Condo Conversions: what's your scariest story?

Question

I think I've got a great deal in front of me but haven't done a Condo Conversion yet... Still working out money details, so I don't have those totally clear yet, but the City seems very encouraging and I know thats a good thing. Have heard nightmares about not being able to find insurance (dated anecdotal story!), and am looking for other things to watch out for. Its an older building, so there are not dual walls between the units; I imagine I may have to remedy that, as all the condos I've seen need to have an airspace between them.

And will need an attorney to set up the HOA. Do you have to start out by funding the HOA yourself?

Any advice?

And will need an attorney to set up the HOA.  Do you have to start out by funding the HOA yourself?

Any advice?

Alan Brown · Answer

Wow, Account Closed,  excellent points!  I do have 25 years as real estate broker, and almost the same in construction management, so most of this is not new... but a great list nevertheless on a concept that I know is very litigious, thus the question.  Insurance of all kinds is something I have thanked the heavens for on numerous occasions, but still, I always feel like I haven't thought of all the possibilities that could happen... like when someone has flood insurance but discovers they are not covered for hurricane driven water!!  How does one cover all possibilites???

I like the point about paying in advance for closings!  I could sure see that one sneaking up on you...

thanks guys

Account Closed · Answer

@Alan Brown The insurance issue you mentioned actually is a huge problem in all areas with significant new multi-family development (FL, CA, AZ, CO, NY, Etc.) due to class action lawsuits alleging construction defects. In St. Louis there are not enough new multi-family developments to put together a suit with enough volume so we have been spared that problem. Many construction focused insurance companies exclude coverage for residential construction. However, there are a handful of insurance companies still involved in residential construction.

It varies by jurisdiction but in my area most building code issues that were not in force when the property was originally built are not required to be remedied to get approval to renovate. However, if the building is destroyed due to a fire or storm your insurance will only pay the cost to rebuild as is and not any extra expense that results from meeting the new codes. It is very important that your insurance has the ordinance or law endorsement which provides coverage in this situation.

The most tedious part of setting up the HOA is getting the HOA qualified by FHA so that buyers can use an FHA loan to purchase a unit.  This link provides a step by step guide to qualifying for FHA financing. FNMA has other similar requirements before the condo can be approved. @Dion DePaoli is right on about most lenders being unwilling to finance the units in your complex until the HOA is approved by these government entities making the mortgages much easier to sell off.

In my experience the bank providing the construction financing will set up a deal with you committing to fund the unit mortgages until approval from the government entities is achieved. THis lender has already financed the entire condo so will not have the same hesitations as a traditional mortgage lender. They also have an incentive to see the project succeed which requires the ability to sell off the units.

Getting an environmental study completed and obtaining all of the approvals needed from the local municipality before actually purchasing the property is also a way to reduce a potential disaster.

Marshall Downs · Answer

Wow, where to start? I know you haven't done a condo conversion, but what's your experience in other real estate? This is one of the trickier types of projects to pull off. In addition to local municipality support, good financing and insurance I recommend all the following (not necessarily in order):

1. Well developed proforma that has been looked at by any partners, contractors, bank, other developers, etc. The more people to poke holes in the document the better. Compare the final unit and SF development costs against local market to see if you are within range.

2. Have a huge contingency line item on an older building your converting. There will be things that pop up that no one had thought of. Anything from environmental (i.e. asbestos) to a new building code requirement can blow up a budget

3. In addition to a financial contingency, schedule in extra time for construction complications

4. Find an architect with experience in reuse renovations. See if their firm can also do condo docs

5. Get environmentals done early

6. Take local building official through to review what has to be done to bring up to code. For example if you have stairways that are not code compliant or if you need an elevator or do you need sprinklers

7. Discuss project with a few realtors to get their take on market. Create conservative, moderate  and aggressive price points

8. Talk to neighbors to see if there may be any pushback to your project

9. Talk to atty about master deed and costs and understand how common elements are treated

10. Talk to title company about setting up master title policy and paying in advance for closings as units are sold. (This one saved us about $15-20k on a project)

11. Have a marketing plan and budget

12. Make every effort to protect yourself and your investors. Condominiums are a highly litigious form of ownership

13. Keep a close eye on common maintenance costs and develop your HOA budget to hand off to owners when you are finished

14. Check numbers to see if project works as rentals as a backup plan

I'm sure I've left off hundreds of items, but these popped up to top of mind.

Good luck!

Avrohom New · Answer

@Dion DePaoli Thank you for that insight. I'll clarify what I had in mind with that question: do you know of potential issues relating to buying all the units in a building that is set up as a condominium and then dissolving the Association?

Thank you

Alan Brown · Answer

Wow fantastic insight, thanks, @Dion DePaoli.  This is good.

Also, a little backstory:  the reason I mentioned insurance, was a developer I worked with in Colorado finished a condo complex in the early part of the 2000's, when there was a rogue lawyer whose business  model was buying a condo, tearing into the structure looking for any defects (as minimal as sheetrock screws might be spaced @ 12" instead of 8"), then going after the builder, which of course was actually the deep pockets of the builders insurance company.  He did this in multiple cases, which began to scare the insurance companies out of writing policies for condos.  I had thought it was a national issue, but found out last night that it was local to Colorado.

thanks

Dion DePaoli · Answer

@Avrohom NewI mean selling all the units out as the developer.  Ensuring the project is approvable for conventional financing goes hand in hand with that.  A project that doesn't qualify for conventional financing will be limited to those buyers who can pay cash or obtain financing from other sources.  This limits the universe of potential buyers which slows or stalls the project sell out.  In the pre-crash condo boom, this was the biggest issue.  Projects which could not get qualified stalled out and many turned into multi-unit rentals.  Right now there is also a built up excess supply in your backyard of condos where the developers of many projects are left holding the tail of those developments.  This means the developer is still holding onto 10% to 20% of the units and sales are slowing down.  This is unfortunate for those developers as those tails is where much of the profit comes from.  Also, depending on the level of sold units the developer may still be required to maintain the property as opposed to turning it over the HOA or they may have lost control but still have units then being subject to the will of the HOA moving forward.

Avrohom New · Answer

@Dion DePaoli Hi Dion, what do you mean by "exiting the conversion is the biggest issue"?

Thanks

Dion DePaoli · Answer

Exiting the conversion is the biggest issue.  Miami Florida is going right back through this nightmare as it did right before the crash.  Over supply and developers are getting stuck holding the tail units.  Your attorney will setup the HOA with the CC&R's and you both will designate at what point, usually in terms of a percent of units sold when the association will take over.  Until then, you as the developer control the property.Getting sales going is the barrier.  A vacant conversion will need some cash buyers to establish some level of RE value.  Lenders won't be the first in.  Once you have some cash sales, you can reach out to a lender or two and have them start working on getting your project warranted to be conventional loan ready for borrowers.  Depending on how many units you have you may need a couple of lenders willing to offer financing for the units as they typically will not exceed 15% or less of the total units.  They will also have some other criteria which restricts their lending capacity like the number of non-owner occupied units.  Not a bad idea to chat with one as you get going to get the lay of the land.  I haven't seen a complex that has been completely uninsurable.  I suppose those may happen from time to time but not all that often.  Good luck.