When an investor is seeking an investment in a new condominium project, the possibility of purchasing an existing rental property for conversion to condominiums should be considered. While building a new property can be profitable, there are many benefits to converting the existing property.
The Condo Conversion
There could be several reasons why an owner of a rental apartment property would want to convert his project to condominium ownership. For example, he could want to convert because his tax shelter may have changed because of tax laws. He could be at the point where an increase in rents should be made, but that could heighten the risk of vacancies and turnover in tenants. The owner could just want to make the conversion for profit.
The demand for condos has remained strong. Condos can be more affordable, particularly for first-time homebuyers. In many markets throughout the country, condominiums are still strong competitors to rental apartments. For many people, a third alternative‑owning a condominium apartment is the answer. Tax deductions for mortgage interest and property taxes can be beneficial in bringing down the monthly cost of the unit below a rental unit of the same size and quality.
There are buyers for condo units in most communities. Young singles and couples looking for an affordable first home make up some of the buyers. Professionals and empty nesters that can afford the more up-scale units make up another phase of the market. These groups still want the convenience of living in downtown or close-in locations because of the benefits of the urban environment.
Benefits For A Conversion
- Profit. The per-unit value of a condominium for sale is usually higher than the value of a rental unit. (Value of a rental unit is based on the cash return from the rental of the property. Sale prices are based on comparable house or unit sales based on square footage and amenities.)
- Gain Funds For New Investments. An excellent way to free up funds for new investments.
- High Demand. The owner may be offering his units for sale in a market in which there is a high demand for the purchase of housing vs. a low demand for rentals.
If the apartment or commercial building has an older mortgage with interest that is lower than the current market, the lending institution could be helpful with financing. With the conversion completed, the old loan could be repaid before maturity, with the lender then able to reinvest the money at current rates. Also, the lender would be able to invest in mortgage loans on the condominium units, which have been very sound investments over the years.
The Condominium and Co-Operative Abuse Relief Act of 1980 (P.L. 96-399) seeks to minimize the impact of conversions on low-income, elderly, and handicapped tenants. The law is restricted to conversion or rental properties and does not cover projects that were originally built as condominiums or co-operatives. The federal law is not applicable if any state or local government opted out of the federal scheme of regulation by enacting appropriate laws. (Check with your Attorney if considering a conversion.)
Advantages of a Conversion
When an owner converts existing rental apartments to a condominium project, there are certain advantages over building a new property. Some of these are:
- FINANCING. Since the structure is already there, loans may be easier to secure.
- MARKETING. The owner is estimating market conditions for selling the units only weeks or months ahead rather than years.
- MATERIALS AND INFLATION. Cost factors will be easier to estimate, again because of the shorter period. This reduces problems of cost spiraling of labor or materials, labor strikes, or shortages.
- LESS FACTORS IN PLANNING. As in financing, since the structure is already there, many less cost factors will come into the planning. Only permits, engineering, legal and selling costs, etc., will come into planning.
- LOCATION can be a definite advantage. Owners can pick older units near a downtown or other desirable location where no open land for construction is available.
- SALES. Units can be offered at competitive prices. Units that are in a sound structure built years ago can offer greater value than newly built units, even after major improvements and refurbishing. Often, according to HUD data, approximately 25% of the units can be expected to be purchased immediately by the existing tenants.
- Density & Zoning. The structure is already located in an established area and shouldn’t be affected by density or zoning requirements.
Benefits to Tenants in a Conversion
As stated, only about 25% of the tenants will be expected to purchase one of the units. There are advantages for this tenant to make this purchase, and this should be communicated in sales information to tenants.
The property is located in a familiar area. The tenant already knows this neighborhood.
After the purchase, the former tenant now has the usual advantages of ownership: A tax deduction on the portion of the monthly payment that is interest. The benefits of appreciation of the value of the unit in the future. The reduction of loans each month from the principal payment.
Above all, the new unit owner is free from the problems of rent increases. The monthly payment is an amortized loan, which does not change during the life of the loan. There could be small increases in the charge for common area maintenance, but this is not in the same league as rent increases.
Ideal Conditions for a Condo Conversion
The investor cannot just pick any available apartment property. Not every property can be a successful condo. Certain conditions should exist for a successful conversion. Here is a checklist of some of the most important factors that should be considered before starting a conversion of an apartment property:
- The location would preferably be in a highly desirable residential community. The local market for single-family homes and apartments should be active and doing well. If there are other condominium projects in the area, they should be checked to see how sales are moving.
- Vacancy factors and turnover in rentals to tenants are important. If the building is not desirable as a rental property, who will be the buyer of the unit? Both the turnover factor and vacancy factor should be low.
- Zoning. Ordinarily, a rental project that complied with local zoning and subdivision ordinances will not face zoning problems when the building is converted, since the conversion is not considered a change in use.
- Check the leases. When do leases expire? A few long leases scattered throughout the building could play havoc with a planned conversion. Do the lease applications of the present tenants show people who are prospective buyers?
- Demand. Is there a demand for housing in the projected price range of these units?
- Size of units. Units should be larger than the average local rental apartment. The prospects will be most likely ex-renters who want more space, or previous homeowners who are used to having plenty of space.
- Amenities. Location, as we said. Air conditioning, new carpeting, and appliances. Each unit offered for sale should be returned to “like-new” condition.
- Condition of structure. A well-built, high-quality building is best. Make sure the roof, wiring, plumbing, etc., are in good condition. Hire an engineer for the inspection.
- Experience. If the owner is not experienced in condo conversions, have a real estate agent or attorney who is. This type of action is more of a legal problem than a construction or real estate problem.