The for-sale market has been slow to erupt again, and is ripe for new entrants. So much so that many owners are now eyeing the opportunity to convert for-rent properties to condos.
With a strong demand for new product coupled with low supply, an increasing volume of rental properties are beginning the conversion process in their respective markets.
“[Many condominium properties] came in at a time where they were difficult to sell at a level that anyone wanted to sell at, so they chose to rent them up with the opportunity to come back to the market any time they felt that things were prime,” says Paul Zeger, principal at San Francisco-based Polaris Pacific.
Zeger has been in the business for 26 years, and it’s the third swing of conversions he’s seen. During the Great Recession, many purpose-built condos became rentals as the market demanded, with owners biding their time until the for-sale market bounced back. And that time might be now.
That's especially true given the lack of new for-sale assets in the pipeline right now–at least in California. San Francisco in particular will see the deliverance of about 8,000 units through 2015, Zeger says. Yet only 500 condominiums were scheduled for that period, leaving room for former condominiums to stake their claim in the market again.
Not all conversions are erupting from failed projects, though. Some developers have intentionally set out to rent their product for about five years to mitigate their risks.
“One of the biggest liabilities with condominiums is the big construction defect lawsuit,” Zeger says. “That’s a risk that the developer takes if they go into for-sale, is the customer saying you didn’t do a good enough job and you have to go back and fix it, you owe us money.”
So, renting is another way to test the playing field before jumping headfirst into the for-sale market.
Such is the case with the Bond in Oakland, Calif. By building a new property on the outskirts of a prime market, developers were able to await the perfect time to deliver the 101-unit luxury condominiums, once Oakland caught up with San Francisco. The time spent renting allowed them to address building issues, and more accurately gauge HOA fees thanks to a better-understood cost of operations.
“It gets you, in some ways, almost liability-proof in the sense that you have an opportunity before you sell it to really debug the property and make sure that it’s perfect,” he adds.
The Bond was able to ride the rental escalation wave after opening in 2009, and now that the time is right, the owners can sell units at a price that’s comparable to its immediate competition, and significantly less than the nearby San Francisco market.
“Condo conversion is most effective at the beginning of a new cycle,” Zeger says. “You can deliver, immediately, inventory, that if you start construction today, you’re two years away.”
Now, plenty of inventories being built will have a condominium map on it so developers have the option to eventually turn the building into a condo. But some properties might be a little too late.
Developers would have had to start on new product two years ago to deliver to a hot market today. That plan, however, wasn’t economically feasible thanks to a tough lending environment. Even today, developers sitting on land are at least two to three years away from delivering condos, and the economic period is likely to adjust.
Preparing for Conversion
By obtaining a final public report on the property issued by the state, developers can determine if they’re allowed to sell and close their multifamily building as a condominium. The process varies state to state, but in California, it can take about three to six months.
The next step is giving the tenant the notice to sell, and a right of first refusal to occupy and own the unit upon conversion. The 90-day agreement includes terms of the offering, determining what condition the unit needs to be delivered in. It’s a money-saving endeavor in that it saves owners on marketing when they successfully transition tenants to buyers.
But this will only be a small amount of residents, maybe 5 to 10 percent.
“Typically renters are renters,” Zeger says. “That’s either their mindset or what’s economically viable for them.”
-Linsey Isaacs is an assistant editor with Multifamily Executive magazine. Follow her on twitter @LinseyI to continue this conversation.