Condominium Conversions: the Considerations and the Process
| Publication year | 1979 |
| Pages | 764 |
| Citation | Vol. 8 No. 5 Pg. 764 |
1979, May, Pg. 764. Condominium Conversions: The Considerations and the Process
Dennis M. Richardson is currently serving as Chairman of the Board of Advocates at J. Reuben Clark Law School, Provo, Utah.
A condominium is a form of real property ownership that is a creation of local statutory law. To be classified as a condominium, the unit must first be a separately owned entity that is part of a multi-unit real property complex, and second, have an undivided tenancy-in-common interest in all appurtenant real estate and improvements thereon. Although twenty years ago condominiums were virtually unknown in the United States, they are rapidly taking a foremost position in the American housing industry. Between 1970 and 1975 the number of condominium units grew to more than 1.25 million, which represents nearly a fifteen-fold increase. In fact, during the years of 1973 and 1974, condominiums accounted for 25 percent of all new housing starts in the nation.(fn1)
In addition to newly constructed units, recent years have revealed an increasing number of condominiums converted from previously rented apartments. It has been estimated that 100,000 units were converted from pre-existing properties by April 1, 1975.(fn2) Whether new developments or conversions, condominium housing has taken root in America and is an accepted alternative to the traditional single family dwelling.
The scope of this article is limited to considering the application and process of converting condominium units from existing rental apartment properties.
There are two major categories of conversion developers (converters): (1) The professional who purchases an apartment building from its prior owner with the express intention of converting and selling it as condominiums; and (2) the apartment owner who wants to divest his interest in the most lucrative way possible. The information that follows applies equally to both categories except that the professional developer would do much of his analysis before he commits himself to purchasing the apartment building, while the owner would initially need to determine whether conversion was the best way to dispose of his property.
Whether a given apartment complex would be suitable as condominiums depends on several factors. First, it must be structurally sound so that a minimum of capital will be needed to restore it to a safe and marketable condition. Money spent in structural restoration does little to enhance the marketability of the individual units, but may be mandated either by a required engineering study or by the
required building code provisions of the local municipality. Second, the architectural design and lay-out of the complex should be spacious and functional. Experience has shown that condominium buyers generally require a sense of limited privacy if the units are to sell quickly under normal market conditions. Third, the proposed property should give the appearance of durability and strength, for it must appeal to the unit buyers as a place of permanent residence and will not be marketable in a deteriorated condition. And fourth, not only must the location of the building be near enough to shopping and business centers to be convenient, but ideally it should be located in a neighborhood of single family dwellings that are selling at a price substantially higher than that of the condominium units themselves. This is preferable since single family houses will be the primary competition of the condominiums and if the houses are selling at or near the purchase price of the condominiums, marketability of the units will be severely hampered.
The following is intended to serve as a basic guide for the condominium converter. It is not inclusive, and indicates some of the areas referred to above, but should be given careful consideration when determining whether or not to commit an existing apartment building to the conversion process.
The following checklist is useful when considering a rental property for conversion:
Modern buildings with deluxe features.
Solid construction and good design. (Pay close attention to noise-dampening characteristics.)
Buildings that require few changes.
A good location---preferably with a unique feature such as a park, nearby shopping or school.
A building with short-term leases that can be honored during conversion.
A profile of the potential market (from Census Bureau information).
Competition in the area.
New construction in the area.
Rental prices in the area.
Single family home resale prices.
Market AnalysisCredit reports on renters, if possible.(fn3)
Many projects have suffered dismal failure only because they were not preceded by feasibility studies; too many projects conceived by wishful thinking or intuition alone have caused immeasurable losses that could have been avoided through feasibility analysis. On the other side of the coin, a great many developments have enjoyed enviable success resulting from application of feasibility recommendations.(fn4)
The first step in determining whether or not the proposed property is economically feasible for conversion is to conduct a market analysis. The purpose of this analysis is to determine what the condominium units could be sold for in the local marketplace. There are primarily two ways to arrive at the fair market value of the condominium units---the fair rental value method and the cost per square foot method.
Fair rental value appraisal. (FRV) is performed by taking the approximate total monthly cost for a condominium unit's mortgage payment, taxes, insurance, and association fee and comparing it with the average rental cost per a comparable apartment in the vicinity. For a rule of thumb, as the cost for the condominium purchase exceeds 10-15 percent of the comparable rental expense, the salability of the units decreases proportionately.
The 10-15 percent additional expense can be compensated for by the tax advantages of property ownership.(fn5)
Cost per square foot appraisal is performed by comparing the anticipated selling price of the converted units with the cost per square foot of new and used condominiums being sold in the area. The cost per square foot normally should be higher for smaller condominium units because they enjoy equal shares of the common areas with the larger units although paying a lesser purchase price. When using this method of appraisal, as a general rule the converted condominiums will be considered used units and often sell for 10-20 percent less than new condominiums in the area.(fn6)
Both the FRV and cost per square foot appraisal methods give only general indications of the fair market value for the converted units. Additional considerations that should be weighed are: (1) the uniqueness of location (i.e., special amenities, key attractions nearby such as resorts, beaches, amusement parks, etc.); and (2) the absorption rate in the local home marketplace (i.e., rental vacancy factors for the area, anticipated number of...
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