Besides the traditional three apartment investment strategies (turnkey, distressed, and value-add), condo conversions are another less common business plan that can be very lucrative.
The condo conversion investment strategy involves purchasing an apartment community, converting it from individual rental units to individual condos, and reselling the individual converted apartments to condos for a profit.
This post isn’t going to discuss which investment strategy is the best, because, like most things in real estate, it depends on what you're interested in and what your goals are. However, if you do decide to pursue the condo conversion investment strategy, here are the nine things you need to consider.
1. Speak With an Attorney
First and foremost, speak with a real estate attorney that specializes in condo conversions. You need to know the state and local laws on condo conversions and the step-by-step process you must follow.
2. Vacating the Property
The largest potential challenge is the process of vacating the apartment building. An attorney will tell you the laws that protect the rights of the existing residents. In some markets, the residents must be given a specific time frame of the notice to vacate. You may even be required to cover their relocation costs and give them a chance to purchase a completed condo. The longer it takes and the more expensive it is to vacate the property, the greater the holding costs.
3. Hidden Fees
There are a lot of hidden fees involved in condo conversions, which the attorney can help you uncover. There are application fees with the city, surveying fees, attorney fees, and fees related to code compliance.
Once the conversion is completed, the city will inspect the condominium for code violations, which you will be required to address. Therefore, another fee is associated with hiring a private condo pre-inspection specialist to inspect the property to give you an opinion on potential code violations and the costs of the repairs.
Another hidden fee is the increase in insurance costs. Insurance on condominiums is generally higher than apartment insurance, so make sure you obtain a quote for the new insurance premium.
Last are the upfront and backend fees you charge for putting together and managing the project.
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4. Financing
You will need to speak with a mortgage broker who specializes in condo conversions to secure financing. This conversion needs to begin before placing the deal under contract so that you can estimate the debt service and other important loan terms, like I/O periods, loan term, interest rates, prepayment penalties, financing fees, and closing costs.
5. Timing
To determine the holding costs and hold period, you need to know the estimated timelines for each step in the condo conversion process:
- How long will it take to vacate the building?
- Once vacated, how long will the renovations take?
- How long will it take to list the condo units for sale after the renovations are completed (post-conversion requirements like setting up the HOA, inspections, etc.)?
- What are the average days on the market and closing timeline?
Add these all together and you have the hold period and can calculate the holding costs.
6. Holding Costs
The holding costs are the ongoing expenses paid during the hold period. These include insurance, taxes, utilities, and debt service. Since you will be generating no cash flow (or some cash flow in the beginning while vacating the property), these expenses must be covered by initial equity.
7. Renovation Costs
There are four aspects of the renovation costs to consider in condo conversions:
- The cost to convert the apartment units into individual condos
- The investment amount required for the common areas
- The cost to address deferred maintenance
- The size of the contingency budget
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8. Sales Process
The first thing you need to know is the projected after-repair value of the condominium units, which requires a sales comparable analysis. You also need to consider the costs associated with marketing and selling (i.e., the broker’s commission) the condo units.
9. Limited Partner Compensation
Lastly, you need to determine the compensation structure offered to the limited partners who invest. What type of return will you offer (preferred return, profit split, or both) and when are they paid (after each condo is sold or when all condos are sold)?
To address all the above, you will need to work with at minimum an attorney, a mortgage broker, and listing broker, and a contractor – all who specialize in condo conversions.
Conclusion
Purchasing an apartment community and converting the rental units into individual condo units is an alternative to the traditional apartment investment strategies. However, you need to understand the laws surrounding condo conversions, the added costs, and the required team members to properly underwrite the deal, successfully complete the conversion, and conserve and grow the investors' capital investment.
About the Author:
Joe Fairless is the co-founder of Ashcroft Capital, a fully integrated multifamily investment firm with more than $2.7 billion in assets under management, and the founder of Best Ever CRE. His podcast, the Best Real Estate Investing Advice Ever Show, is the world's longest-running daily real estate podcast with more than 500,000 monthly downloads.
Disclaimer:
The views and opinions expressed in this blog post are provided for informational purposes only and should not be construed as an offer to buy or sell any securities or to make or consider any investment or course of action.
