A multi family to condos? NOT your typical conversion

[Sergey A. Petrov]

Here is an interesting one that I’ve toyed with over many years but never actually pursued. Any thoughts would be greatly appreciated.

generally speaking, individual units get a higher sale price than multi family on a per unit basis. So if you have a 4-plex at $1m each unit would be $250k. If I comp those four units individually (like for like with all things considered) they might be worth $300k.

I am very familiar with apartment to condo conversions and what all that entails. That is NOT my question.

Every once in a while you see these 4-8-12 unit complexes that were built and initially setup as condos but have been owned and operated (and bought and sold) as apartment complexes for years and years and years. So this would not be your typical conversion. They, legally, already are condos.

What am I missing? Buy for $1m, spend some money “re-establishing” the condo association and sell them off at $1.2m. I am a pro at condos and have the right team in place to get the legal, insurance, financial, etc matters in place fairly quickly and easily. The above $1m to $1.2m is hypothetical and I am capable of calculating the holding costs and the selling expenses. Every time I come across one of these and run the numbers they make sense and come ahead of any other short term play. 

There must be something I am not seeing…any words of wisdom? Has anyone done it? Thanks in advance!

[Greg Scott]

I'm sure you may be able to make some money if you can execute.

On the other hand, I've run across several apartments that started doing a condo conversion, selling off units, and then the market shifted and the seller couldn't sell the rest of the condos at a good price. We call these "fractured condos" and they tend to be dogs. Apartment buyers don't really want them because they now have to deal with an HOA. Condo buyers don't want them because they are at the mercy of the owner of the rest of the building. There is your downside risk.

[Sergey A. Petrov]

@Greg Scott thanks! Agreed fractured condos are no fun! And yes execution and ability to sell them will be key. Seattle market is softening but things still move. Suppose it is a risk benefit analysis since my crystal ball seems to have run of batteries 😁

[Chris Martin]

@Greg Scott identified a "fatal flaw" in re-establishing 'productive' condos. In general, on paper there is certainly the potential to create value in apartment to condo conversions. 

I will note that Fannie Mae underwriting changed since I explored this last. The reading in the Selling Guide under Full Review Eligibility Requirements now says this:

"For investment property transactions in established projects at least 50% of the total units in the project must be conveyed to principal residence or second home purchasers. This requirement does not apply if the subject mortgage is for a principal residence or second home."

I added the emphasis in the bolded sentence. The ability to finance Owner Occupant condos in >50% Non-Owner-Occupied complexes was a show stopper in the past. That bolded sentence that relaxes the financing. Perhaps a mortgage broker can chime in. 

[Chris Seveney]

Quote from @Sergey A. Petrov:

Here is an interesting one that I’ve toyed with over many years but never actually pursued. Any thoughts would be greatly appreciated.

generally speaking, individual units get a higher sale price than multi family on a per unit basis. So if you have a 4-plex at $1m each unit would be $250k. If I comp those four units individually (like for like with all things considered) they might be worth $300k.

I am very familiar with apartment to condo conversions and what all that entails. That is NOT my question.

Every once in a while you see these 4-8-12 unit complexes that were built and initially setup as condos but have been owned and operated (and bought and sold) as apartment complexes for years and years and years. So this would not be your typical conversion. They, legally, already are condos.

What am I missing? Buy for $1m, spend some money “re-establishing” the condo association and sell them off at $1.2m. I am a pro at condos and have the right team in place to get the legal, insurance, financial, etc matters in place fairly quickly and easily. The above $1m to $1.2m is hypothetical and I am capable of calculating the holding costs and the selling expenses. Every time I come across one of these and run the numbers they make sense and come ahead of any other short term play. 

There must be something I am not seeing…any words of wisdom? Has anyone done it? Thanks in advance!

you resolve one big issue if you have a team in place to do the legal docs, but also typically the developer is required to put significant funds in reserve and carry the HOA fees during selling the units. A transition study would be done once all the units are sold and they could also come back at you for repairs, or age of life issues or request you carry additional monies due to the age etc. I have built a lot of apartments that could be converted, but many are never converted as the areas they were built are also very condo friendly and developers do not want to deal with headaches of associations and lawsuits.

[Sergey A. Petrov]

Quote from @Chris Seveney:

you resolve one big issue if you have a team in place to do the legal docs, but also typically the developer is required to put significant funds in reserve and carry the HOA fees during selling the units. A transition study would be done once all the units are sold and they could also come back at you for repairs, or age of life issues or request you carry additional monies due to the age etc. I have built a lot of apartments that could be converted, but many are never converted as the areas they were built are also very condo friendly and developers do not want to deal with headaches of associations and lawsuits.

 @Chris Seveney thanks! Although I wouldn't be the developer, or the builder, or the declarant. There would be no developer to HOA transition, there would be no developer warranty, none of that. It is an existing association. Yes, I would do the budget, establish new bank accounts, enact assessments as per the existing governing docs, probably do a reserve study, make sure it is incorporated, catch up IRS tax returns, get new insurance. I would be doing all this as a member of that association (having elected myself to the board until a few units sell and new board members are added). I may or may not prefund the reserves - lots and lots of condos with severely underfunded reserves or even non existent reserves in smaller associations where owners just prefer to pay out of pocket when the roof needs to be replaced (they essentially levy a special assessment onto themselves). Since my only role in all of this would be as a member of the association and its elected board of directors (again not a developer, declarant, etc) I would be covered by that association D&O policy (which I’ll purchase on day 1) and my liability will be limited by those same existing governing documents which limit board members’ personal liability…I’ve played this out in my head so many times (and consulted developers from before ground breaking through transition and consulted HOAs on the other side and took them through litigation against developers ) . Maybe it is time to actually look for one and do it. Nobody blew any serious holes in my thinking yet :)

[Julien Jeannot]

I can't see a big enough market for condos in an HOA of 4.

Too much risk if 1 unit does not pay their dues or missed an assessment, not to mention getting along in order to vote on anything.