Multifamily to Condo conversion - Create value?

Question

Hi all,

I want to know if converting a multifamily complex (over 30+) units to condos would create value versus the midwest cap rate for multifamily. Condos aren't really too popular here assume you can  convert them to condos rather easily with little to no cost involved.

Since home prices are so cheap/depressed in some markets in the midwest, I am not sure if people would buy condos vs buying a cheap home - especially if a condo could cost more. Think about an A property in a C- minus area.

Has anyone done this with many units and can talk about their experience?

Brian Burke · Answer

This is like being in the pizza business.  Buy the pie, sell the slices.  But there is more to a condo conversion that rolling a pizza cutter over the top to divide it up.

It could create value, but it's not an exercise to enter into lightly.  At first brush, take a look at the dollars per unit for multifamily sales for that vintage of property, and compare that to condo sales of similar vintage and see if there's a delta.  If there's not, stop right there.

So for sake of discussion let's say the property was built in 1980 and multifamily of that vintage trades in the $60,000 to $80,000 per unit range.  If condos are selling for similar prices, the conversion adds no value.  But if they are selling much higher, then it might.  If there are no condo sales to use as comps, that's telling you something--there's no market for condos.

Let's assume that condos are selling for $125,000 per unit for that vintage.  Now there is a nice delta.  But you can't stop there.  You need to examine the regulatory framework for the conversion.  In some jurisdictions you might have to do significant upgrades to the property to bring them up to condo specs.  And these tend to not be cheap things.  Things like upgrading wiring and plumbing, or adding firewalls in attics, fire sprinklers, alarms, soundproofing, wind/earthquake hold-downs, extra parking spaces...who knows...but you need to find out in advance and budget for those.

Then there is the legal cost.  Forming an HOA, getting CC&Rs and by-laws drawn up, a reserve study, and funding the reserve account can add up to a big number.  Then there is the WRAP insurance.  As a developer you'll want to insure against future homeowner lawsuits for construction defects (HOAs are famous for litigating this type of stuff) and this insurance is costly.

Finally, there is the entitlement risk.  What if the governing body responsible for approving your project says no?  I'm not talking about staff...you could walk into the planning department and get all smiles and thumbs-up.  It's not until after you've spent dollars on architects and lawyers that you get to the commission vote.  If they turn it down all that money is gone.

So if after studying all of those requirements and adding up all of the costs, there is still a delta in pricing wide enough to give you a healthy profit margin (risk-adjusted, of course, because there is a lot of risk here) then you have a winner.

Now the elephant in the room...your example was an A property in a C- area.  Would you buy a condo there???

Alex Franks · Answer

Sorry been away from the site for a bit.  Sant Li really depends on the market, then of course numbers and timing. We did two large projects like this. The first was 102 unit shell. Which worked out great. Timing and location, along with the back end rental side helped up. Flip side we took 136 unit tried the same process. It was a complete failure and lost funds. Which I sold out my share and moved on. So there is no right and wrong answer. Now keep in mind that was 2013 /2014 time frame. We have a much different market now. I feel most if not all apartment deals are overpriced. I was recently sent another project here in Charlotte NC. My hometown same thing. Like most deals overpriced. So the investors brought up the condo conversion. Yet so much to even consider before jumping in. First will the city or area you are trying to do this. Even allowing for the conversions. Second numbers, third time frame and so many other variables I can throw into the mix. Side note we did invest in 96 unit in Kentucky but not a conversion. This was a lower income apartment project. Feel free to reach out if I can help in any way

Account Closed · Answer

I am considering doing so since it would be of little/no cost to me and I can basically sell only a few units if I want to raise cash for an investment instead of taking out a loan. If I sold the complex as a whole do you think an investor would pay more just because they would be able to cash out piece by piece as needed?