the building, must have thought this was a steal!

I bought shares of Nortel in 2001 for $50, after they had dropped from a high of $124.50.

And I rode them down to about $2…..

Should I have looked deeper into Nortel?  Should I have done a forensic analysis of their financial statements?  Was I qualified to do so?

Here’s where I want to draw a comparison to real estate once more.

I’m not going to suggest that I, or anybody else, had any clue what was going to happen to Nortel’s share price in 2001.  Maybe some insiders, and maybe some really intelligent and gifted traders, but for the most part, nobody had a clue.

But in the case of 40 Panorama Court, a very simple look at the Status Certificate would have revealed millions of dollars in recent repairs, and millions of dollars of repairs outstanding.

The massive hike in maintenance fees, and multiple special assessments, should have also set off alarm bells.

Is this different from, say, a company cutting its dividend payout by 5% in the 3rd quarter?

Am I being biased here because I’m in real estate, and I know what a “Status Certificate” is?  Or is a physically-crumbling building just a lot easier to spot than three future years of shrinking sales at a Fortune-500 company?

There’s only so far we can take this real-estate-versus-stock-market comparison, and we’re all going to have our own biases.

But I’m just absolutely floored that forty-two people have purchased at 40 Panorama Court since the problems in the building surfaced in 2011, and to be honest, the increase in maintenance fees are something they maybe, sorta, possibly, oughta seen coming.

I feel terrible for the residents.  How can you not?

But people make bad investments all the time, and they don’t always sign a petition to ask the Province to intervene.

If you can stomach a 15-second commercial, watch the CTV news story:

So let me go back to the beginning here, folks.

I’ll ask again: can a condo’s value ever drop to zero?

I don’t know if it’s ever happened before, but this is a good example of how it could potentially happen.

There are 200 units in this building, and let’s say each one is worth $50,000.

That’s $10,000,000 right there.

But what if this building needed $9,000,000 in repairs, and it was going to cost $1,000,000 to run for the next year?

Wouldn’t everybody’s unit, theoretically, be worth zero?

If residents are going to pay $2,000 per month in maintenance fees, how long will it take for them to spend more than their condos are worth?

Ignoring mortgage interest, property taxes, and utilities, just consider that if residents are paying $2,000 in fees, that go toward repairs and operating expenses, and if the units are going down in value, wouldn’t it almost be smarter to just walk away?

It’s a really sad situation, and I can’t help but feel that many of the people who bought into this building were chasing the only chance at home ownership they’d ever have.  I also think they might have been among the most uninformed buyers, and I can’t for the life of me imagine what kind of real estate agent would put a buyer into this situation.

But if the mold in the building spreads, and if the underground parking garage continues to sink, or the concrete continues to crumble, there may come a time when a condominium just might not be worth repairing.

26 Comments

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  1. Trevor says:

    This is so scary to read. You think you are getting a decent deal for an older building just to be able to escape the crazy outbidding wars going on in Downtown and then reality kicks in. But many of the older rental units seldom have major issues if they are well managed, especially in Etobicoke. Then again, those shiny downtown condos are also built with the lowest common denominator of quality behind the scenes (plumbing, HVAC, elevators, etc) and in 15-20 years will have similar issues. CBC did a segment called “throw-away condos”. I’m currently renting in an older building that I feel is fairly well maintained (although the age is really showing where things are falling apart), but overall happy with it. Finally saved up enough to entertain the idea of buying into a market that keeps hiking 22% a year, well-knowing those almost new buildings have tons of problems already from day 1. And once you get it, even if you budget properly, can’t predict things like this. Maybe renting is smarter option until you can afford a townhouse somewhere.

  2. H Marshall says:

    It would be informative David if you posted recent sales activity at 40 Panorama. I think prices have moved up since you wrote this article a year ago.

  3. Sean says:

    Very useful information and comparison. Prices on rundown condos in current housing market is so appealing that one could jump to buy a unit to rent. The reality will kick in when the rent money can not cover the maintenance fee and you cannot sell the unit. The scenario will get even worse when you decide to move in to your unit and you cannot live there because the entire building is infested with bedbug and roaches. Nightmare that I have about a unit I have in Toronto.

  4. Free Country says:

    Thanks for this David. Happily, I have never purchase a condo, for precisely this reason. (Yes, houses have expenses too, sometimes unpredictable, but that is what insurance is for…)
    My question: In your hypothetical example of the condo that is worth zero because of the crumbling building and maintenance / repair costs, you ask “wouldn’t it almost be smarter to just walk away?”. I am not a condo expert, but can you actually, legally, walk away from your obligation to pay condo fees? I would doubt that – otherwise, all the foreign investors who buy condos as investments and leave them empty would just remain incommunicado and refuse to pay fees, putting added burden on the responsible condo owners. I would have thought that, if you are a condo owner and you just want to “walk away”, unfortunately the condo corporation can — and indeed would have a duty to — pursue you legally to recover any unpaid fees. (It would also place a lien on your condo property for any unpaid fees, making it impossible to sell if the value were ever to recover.)

  5. Sabrina says:

    When I look at these situations, I always think about the time I spent looking at real estate in France. I know we’re not Paris (and, these days, that might be a good thing), but even outside Paris, lots and lots of people buy old, dilapidated properties—properties that should be torn down, except that they’re marketed as having “historical charm”—and either do incredible work on them or run out of money in the process. If they succeed, the properties do rise in value and the reason for that is that there is a market of expats who want to live out their dream and they are willing to pay to do that.

    It seems to me that if 40 Panorama Court can be rehabilitated, the people who bought those 42 units may be onto something. Of course, in large buildings, which Paris does not have (but Nice does), you are at the mercy of a large number of fools. But if the building can be salvaged, the story could change in five years. As long as there are people who want to live in Toronto and environs, there is a chance for every piece of property. The job is to make this city and the whole of the GTHA less dysfunctional so that buying anything here seems like a good investment.

  6. Paully says:

    Where is Appraiser on this topic? Appraiser should normally be here explaining to all the lowly renters how a condo falling from $146000 to $43000 is a good thing, since real estate can only ever go up.

    1. Geoff says:

      It’s worth noting that David pointed out how this has to be the only example in the entire city of a condo dropping so dramatically in value. Just as in general stocks have returned excellent results in the past few years (especially US) there’s going to be a few dogs.

    2. Appraiser says:

      Hey Paully. As a professional, I was trained never to focus on outliers in determining market values.

      On a side note, TREB announces a record month for September for both average price (y/y) and number of transactions. Probably a better overall barometer of the market, wouldn’t you agree?

      http://www.torontorealestateboard.com/market_news/release_market_updates/news2015/nr_market_watch_0915.htm

  7. WEB says:

    You didn’t need to be a forensic accountant to figure out Nortel, or even a good investor. All you needed to do is simply look at the most basic aspects of its historical income statements. If you bothered to do about 34 seconds worth of work, you would have discovered that in the previous ten years prior to Nortel’s peak market value, the company cumulatively had earned nothing. Investing in a public company or a private company for that matter without taking a look at the most basic aspects of an income statement is akin to buying a house and not knowing where it is located, how big the lot is, how big the house is, how old it is and how much it could rent for.

  8. condodweller says:

    First of all a comment on these types of buildings. During the last 30 years many old rental buildings have been converted to condos and sold to unsuspecting buyers who thought they were getting a great deal due to the lower than market prices but did not realize the amount of repairs were going to be needed for which they’d end up holding the bag. Many buildings were sold like this during the height of the market back in the late 80’s before mandatory reserve fund studies were part of the condo act.

    I like your comparison of these buildings to penny stocks as they are inherently very high risk IMHO. On the subject of real estate agents being biased I think most are as I have yet to hear a real estate agent recommend investing the equity markets instead of buying property. I spoke with a real estate agent recently and his reasoning for investing only in real estate was that as the name implies, it’s real, meaning you can never lose your investment. Well how real is this building? I know someone who lives in a similar building with over $1000 maintenance fees and there are many in the same boat.

    OTOH real estate agents frequently accuse financial advisors of being biased for recommending investments to their clients vs. real estate. The big difference is that I never heard a financial advisor say that you should not invest in real estate.

    I approach this from the risk management point of view. I think most people accept by now that asset allocation of any investment is important to protect against downside risk. It shouldn’t be a stretch to apply the same principle to real estate investments. Let’s ignore penny stocks as any investment in them is pure gambling and no respectable advisor would put more than 5% of your money in penny stocks if any at all. Yes some blue chip stocks have gone to zero however with any asset allocation you would have been protected and only lost a maximum 10% of your portfolio in theory. I say in theory because the most concentrated professionally managed portfolio will have about 10 stock in it, and a professional portfolio manager will not allow a stock to to to 0 in his/her portfolio. A more realistic portfolio will have 50-250 stocks in it which means your downside risk due to a single stock going to 0 is less than 1%. Keep in mind that most people do not leverage with their investments meaning their risk is linear.

    Now consider your investment in real estate. If you only invest in your home, you are likely leveraged 5-20 times and concentrated in a single investment and a single asset class where if it goes to 0 you have lost 5-20 times your investment. Even if you have 10 properties, although you have a bit of geographical diversification (assuming you didn’t buy 10 units in one condo building because I do know of people who have bought 4 units in the same building) you are still 100% invested in a single asset class meaning when the real estate market drops say 25% you have lost 25% of your portfolio, or 5-20 times that. If you are in a house, all your money is exposed to all kinds of risks, some more likely than others but risks none the less like flooding, fire, tornado, sewage backup which I guess is a form of flooding etc. Just so you know someone in the GTA has been affected by all of these risks in recent years. Sewage backup repeatedly flooding homes has been one of the best kept secrets in Toronto real estate. 200-300k restoration costs can quickly wipe out your wonderful appreciation value.

    In conclusion I suggest that investing in real estate today, even with a very small chance of it going to zero is overall, much higher risk than investing in a well diversified professionally managed portfolio.

    David, I would encourage you to listen to the 15 seconds of advertisement in the video you posted and then you will find out why there have been around 40 sales in the building recently.

    Happy thanks giving everyone!

    1. @ Condodweller

      Awesome insight – this is much appreciated!

      Happy Thanksgiving to you too!

    2. Noel says:

      While you are sound byte that ‘investing in real estate today, even with a very small chance of it going to zero is overall, much higher risk than investing in a well diversified professionally managed portfolio’ appears correct on face when you look at the actual data you are way off base and I can’t believe that David agreed with you. It looks like neither of you have actually looked at the data to see how wrong you are.

      The last plunge in real estate prices in Toronto (1990-1996) was a 25%+ plunge in 6 years for single-family homes (TREB data). The last plunge in the market (Oct 2007 – Mar 2009) was almost 50% in less than 18 months (S&P500 & S&P/TSX data) and that was all stocks, even a ‘well diversified professionally managed portfolio’. In fact, you are also wrong referring to a ‘professionally managed’ portfolio.

      I just ran the numbers on the last 20 year returns on so called ‘professionally managed’ portfolios (ie mutual funds) and it turns out that less than 5% of all mutual funds in Canada beat a simple broad-based index fund over the last 20 years and that’s with survivorship bias, ie that is the % of funds that are still around 20 years later as many were closed, merged or somehow changed. So the number is likely closer to 1-2%. On top of that, the funds that beat the index are, for the most part, esoteric and very focused funds that you would never put all your money in anyway, as that would be too risky, whereas you would in an index fund. With Index funds you have a 98%+ chance of beating ‘professionally managed’ funds at 1/10th the management expense ratio.

      Also, if the real estate you are investing in, which for most people is their home, they have a place to live while they are waiting for the market to recover. You cannot live in a portfolio. As such, not only does a portfolio not provide you with a place to live but the risk level is much higher. Real estate, especially single family homes, will ALWAYS eventually be worth more as they are not making any more land. A stock portfolio theoretically will not but you can limit your risk by buying a low cost broad-based index fund.

      So. your ‘insight’, not so ‘awesome’ as David Fleming thinks.

      1. Appraiser says:

        @ Noel. I think you will find that the affliction most bears suffer from is extreme sophistry.

        1. condodweller says:

          @Appraiser: I think it’s time for you to get a new line as name-calling doesn’t add to the conversation. Noel at least did some research and took the time to formulate a counter-argument.

      2. condodweller says:

        Perhaps David called it awesome insight, which doesn’t necessarily mean he agrees with me BTW, because he knows that the 90-96 plunge was actually 50% if you count the 25% crash in 89, and the long-term average return on real estate is about the same as inflation. You are cherry picking data selectively and leave out relevant data to support your argument. Ironically, if you look at the full picture you are supporting my argument. First of all, I fail to see your logic on how your investment going down for 6 years is better than it going down in 18 months. I’d prefer mine to only go down for 18 months. Second, if you consider the recovery time, which for real estate was about 23 years vs. 5 years for stock indices, again I’d prefer the 5 years, especially if you consider that if you had a basket of good quality stocks, something a reasonable money manager might pick for you, the recovery time was only a year.

        Mutual funds weren’t what I had in mind, but again your case would be stronger if you used them for your comparison as broad index funds may outperform them making your case weaker. Equity portfolios have long-term average returns of about 8% which is much higher than inflation.

        This article has an interesting perspective on real estate vs. equity investing without taking a bull/bear position.

        http://news.nationalpost.com/full-comment/bruce-yaccato-youd-have-to-be-crazy-to-buy-real-estate

        I particularly liked this quote:

        “If median-income people borrowed hundreds of thousands of dollars to speculate on the price 30 years hence of a single, highly illiquid asset that wasn’t a house, they would be called financially insane.”

        This quote addresses your point about the value of living in your home more eloquently than I could:

        “Shiller does concede there are “implicit dividends” to ownership that can’t be measured. “There is no way to put a dollar figure on the psychic benefit one gets by owning and living in one’s own home.” But then, he argues, it becomes not an investment or even a good place to park your dough, but the consumption of a luxury good, which should be left to those who can afford it.”

        Regarding your point about having a place to live while you wait for the price to recover remember that you will be waiting 25 years. What if you were a 60 year old counting on the equity in your home to retire on?

        Your final statement, I’m sorry to say is totally false: “Real estate, especially single family homes, will ALWAYS eventually be worth more as they are not making any more land. A stock portfolio theoretically will not but you can limit your risk by buying a low cost broad-based index fund.”

        If you bought a house in 88 was it worth more in 90? In 91? In 95? …… in 2010? If you bought a house today and the market corrected next year by 25% and it takes another 25 years to recover will it be worth more in 2017? In 2018? In 2020? in 2025? in 20130? Not to mention if you take a hit on any of the calamities I listed in my original comment. I wonder what will happen if sewer flood damage ever has to be disclosed on a sale (David, I’d love to see an article on this). A low-cost broad-based index fund, however, will ALWAYS be higher 5 years later as markets generally recover after a major crash in a few years.

        Note that I’m not particularly bearish on real estate as I do own my home and have other real estate investments. However, that may be subject to change if prices keep going up at this rate.

        1. Libertarian says:

          Condodweller, I agree with all of your comments that you’ve written in this post. I, too, own my home, but like to have a diverse portfolio of differing assets as a way of decreasing risk.

          But I’m guessing that people will challenge your comment, “A low-cost broad-based index fund, however, will ALWAYS be higher 5 years later as markets generally recover after a major crash in a few years.”

          None of us can predict the future, which is why we diversify our assets. So to say that the index will ALWAYS be higher 5 years after a crash is too extreme of a prediction. Yes, that’s been the case throughout most of history, but we can’t take it for granted going forward. Just as we can’t take for granted that every piece of real estate will be worth more in the future.

          1. condodweller says:

            @Libertarian. You are right it’s never guaranteed but highly likely. I reused Noel’s exact words for dramatic effect. For the trend to change, the fundamental way in which public businesses work and are valued has to change or our political system as we know it has to change in which case we are going to be too busy worrying about the tanks rolling in our streets and bombs falling on our heads to be concerned about our property values. How’s that for dramatic effect? I never thought of myself as much of a writer, but I must say I enjoy writing these. It probably explains the increasing length of my comments 🙂

  9. James says:

    The $2,000 fees were for only four months to pay to remove mould. Joe Vero, the administartor is now gone and the board of directors have assumed full control.

    It is most likely that the board will cut the fees as much as they can. Maintenance and repairs will be cut to the bone. That will give the owners immediate financial relief.

    The danger is that the long-term loans will need to be paid so there will be no or little money put into Reserves. In a few years, or sooner, the building will start to detoriate again.

    You miss one important factor here. Many of those sales you wonder about may have been to slumlords who rent out individual rooms and overcrowd the building. If the units can be bought cheap and you can rent each room out, there can be good money made in rundown condo buildings.

  10. Noel says:

    You are using faulty logic. Each unit is not worth theoretically zero because the $9M in repairs the building requires would likely cause each unit to be worth market value which we can reasonably estimate to be an average of somewhere between the $50K and $195K (ie $10M + $19M repairs divided by 200), but likely closer to the $195K as a unit sold in 12 years ago for $146K.

    Another way of looking at it is that if they are theoretically worth zero that people should be theoretically be willing to give them to you for zero. That means all you have to spend is $9M/200 = $45K to get $146K+ of value from a unit. That won’t happen.

  11. Steve says:

    The trouble with condos is that you have very limited control of the property … and you don’t own the dirt either. Condos are apartments and great for rentals.

    1. Noel says:

      Yes you do have an undivided interest in the dirt, ie the land underneath the condo.

  12. m says:

    I would think it in the owners best interest to have a large special assessment, on the order of $50k per unit (i.e. $9m repairs / 200 units). That way, they can do the repairs, stop the hemorrhaging, and get an excellent return on investment.

    Using your sample numbers above, it seems reasonable to assume that an owner with a condo worth $50k today would see their value increase to at least $150k if they invested $50k in repairs. How many other investments offer the opportunity to double your money?

    It may still look bad compared to the initial purchase price they paid. But their choices now are limited to:
    1) Sell now, lock in the market value loss, and find another (likely much more expensive) place to live.
    2) Pay an extra $1k/month, wait years for the market value to recover, and live in a semi-permanent state of construction.
    3) Pay $50k now, and reap the benefit of immediate repairs and $100k increase in market value.

    I’d definitely be going for option #3.

    1. Izzy Bedibida says:

      Point 3 makes the most sense in both the sort and long term. Unfortunately, the residents of that building more than likely will not be able to afford/absorb that kind of increase.

      1. Anchy says:

        Exermetly helpful article, please write more.

  13. Buckley B. Buckington says:

    A good example of condos going to zero would be the Penhorwood Condos in Fort McMurray. In that case there would have been no possible way for any of the buyers to have discerned the problem beforehand.

  14. myeo says:

    Land value minus demolition cost is likely the cheapest solution.

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