Why Condo Deconversion Could Make Sense for You
The real estate market is constantly shifting and condominium units are no exception. Condo deconversion rates are on the rise as the market attempts to self-correct after countless buildings "went condo" in the early 2000s. For example, since 2017, Chicago's real estate market has been the top in the country when it comes to the deconversion process for both commercial and residential properties.
This is a trend that's here to stay, particularly in cities like Chicago where there are large-scale deconversion projects impacting unit owners and condo buildings. According to Alexander Argianas, Vice President of Argianas & Associates, there have been properties such as the $112 million 1400 N Lake Shore Drive property and the $60 million condo apartment Century Tower in the loop that are impacting condo owners. Let's take a look at how condominium associations are impacted by this topic.
What Is Condo Deconversion?
According to the Illinois Department of Financial and Professional Regulation, Division of Real Estate, deconversion refers to the process of selling the entire condominium property to a third party. In return, this third party turns the units into rental units. This means that rather than having singular condo owners, the entire building is owned by a single third party.
Why Condo Deconversion Is Gaining Popularity in Illinois
There are many reasons that a condo owner might run into deconversion in today's market. We've outlined some examples below.
- Buildings are getting older and need repairs: Especially in a historic city like Chicago, the buildings themselves are old. As you can imagine, repairs are expensive and cost a lot of time. If condo associations don't have enough reserves, they are likely subject to special assessments to catch up on maintenance and deferred capital improvements;
- There aren’t enough rental properties available: As Chicago is an incredibly desirable place to live, the sheer volume of rental apartments is sufficient in meeting population demands. Even though condos have been popular over the last couple of decades, there is a significant gap in rental properties. This is an opportunity for real estate investors to purchase buildings in popular neighborhoods such as Lincoln Park without having to build them. As the cost of construction continues to increase, condominium conversions make more sense;
- Real estate prices have skyrocketed: Over the past few years, the real estate market has seen a significant boom and resale values have been impacted. Typically, condo deconversions would start at approximately 9x the rent roll, but some condominium association communities are seeing negotiations up to 20x the rent roll. This is an opportunity that can't be refused. For example, if there is a condominium that is facing a special assessment of $150,000, the unit owners might feel silly turning down such a lucrative offer that leans into the explosion of the real estate bubble;
- New special inspections are being ordered by local municipalities, state statutes, or federal restrictions: Condos will eventually be forced to keep up with maintenance, funding, capital improvements, reserve studies, etc. Even though this is the right approach to benefit individual owners, this way is more expensive. New inspections are expensive and time-consuming, only resulting in residents finding more issues than they anticipated. This unveils additional problems and a money pit that a simple investment can fix, making a deconversion offer seem incredibly appealing.
Reasons to Consider Condo Deconversion
Now that we've been discussing deconversions, you might be wondering about some reasons to consider doing so.
- You make more money – Eliminate the hassle with listing your home (sellers make 20-50% above residential value);
- Cheaper fees – Cheaper Commission and Attorney Fees (15-30% fewer fees due to bulk sales);
- Option to rent unit – You don't have to move (and the process takes six months for you to decide your next move);
- Financial issues – Many communities are facing financial hardships similar to the great recession.
From elevators to roofs to facades, there are many issues that can impact buildings as they age. Deferred maintenance issues can be especially impactful for buildings built before the 1970s. For buildings that don't have sufficient reserves, this can be particularly troubling, especially as repairs often go hand-in-hand with safety. To bridge this gap in funding, board members might turn to loans, levying a special assessment, or increasing assessments, but residents might be unable to keep up with their shares. This is when the deconversion process is especially appealing.
Low Resale Prices
A unit owner might have a difficult time selling their property at a profit, especially as the market fluctuates so drastically and interest rates are high. A condo association might rely on a deconversion to help recoup some of the money that was spent on the sale of the unit.
Low Owner Occupancy
There might be a high proportion of renters vs. unit owners in certain instances. This can make it more difficult to get the right liability insurance and can impact the minimum occupancy owner rates for condominium mortgages to protect their resale values.
In some condo associations, deconversions might be subject to state and local laws such as the Illinois Condominium Property Act. This states that if 75% or more of ownership approves the sale of units, the action is binding for all owners.
Downsides of Condo Deconversion for Owners and Board Members
As you can tell, condo deconversion isn't necessarily a good or bad thing for condo owners and there are many factors that impact the situation. For some owners who are looking to sell and make a profit, it can be a positive thing. On the other hand, there are downsides such as leaving a building or location that you love for short-term financial gain.
The Loss of Guaranteed Residence
If you own your individual unit, you might be unfairly forced out of your property before you are ready. Not everyone has the means to support such a short-notice drastic life change and this sudden decision can have a ripple effect. Some states such as Florida are experiencing the lowest housing income in the history of the state; some people may be making a significant profit while others are scrambling to find a suitable new living situation. In some instances, people are stuck renting the home that they had previously owned at an increased monthly payment.
The Loss of Long-Term Equity for Short-Term Gains
Having a home that you own can help provide you with a sense of security not only for your immediate family but for future generations. Purchasing strategic properties is likely an emotional decision as well. If you get stuck renting from a new landlord, you lose out on the opportunity to pass this equity onto your heirs. Unit owners are also no longer able to get a loan based on mortgage equity.
The Loss of Community Influence
If you're part of a condo board or association's board, you have a direct impact on every decision that's impacting the community. Some people are even motivated to become board leaders. With condominium deconversions, these residents forfeit the opportunity to have a say over their new landlord which can mean losing a say in rental prices, board rules, a potential sale, etc.
Requirements for Illinois Condo Deconversion
Each state has unique rules when it comes to rules surrounding condo deconversion. In Illinois, the law (765 ILCS 605/Condominium Property Act) states that a homeowner's association (HOA) needs to take a vote on this decision. In order to force a sale to a third party, the percentage of votes needs to be at least 75% of owners voting "yes" to sell. If this is achieved, the action is binding for all unit owners. In the city of Chicago, there must be an 85% vote of the owners for this to be achieved.
Factors to Consider Before Deconverting Your Condo
Here are various factors to help you determine when deciding about your particular building.
If you're able to transition your condo building into apartment rental units, it can be incredibly profitable, especially if you're able to achieve current market rates. New construction buildings aren't able to keep up with demand and there is a limited number of rental units available, resulting in rental prices steadily increasing. This means that developers and real estate investors are seizing these opportunities as they come to transition condos into another source of profit.
Letter of Intent vs. Binding Agreement
Usually, there are two ways that the deconversion process plays out: through an unsolicited offer that a developer or purchaser makes or that the association goes out of its way to seek a purchase offer for the units. In the case that the association receives an offer, it is typically included in a letter of intent. This letter usually contains the general terms of a potential sale, but this letter is not a binding offer or a purchase agreement.
Building Code Violations
There are multiple municipal codes by which associations must abide such as sanitation and fire safety regulations. Some construction projects also need specific permits from the local government before any work can be completed. If there are uncleared permits or code violations, this can result in a slower sales process or one that doesn't happen altogether.
Specifical legal considerations are factored into this process. For example, once the sale has been approved, it becomes "the duty of every unit owner to execute and deliver such instruments and to perform all acts as in manner and form may be necessary to effect such sale.". Put another way, all owners must sign and execute the sales documents to abide by the Illinois Condominium Property Act. Other legal considerations include unpaid assessments, written objections, contract distribution, voting, and informational meetings.
Learn More about Condo Deconversions with 33
If you're looking into a condo deconversion but you aren't sure where to start, our team at 33 Realty is here to help you! Condo buildings can be an incredible opportunity to turn into rented apartment buildings but the process isn't always straightforward. Our team has extensive experience with this process and our Chicago property management and brokerage company can help you every step of the way. Contact us today to get started.
When’s the “right” time to consider a deconversion?
There isn't a strict timeline when it comes to this process, but factor in the age of the building, what the rental inventory is like in your area, what the need is for capital improvements or modernization, and what the overall market is like. When you look into those factors, you'll have a better idea if this is an ideal time.
Will the buyer make individual offers to each condo owner?
No, developers don't talk to individual owners with specific offers but instead, make an offer on the property as a whole. In the majority of cases, deconversions are bulk sales that happen in one swift transaction.
How does an association determine the price of the building?
An experienced appraiser is often involved in this process as it's impossible to determine the value of the units individually. The process isn't as straightforward as adding up the value of all the condos by looking at listings and recent sales. The price will be determined based on the whole picture and investment opportunity rather than as a piece-by-piece transaction.