Condo Conversion: Pros and Cons of Rental Conversions

Estimated reading time: 7 minutes

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What Does It Mean When an Apartment Complex Converts to Condominiums?

Real estate investments are diverse, offering numerous strategies for investors to explore. One approach that has caught the eye of many savvy investors is the condominium conversion of apartment buildings. This investment strategy isn’t limited to just one type of investor and is becoming increasingly popular as it provides outsized returns. This guide will walk you through converting multifamily rental units into individual condos. Converting an apartment complex into condominiums, commonly known as a condominium conversion, involves transforming rental units into individual units that can be sold. Property owners who undertake this process go from landlords of rental properties to condo developers and sellers of condo units. This significant shift in the real estate investment strategy comes with challenges and opportunities.

The key 🗝 is identifying the right market and property for conversion. Then, structuring the finance correctly.

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What Is the Major Objective of Condominium Conversion Restrictions?

In recent years, the multifamily market has seen substantial growth. Recent years have consistently marked the increasing number of multifamily units completed, except in 2020, a trend expected to continue. Factors like favorable demographic trends, a strong job market, and reduced affordability of homeownership are fueling the demand for multifamily properties.

To have growth, there must be capital. Developers must provide returns for capital to be involved. The yields have begun to reduce to what high teens in the past 12-24 months. Multifamily is still a safe place with a higher yield return than the stock market (Averages 3% – 13% over ten years, depending on the fund). 

Local laws and state regulations often restrict condominium conversions to protect current residents and maintain a balance in the local housing market. These restrictions could include requirements for tenant relocation assistance, maintaining some units as rent-controlled, or even moratoriums on such conversions when rental markets are tight. The primary objective is to prevent the rapid depletion of affordable rental units and ensure that conversions are done responsibly.

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What Are the Pros of Converting Condos?

1. Property Value: One of the most compelling reasons for conversion is the potential increase in property value. Condominium units often sell at a higher price than the entire building may earn through rental income.
   1. if an offering does not work at the seller’s lowest minimum asking price, there may be an opportunity for a conversion. It was the difference between acquiring and passing on the property and not allowing investors to take advantage of it. 
2. Cash Flow: While rental properties offer a steady flow of passive income, selling condo units can offer a large lump sum, improving the owner’s cash flow.
3. Reduced Management Burden: Property owners find that managing individual owners through a homeowners association is generally less demanding than dealing with tenants in a rental property. And after all the units are sold, the property is turned over to the association, which is self-managed by the Condo Owners.
4. Market Adaptability: In high-demand areas, converted condo units can sell quickly, enabling building owners to capitalize on current market conditions.

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What Is a Condo Conversion in Real Estate?

In the realm of real estate investors, a condo conversion is a tactical maneuver. It transforms a rental building into a condominium where individual units are sold off. It’s not just a legal formality; it involves considerable effort. This includes adhering to local municipality rules, paying application fees, and possibly making renovations to meet code requirements.

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Key Steps and Considerations

1. First Step: Consult a real estate attorney and a mortgage broker to understand the legal requirements and financial implications, including attorney fees and potential hidden fees.
   • a. ​Determining the feasibility of the project can be the first and longest hurdle.
     1. Will the jurisdiction allow for condominiums? 
     2. Can you find a lender that will allow partial release of liens? 
     3. Do you have a partner lender to back the buyers interested in purchasing the individual condominiums? 
2. Application Process: Prepare documents and get approval from city departments or other local jurisdiction authorities.
3. Cost of Construction: Make necessary upgrades and renovations to common areas and individual units. Remember that construction projects can be expensive, and sometimes higher interest rates may apply for loans.
4. Unit Owners and Condo Associations: A condo association manages the common areas once the units are sold. The unit owners generally form the association and could require special assessments for maintenance.
5. TIC Owners: In some cases, Tenancy in Common (TIC) owners might be part of the building. They will also be affected by the condo conversion process and may have the option to buy their unit before it’s sold to external parties.

Legal side to Conversion

1. Local and State Laws: DC condo conversions, for example, have new rules and restrictions that may not apply in other states. Awareness of the residential tenancies act and other local regulations are essential.
2. Rent Control and Relocation Assistance: If the existing building had rental apartments under rent control, provisions for relocation assistance for current residents must be made.
3. Residential Spaces and Commercial Buildings: If your multifamily property also has commercial spaces, these might have separate rules for conversion.
4. Good Investment or Not?: Weigh the benefits against the costs. Consider the state of the real estate, rental, and housing markets in recent years before taking the plunge.
5. Timing: Undertaking a condominium conversion takes a lot of time, sometimes years. Could you factor this into your calculations, especially if the real estate market is volatile?

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Conclusion

Converting a multifamily property into condos can be good, but it’s not for the faint of heart. The process can be intricate. Understanding local laws to managing construction costs and navigating the complexities of residential spaces and commercial buildings. With the right approach and extensive experience, converting a property can be a lucrative real estate investment strategy. And, a great tool in an operator’s belt when trying to grow.

Property owners can successfully navigate the maze of condo conversions by understanding the intricacies. These include local municipality rules, legal requirements, and financial implications. Make sure you consult professionals, like a real estate attorney and a mortgage broker, to ensure you are well-prepared.

When done right, the conversion results in significant profits and open up new avenues for investment, including higher price sales and lower maintenance costs in the long run. Just remember, this is not a traditional flip; it’s a long-term game with its rules.

If you want to identify the ideal market for condo conversion, please feel free to contact me at jeff.davis@bridgestoneinvest.com. With the right due diligence, this investment strategy can open up new and lucrative opportunities in a challenging landscape.

Always consult with a financial advisor, CPA, or CFP to make sure your financial plans align with your goals, risk tolerance and financial situation.

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