Apartment to Condo Conversions

By Howard J. Willis *

South Florida has been a leading market in a national craze sweeping the rental apartment industry. Developers across the country have purchased conventional apartment complexes as a result of the growing demand for affordable housing – for owner-occupants and for investors. With the rapid rise in median-income housing prices, a variety of demographic groups including young workers entering the labor market, seniors seeking to downsize, middle-income older workers as well as investors – have all combined creating formidable demand for more affordable housing, especially in the under $300,000 price range. We took a look at several local condo conversions and examined the national trends to give you a glimpse of what opportunities this housing-type may offer you.

What exactly is an apartment to condo conversion? 

Condo developers or “converters” typically seek an urban/suburban apartment complex in communities where single-family home prices have significantly appreciated … i.e. desirable local communities where there is little competition for homes priced in a range of about 60% to 80% of the area’s average single-family homes.  The converter estimates at what price per unit the complex may be purchased for, and then costs out renovations to the grounds/landscaping, parking and drives, exterior walls and roofs, etc. Every effort is made to minimize adding any additional structures that imply added cost and time. Typically, the interior improvements are limited to re-painting, new carpeting and limited changes in the kitchen and baths. Many developers target the first 15% of their sales to existing tenants, giving discounted pricing to jump-start sales and revenues to continue the sales process.  Then, often the next wave of buyers are investors buying mostly for speculative purposes. Some converters will offer early or close-out incentives by offering to replace aging kitchen equipment, washer/dryer, and perhaps a new granite counter-top.  The most striking difference in conversions is the fact that many buyers acquire units still occupied by the tenant under a continuing lease agreement.  Once the lease expires, the new owner/investor can elect to continue to rent, make any improvements or move into the unit – at the sale the new owner stepped into the shoes of the former apartment complex owner.  The new condo association now operates the community charging each owner a maintenance fee, replacing the prior owner as responsible for the grounds and buildings.     

What is driving the condo conversion market?

Primarily investors. The industry’s conventional wisdom experts suggest that with 15% to 25% or higher cash on cash returns and more immediate turn-around times than multi-year new construction, a variety of investors and developers have borrowed billions to convert properties. Likewise, big and small apartment owners find the premiums in conversion prices compared to re-selling as apartments as too tempting to ignore. According to one analyst, the national average sale price per conversion unit in 2004 was $123,575 per unit, growing by mid-year 2005 to more than $155,400 per unit for an increase of 25%. 

Affect on affordable housing

It would seem initially that condo conversions are a great opportunity for first time home buyers who have been priced out of the housing market in recent years. But, the reality is that investors are driving demand, some by buying for their children and all buyers banking on continued rates of appreciation in housing prices at all levels.  Many occupants therefore turn out to be renters.  Many buyer-occupants do buy, but sales agents often cite the many buyers who either have marginal credit and/or the lack of an adequate down-payment as barriers to buying. Many first-time buyers find it difficult to fund even the 5% to 10% down on a mortgage plus closing costs …. +$9,000 to +$18,000 on a $180,000 condo purchase.

Risks and rewards

Some analysts believe that as interest rates rise, condo conversion investment risks increase. The theory behind this suggests that as rates rise, single-family homes for sale inventory likewise rise. In our visits to several projects right here in Central/West Broward this did not appear to be the case. As noted in an earlier article, single-family inventories have tripled and in some communities reached six to seven months inventory in recent months in Broward. However, the conversion projects we inspected were more than 75% sold-out in prices ranging from $155,000 to $215,000.  So, while it is premature to say what affect interest rates will have down the road, there appears to be a lot of pent-up demand for affordable homes by both investors and homeowners. Another factor deserving attention is to what degree the “flipping” of condo units by speculative investors can or will continue. As some real estate veterans cite this as a warning sign of an overheated market, it will be interesting to watch how the current market cool-down may affect the new construction market. And certainly, the savvy buyer must take into account new development condo projects just entering the construction pipeline in South Florida.

How do you see it?

My own view is that most of these projects tend to be near the beaches and start at price points well above the high-end of conversion pricing, suggesting that the two are basically distinct markets and products.   It would appear that condo conversions may be better positioned to withstand potentially higher risks that new development condominiums now face. What will happen as more condominium projects near completion, requiring the speculative investor segment to close and carry their operating costs?  Many of these investors counted on “flipping-out” – what if they have to rent at negative cash flows?  That’s a scenario longer-term investors will be watching as some wait on the sidelines to buy smart and hold for a few years.   

• Howard Willis is Broker/Associate and a Partner of Keller Williams Realty Partners South West Broward.  He and his wife and business partner Allegra are principals in the Allegra & Howard Willis Real Estate Group.  Howard has a law degree and specializes in providing real estate consulting and services to premium homes, condominiums and commercial real estate owners and buyers. Call with your questions and comments to (954)949-0444 or to howard@thewillisgroup.com. Learn more about Allegra and Howard and the Willis Group at www.thewillisgroup.com