Understand the Risks/Rewards of Investing in Gated Communities

This is a great time to buy, but do your homework first. Carrying costs and community rules can kill your investment.

Palm Coast, Florida – January 24, 2009 – When someone purchases a lot in a gated (or private) community as an investment, they assume far more risk than most realize. All real estate investors confront the realities of high transactions costs and asset illiquidity. But gated community properties purchased as investments carry additional risks and higher carrying costs as well.
Nearly two years ago, I wrote an article entitled "Investing in Gated Community Lots? – Understanding the Risks." At that time, GoToby.com was only a few months old and was yet to be discovered by many of you. Besides, the real estate market decline had yet to receive much attention. Recent events make the topic more relevant than ever.

Universal real estate investment issues

  • Lack of current market information – Unlike the stock market, real estate trade information is delayed by the time lag between the sales contract and the public disclosure at closing, typically 30 – 90 days.
  • Lack of liquidity – You cannot call your real estate agent and tell them to sell your property when the market opens in the morning.
  • High transaction costs – Rather than a few dollars per trade, real estate transactions carry relatively high commission rates, documentary stamps and other costs; inspection, survey, appraisal, loan origination, etc.
Of course  down payments for real estate purchases are less than margin requirement in the equities market, providing greater leverage – good if the market rises, disastrous if the market drops significantly.

Investments in private communities

Gated or private communities have unique issues affecting risk, centering mostly around deed restrictions, association expenses, and club membership.

Deed restrictions

Conditions, Codicils, and Restrictions (CCR) vary by community. They are filed as public records and attach to the deed. Some may require the property owner to commence construction within a specific time after closing. If the property doesn’t "flip," the owner is stuck with a fine. The build-out requirement transfers to the new owner, making the lot more difficult to sell. Other CCRs address architectural and landscaping requirements, which can significantly increase the cost of construction. Still others may dictate periodic lot maintenance, an additional expense.

Association expenses

Private communities have governing boards, usually designated as Property Owners Associations (POA) or Home Owners Associations (HOA). Some have an additional Community Development District (CDD). These bodies oversee CCR enforcement, common area maintenance, and shared services (i.e. security). Expenses are born by property owners. Assessments levied by the board are enforceable. Failure to pay an assessment can result in a lien or foreclosure filing.
Before a community is sold out, the developer typically controls the boards, sometimes subsidizing the association expenses. By doing this, association fees are kept artificially low to make the property more attractive to potential buyers. Once the developer turns over control to owners (as is required by law when most of the property is sold) the real expenses become known, potentially causing increasesed assessments.
Additionally, developers, while in control, may let service contract to firms with whom they have a vested interest. Property owners may end up paying a premium for the uncompetitive contracts.
In one local case, the POA while under developer control paid $20,000 per month for security. There are only five homes in the community, four of them builder models. The remaining lots are vacant. The luxurious clubhouse and beautiful golf course (owned by the developer) are the only real assets requiring such a high level of security. Once property owners gained control of the POA, the contract with the security firm was terminated.
Further, if a number of property owners refuse to pay POA fees, the remaining property owners become responsible for the deficit. Board choices are to reduce services and/or increase fees.

Club membership

This is the area that’s most likely to trip up investors. Most amenity rich communities have a club with various membership options beginning with social memberships (clubhouse privileges). Property owners can add additional privileges (tennis, golf) by upgrading their membership, thereby increasing their dues. Developers usually own and operate the clubs. A member deposit (usually several thousand dollars is required) and dues must be current to maintain the membership in good standing.
It sounds simple, but the devil is in the details. Here are a few examples from real life:
  • Typically, only a small membership deposit is required at closing. The balance of the deposit and the commencement of dues begin in the future, when the amenities are completed. Not a problem for the average investor who does not plan to own the property that long. But what happens if the property does not sell? Thousands who invested in the 2005 timeframe have learned the answer. They are obligated to pay the remaining deposit and begin paying dues.
  • The developer requires some level of membership, which is transferrable to a new buyer. However if the property owner relinquishes their membership, neither they nor any subsequent owner can get a membership in the future. The fear of having an "amenity orphaned" property with reduced value pressures owners to continue to pay, even though they may live elsewhere and are unable to use the membership themselves.
  • Investment homes and condos are usually rented through a property management firm. One developer has a policy that will not allow a renter access to member privileges unless the property owner used the developer’s in-house property management company – a form of extortion.
  • Most "refundable member deposits" are not easily refundable. Most developers place the member on a waiting list for a refund. Developers are not required to escrow deposits. If the developer fails financially, members become unsecured creditors.
  • Several communities have members who are not paying their club dues. The developers often reduce services to cover the revenue shortfall.

When things go wrong

One example of investments "gone bad" is exemplified by the Conservatory, a Ginn development in Palm Coast, Florida where 337 lots were sold in 2005 at prices ranging between $329,900 and $529,900. The developer fulfilled his promise to deliver a championship golf course and magnificent clubhouse. But most of the buyers turned out to be investors with no plans to build. They planned to flip their lots long before the above mentioned issues kicked in.
But the flips became flops when the real estate market tanked. All recent re-sales have been either lender-owned (via foreclosure) or short sales at prices well below $100,000. In addition to the acquisition cost, investors have incurred annual expenses for interest, taxes, association fees, and club dues totaling between $30K and $40K per year, raising their accumulated investment by that amount annually. These properties simply will not appreciate in the future at a rate sufficient to make these investors whole.
The long term prospects for the Conservatory are promising, provided the Ginn Company or a successor surmounts the cash flow burn rate of the luxurious amenities. As I was writing this article, I received an announcement (details tomorrow) from Bella Collina, another Ginn development near Orlando. Bella Collina is the "Conservatory on Steroids." The announcement opens Bella Collina Club membership to non-property owners (outsiders). Invitational Memberships will be recallable after four years. The goal is certainly to increase club usage and revenue. The Conservatory’s amenities, including access to the Hammock Beach club, offer an attractive lifestyle. But as I said in my article nearly two years ago, "the road to a successful development is sometimes paved with regretful investors."

Time to Buy

All that said, luxury communities can present great investment opportunities. Market timing is important. Those who buy at the top have a hard time realizing their investment goals, as do those who purchase in communities that are ill-concieved from the start. Now is an excellent time to be a buyer. Both property prices and building costs are low. There is quality product available and there are quality developers and builders. But don’t go shopping wearing "happy ears." Understand the association restrictions and fees. Read the membership offering – every word. Ask questions, and get the important answers in writing – in the contract.
4 replies
  1. Wil Hessert
    Wil Hessert says:

    Caveat Emptor

    Toby, great article. We live in a gated community and insisted on seeing the Covenants before we purchased. Read them cover to cover. As it turns out, we were one of the few residents who did. Even at that, many of the salesman’s ‘assurances’ proved to be false. For example, how many homes could be built on the golf course in the community, what the Community Development Fees would be capped at (there was and is no cap) and an ambiguous explanation of the Developer’s Bonds that were used to develop the infrastructure. None of these explanations ended up in our contract as we took them at face value. All proved to be erroneous. At the end of the day, Real Estate is usually one of the larger investments a person makes, and if ruled by emotion rather than fact finding and cold logic, the outcome can be problematic. A Classic example of Caveat Emptor, or buyer beware! Thanks for an excellent article.

  2. Brenda Donaghue
    Brenda Donaghue says:

    CommeThese afford not only wonderful amenitiesnt o

    I respect and appreciate everything you report, Toby, but I must disagree with you on this one. Yes, there are some developers who have sarted communities and, for lack of financing or some other reasons, have ceased to develop that community. However, there are still some wondeful, very affordable gated communities in our town, particularly Rivergate, Grand Landings and even where you personally reside, Grand Haven. These afford wonderful amenities, in some instances, lawn care and something sorely needed in Palm Coast—-security. Don’t make a few bad apples spol the basket for all the lovely gated communities. Real estate is challenging enough right now.

  3. Jane Gentile-Youd
    Jane Gentile-Youd says:

    We love our gated community

    You only talk about buying vacant lots for investment to flip but your article fails to mention all the perks and protection we get from LIVING in a gated community. Not only do we have 24 hour security at two gates, our common landscaping, street lighting, lakes, fountains, association buildings, sidewalks and roads are constantly being improved upon. For the $306 per quarter we pay we more than reap the rewards of every penny.
    Our CC&R’ protect our propety values and prevent such eye sores as commercial trucks, boats, sheds, crazy colors and unkempt homes.We would not trade our gated community for anything. We are always called to announce a visitor and strangers are not allowed into our comunity. Safety is the Number 1 issue here in Plantation Bay
    We would not trade it for the world.
    ANY invetment in land with the intention of only flipping has it risks – just look at the lots in Palm Coast which were selling in the $70,000+ two years ago – look where they are now.. So when you talk about risky investments it is vey unfair to limit your opinion to only ‘gated commuitys with CC& R restrictions.
    By the way the club here is private and there are no rec leases required.
    A happy 7 year resident in Plantation Bay

  4. Toby
    Toby says:

    Reply to Jane

    I live in Grand Haven, also a gated community. I share your reasons for liking where you live. We are so happy here that I tell people my next move will be in an urn. I know that residents of nearly every local community (at least those communities who actually have residents) feel the same. But my article was specifically addressed to those considering investing in property in a gated community, not living there. Yes, lots in Palm Coast also took a nosedive from peak prices, but the owners did not have to incur the additional carrying costs of association fees, club initiation fees, or club dues.

    Over the past several months, I’ve heard from so many readers that were simply not aware of the added requirements. My article is intended to educate those who might have followed in their footsteps.

    There are issues that come with owning and living in gated communities, however. For instance, condo and home owner associations can stray from their mission to represent all property owners. Refundable member deposits that are not really that refundable affect residents as well as investors. But I’ll leave that discussion for a future article.

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