Condo Conversions…in Reverse
February 23, 2009
The world of condominium developments and conversions, that peaked in 2006, now resembles one of Bill Murray’s lines from the comedy movie, Stripes, when he described his injured drill sergeant, Hulka, as “blown up sir!” (goofy accent omitted).
As condominium markets around the country rebalance, we are likely to see a growing trend of bulk transfers of condominium projects throughout the distressed real estate market. Many of these projects will be changed back from for-sale condominiums to multi‑family rental projects – if they can.
Buying and financing, or even just foreclosing on, a “blown condominium” project, and converting it back to a rental project, is not a simple task, and is one that can take a few different paths, depending, in large part, on the status of the condominium formation and unit sales.
“Condominium Association Not Yet Formed; and No Sales” – If a planned condominium project has not been legally formed, through the recording of the
required documents, and no condo units have been sold (or all unit contracts may be cancelled), then the legal conversion back to a rental project can be accomplished pretty easily. In that case, the biggest challenge will most likely be the lease‑up or completion of construction.
“Sold Units” – On the other hand, once condominium units are sold, the difficulty with conversion back to a rental project increases. The transaction changes dramatically once the condominium documents have been recorded (thereby forming the condominium association) and condominium unit sales begin to actually close, resulting in joint ownership of the project by the developer (or buyer, lender or other transferee) and these other unit owners.
The biggest logistical hurdle for a project owner of a busted condo deal is that the control of the common areas of the project must eventually be turned over to the condominium association, acting through a board of directors elected by its members. This problem may be mitigated to some extent if only a relatively small number of units have been sold, since the project owner may be able to control the elections of the board through its ownership of most of the units. Even while the board is under the project owner’s control, however, the minority unit owners can cause a lot of headaches by exercising various rights under the governing laws and condominium documents. Clearly, unit owner “interference” is one of the unique features of owning and operating a failed condominium project.
There are a number of legal and business strategies that may be employed to reduce these problems, including: (1) possible amendments to the condominium documents, where permissible, (2) “partnering up” with, and obtaining proxies from, certain unit owners, and (3) the buy-back of units to retain control, to name a few. These strategies must be thoughtfully and carefully deployed, often in concert, to maximize the results. This is an area where we consult closely with our clients.
In addition to the issue of sharing control of operations with unit owners, the other primary concern we encounter with the acquisition of failed condominium projects, is the potential liability of the project owners for construction defects. The level of this risk, and the possible strategies for avoiding it, depend primarily on the applicable state law and the terms of the unit sales documents, as well as, in some cases, the actions and elections of the project owner.