Deconversions on the Rise: What You Need to Know

Various parts of the country are seeing an uptick in condo deconversions, with multi-unit buildings that were converted from apartments years ago reverting back to that status. Owners may have dollar signs in their eyes and dreams of avoiding the costs of long deferred maintenance or modern upgrades, but they need to have the full picture before pursuing the strategy.

“It’s certainly a more complex process than anyone can really appreciate at the beginning,” says Kelly Elmore, a principal in the Chicago office of Kovitz Shifrin Nesbit. Read on to learn more about what’s involved.

The Impetus for Deconversion

The move to deconvert can be partly explained by investors responding to the increased demand for rental units in recent years.

“Buyers are looking to park their money somewhere, and the return on real estate has been good, especially as far as apartment rentals,” Elmore says. “A lot of the buyers have realized they could purchase a building and convert it, and it was a lot cheaper than building new apartment buildings.”

Those investors aren’t limiting themselves to Chicago, where Elmore’s firm has steered multiple associations through the process.

“I’m seeing a lot of it in Southern Florida, and I think it’s only going to get more prevalent as a result of housing issues,” says Alessandra Stivelman, a partner/shareholder in Eisinger Law in Florida who focuses on real estate and association law.

She cites the new Fannie Mae mortgage requirements, unfunded reserves, and potential changes in the law in reaction to the tragedy in Surfside. “For people on fixed incomes who can’t afford to pay double what they’re paying now, it’s going to be a sticker shock.”

Deferred maintenance, pushed onto center stage following Surfside, is certainly a driver behind a number of these deals. “Some associations are at some level of distress, and owners are facing major capital expenditures and special assessments where maintenance hasn’t been done in years,” Elmore says.

Moreover, deconversion can land them a premium price for their units, more than they otherwise are likely to reap. “The prices owners are being offered are above market value,” Elmore says. And owners frequently can enjoy the premium without even needing to move. They can become tenants, stay in place, and dodge a hefty special assessment.

Not all decoversion targets are in distress, though. Brad van Rooyen, president of HomeRiver Group-Florida, the management company for about 160 associations in the state, is currently working with three associations in the midst of the deceonversion process: “These are phenomenal class A properties that are like resorts.”

How It Might Play Out

In the typical scenario, an investor or real estate developer purchases all of the units and “deconverts” them into apartments.

“Generally, the sale proceeds are based on percentage of ownership,” Elmore says. “We’ve seen situations where two owners had the same percentage in the declaration and the same kind of unit, but one faced an alley and the other the lakeshore. In that type of case, it did make sense to adjust, but those situations are few and far between.”

Reserves and operating funds usually are distributed back to the owners following the sale. “In nearly all of our deconversions, that’s one of the terms in the sale,” Elmore says. “It’s an incentive for the owners because it wouldn’t happen if they sold their unit individually.”

The details can vary greatly, though. For example, in van Rooyen’s associations, a single entity is slowly buying up units. “They’re using their bulk power to amend the bylaws to include a first right of refusal. If every owner has to give all the other owners the first right of refusal before they can put a unit on the market, the bulk owner can use it to buy the other units.

“Within the next two to five years, those communities will collapse back into apartments.”

Other arrangements take a different route. “Some associations are approached with an unsolicited offer; others have heard about it and list the building just to see what they can get and if owners are interested,” Elmore says. The way the process begins can make a significant difference when it comes to owner sentiment toward the idea.

“In some associations, owners are very, very opposed to the sale,” Elmore says. “It might be because they want to live there forever and deed it over to their kids. It’s not a price issue; they just don’t want to sell.” If it is a price issue, they may be able to challenge the price they’d receive in court.

“Regardless of how the process starts, the biggest issue is that the board must comply with the state condo act and the bylaws,” Elmore says. “For example, they have to send proper notice about the meeting where the vote will occur. We spend a lot of time advising clients on how to properly conduct the vote.”

The number of votes required for approval depends on local law. The Illinois Condominium Property Act requires 75 percent of owners, for example, but the City of Chicago requires 85 percent. “We looked at states across the country, and other states range from 75 percent to 100 percent,” Elmore says.

So what part does the manager play? “Their role is usually governed by the scope of their management contract,” Elmore says. If it doesn’t include deconversions, the manager might request an additional fee.

Otherwise, though, it’s generally business as usual. “We just manage the association as we would normally, with the exception that we’re dealing with fewer owners,” van Rooyen says. “Once they dissolve the association, our role ends.”