Condo Deconversion: The Good, The Bad, and the Reality

Condo Deconversion: The Good, The Bad, and the Reality

There’s a lot of turmoil in the housing industry today, and it’s hitting community associations hard. New restrictions from Fannie and Freddie are dark clouds full of special assessments looming on the horizon, and the housing bubble is growing rapidly with no real signs of stopping, inviting investors and tempting homeowners to sell. Because of all of this, a lot of condominium associations are considering a tactic called “condo deconversion.”

A condo deconversion is basically a bulk sale and process by which all units in a condominium building are sold in one transaction to a real estate investor, who will then turn the property into rental apartments. (Its counterpart is “conversion” which is when an apartment community is converted into a condominium or co-operative and sold off. Even though the terms are connected, there’s no requirement that a condo building was previously converted in order to be deconverted.)

Deconversion might sound like an extreme option, but it’s quickly becoming a sought-after fix for communities struggling with expensive deferred maintenance issues.

Why Condo Deconversion Is Gaining Popularity

There are a lot of reasons why this trend is taking off. Those FNMA and FHLMC restrictions, for example, are about to start causing some serious problems for condo boards. Requiring that the condo buildings meet a specific level of health by withholding approval for any future purchase loans for units in the community is stressful for everyone involved, and can often only be

Buildings get old and need repairs.

Building repairs are time-consuming and costly, and only get more expensive as buildings start hitting 30 and 40 years old. Communities with underfunded reserves will likely be subjected to overwhelming special assessments to catch up on the deferred capital improvements and maintenance over the years. The current real estate market means that deconverting could offer an alternative where unit owners get out with a profit rather than pouring money into special assessment costs.

New special inspections being ordered by local municipalities, state statutes, or federal restrictions.

The condominium lobby and real estate lobby will go kicking and screaming, fighting new inspection and reserve laws. Yet eventually condominiums are going to be forced to do the right thing and keep up with maintenance, capital improvements, reserve studies, and funding. It’s the right way to govern a condominium, but very infrequently is the right way the cheap way. These new inspections will be costly and time-consuming, and will likely expose more problems that only money can solve, exposing an underfunded community for the money-pit that it has slowly become. Selling in bulk to an investor pushes that responsibility onto someone else while pocketing a bit of profit.

There aren’t enough rental properties.

Condominiums have been popular in the last 20 years but there is a tremendous supply gap in rental properties, and this is a way for real estate investors and developers to acquire properties without having to build them. With the cost of construction, it makes more sense to take an old building, even an old building with long-deferred maintenances and problems, rather than invest in wholly new construction. It saves time and allows for a far quicker return on investment. It’s a sound move to buy them out and rehab the structure.

The price of real estate has skyrocketed.

The housing market is experiencing yet another quickly-growing bubble. Condo deconversions would typically start at 9x rent roll (the cumulative value of projected monthly rents for all of the units in the building), but some communities are seeing negotiations beginning as high as 20x rent roll! As Don Corleone would say “it’s an offer they cannot refuse.” For a condominium facing a $150,000 special assessment, they may feel that it would be foolish to refuse such a lucrative offer. Why pay a special assessment when you can ride the high of the real estate bubble?

What Does Condo Deconversion Mean For Owners and Board Members?

Condo deconversion is not a cut-and-dry good or bad decision. It’s a complicated process and has pros and cons on every side.

The good is that it can offer hefty profits and a get-out-of-jail-free card in a way. For some owners, it can mean a massive profit and an incredible opportunity to escape a very expensive, long-term situation. For board members who are stuck with the neglect from previous board decisions, it can mean walking away from a series of problems for which you would have been unfairly blamed.

The downsides, however, can be drastic and dangerous for owners:

Loss of Guaranteed Residence

For some, it means being forced out of their homes, into an increasingly hostile real estate landscape with no time to accommodate a drastic life change. Some states, like Florida, are experiencing the lowest housing inventory in the state’s history, meaning some may make a fortune over what they paid for their condo unit only to have to pay that fortune forward, and then some, just to find a new roof to put over their heads. Or, they could get stuck renting the home they previously owned at a severely increased monthly payment.

Loss of Long-Term Equity For Short-Term Gains

Homeownership provides security for yourself and your future generations. For those stuck renting from their new landlord, you lose the ability to pass on equity to your heirs. Unit owners can also no longer get a loan based on mortgage equity or use their home to guarantee a large purchase or supplement legal aid.

Loss of Influence in Your Community

As a member of a community association, you have power. You have a say in every issue that the community faces. You can determine who represents you on the board. You can even run to be part of that board! By deconverting your condo association, those residents that remain forfeit their power to the new landlord. The landlord decides what will and will not be repaired, and when. Once the landlord takes control, they can raise rents as high as they want, regardless of the negotiated rent roll they purchased the property for. There is no requirement to seek approval from residents the way an association board is required to seek approval for the annual budget.

Requirements For Deconverting Your Condo Association

Depending on the state, you do not need a unanimous vote to terminate an HOA or a condominium association, so even if there are objections it can happen to most condominium associations. In Florida, for example, if an investor buys 80% of the condo units, the last 20% can be compelled to sell if the condo has been deconverted. In fact, as of 2007, 80% of owners can allow for a Florida condo deconversion if more than 10% of the total ownership did not object. Other states will have their own provisions for condo association termination, so be sure to check your state’s legislation.

Some owners may argue that the association’s board needs owner approval before it can even begin looking into the possibility of a sale. In reality, the board has a fiduciary duty to bring all the best value and opportunity to the owners they represent, meaning that they can and should be researching opportunities like deconversion if the benefit is great enough.

Can the board sell out the condominium from under the owners? No. They will still be required to get the state’s minimum approval percentage within the community. And if there are condo deconversion negotiations going on, the board has an obligation to keep the membership informed and should provide full transparency.

Revitalizing Your Condo Community

Deconversion is an enticing opportunity for condo communities facing mounting special assessments or dues increases to confront long-term deferred maintenance. And while it might be the right choice for your condo building, it is not as simple as just pushing a button and making everything disappear. It’s a decision that requires a lot of thought, due diligence, and communication with your community.

While you can’t go back in time and undo the maintenance deferment of boards past, you can do the right thing for your community today and start a conversation about the importance of building integrity and health, and how the benefits will always outweigh the cost. Your condominium building needs a diligent board of directors working for the good of the community. It requires regular maintenance, capital improvements, fully-funded reserves, good cash flow, and a proper delinquency and ethical collections solution. Call Axela to let us help you recover some of those missing funds by collecting on your delinquent assessments, and avoid deconverting your condo association.