Condo conversion that never fully convert.

[Stone Jin]

Hi all,

I'm looking to see what your thoughts are on condo conversions that never fully sell out. The complex is then managed as rentals and for sale. I'm looking at REO of individual units within larger complexes. Are there any pros and cons to purchasing these? Competition against the management company on rentals? Are the HOA fees fair since a portion of units are still owned by the management company? This is in the PHX market and I'm seeing a lot of properties that fall in this scenerio.

Thanks

Stone

[Jeff S.]

I’ve recently been offered several fully entitled condo complexes that are mostly rentals and there are substantial problems with each.

In general, a condo complex where the minority of units are owner occupied will not be warrantable. This means that potential owner occupants will not be able to finance using Fannie Mae or Freddie Mac backed loans. Warrantability has several classes and it’s important you understand each of them (you can Google “condo warrantability†for many explanations). If you intend to buy the units with the ultimate intention of selling to owner occupants, their financing options – and thus market demand – will be extremely limited.

If you intend to buy the units as long term rentals, and you are a minority owner in the complex, then understand you will have many business partners who you don’t know and who all have disparate interests. The majority owner, if there is one, will have virtual dictatorial control over the complex. This is particularly true of management and the HOA fees, which can become quite onerous and even punitive. Majority owners will act in their interests to rent or sell their units first.

If there is not a majority owner, then I hope you are a good politician adept at forming coalitions to control the board. Is this something you really want to get into?

I was recently offered over 90 units in a 130 unit complex owned by run by a rogue’s gallery of owners who are all suing each other, a prior owner, and a lender. The numbers in this complex made a lot of sense, but the climate did not. I made it clear to the agents involved that I would consider buying the entire complex and run it as 100% rentals if they could figure out how to get everyone to sell and insure title to me. How they do that is up to them. Beyond that, my life is too short to consider these kinds of deals. I suspect yours is too.

I was also offered an entire condo complex of 100% rentals that would barely cash flow as rentals using highly leveraged financing. The play here would be to barely squeak by over the (hopefully) short term, and sell to owner occupants as the condo market picks up, for a substantial profit on each unit. I can’t imagine when this will happen. To make a deal like this work, I’d pretty much have to empty the complex while I sell and carry the deal out of my pocket in the interim. This too makes little sense to me.

Jeff