Two years ago, Kelly Elmore was the only attorney at her firm dedicated to handling work stemming from condominium deconversions in Chicago.
Today, that unit at the “condo law firm” Kovitz Shifrin Nesbit has 16 members — five of them attorneys. It represents a growing community of condo associations that vote to sell their buildings to investors, who then “deconvert” them and bring them to the rental market as apartments. Elmore said she’s closed 23 deconversion deals, and is slated to close several more, covering almost 1,600 units in total.
Brokers and investors have also taken notice, as condo associations throughout the city and suburbs look to cash out and turn over their units to buyers willing to pay a premium for them.
“The business has quintupled,” Elmore said.
For sellers, deconversions represent a chance to sell their condos for a premium over what they would fetch individually. For buyers — even those paying market-value or more for the units — it’s a way to take in rental income in Chicago’s hot apartment market, boosted in part by a trend in recent years toward renting rather than buying.
Joe Smazal of commercial brokerage Interra Realty has closed six deconversion deals around the city valued at just under $80 million. He has two more under contract for about $13 million: a 34-unit building in Buena Park and another 34-unit building in north suburban Evanston.
“There remains more buyers than sellers for buildings of scale in areas where these things are happening,” he said.
In many cases, deconversions simply bring the building back to its original state, a reversal of the “condomania” craze of the 1970s and early ‘80s when apartment owners converted their buildings into condos to profit from the growing desire for homeownership.
Those familiar with deconversions said properties that are good candidates for them tend to have things in common. Most are older, often with deferred maintenance. That’s a motivator for condo owners looking down the barrel of a looming special assessment to pay for it.
“There’s a lot of old buildings built before 1980 and they’re in very good neighborhoods,” said Steven Ginsberg, an attorney who has worked on deconversions on behalf of lenders, investors and condo associations.
“People who are buying condos now, especially in nicer areas, they’re looking for a better product type than what’s available in these buildings,” he said. And when multiple owners in a building decide to sell around the same time, they begin competing against each other for buyers. “That’s going to devalue those units. You’re lowering those values by creating a glut,” he said.
In a lot of cases, many of the units already are investor-owned, sometimes as many as 75 percent, making it harder for buyers to get financing to buy a condo unit in the building.
“Lenders don’t like to own in a rental property,” said Steven Livaditis, a principal at commercial brokerage Essex Realty who has done more than a dozen deconversions in the past year.
The buildings also tend to have smaller units, such as one-bedrooms or studios, said Joe Scheck, a colleague of Livaditis’.
“These are old vintage buildings built after World War II to be apartments,” Scheck said.
If a building does fit the bill for a deconversion, investors have been willing to pay. Smazal recently brokered a 117-unit Lakeview condominium that was turned into a rental property. Beal Properties paid $30 million for the building, about $256,000 per unit. That’s about 60 percent more than the average price paid recently for condo units in the building, Smazal said.
Marc Realty Capital, the investment arm of commercial property owner and manager Marc Realty, is also involved in two big pending deconversions. In one, the firm offered $30 million for a 68-unit Gold Coast building, which at $441,000 a unit, would be close to double what’s been offered elsewhere.
And it’s also looking to complete the biggest deconversion yet, a $100 million deal for the 449-unit River City complex in the South Loop that’s expected to close in July, and averages around $225,000 per unit.
Why are investors willing to pay so much? Because even when paying a premium, deconverting a building can make financial sense, experts said. Ron DeVries of consulting firm Integra Realty Resources said building a new apartment property is easily $200 per square foot in hard costs, escalating to $300-$400 per square foot depending on extras.
Compare that to the $271 per square foot Marc Realty is spending on River City. And then there’s the process of obtaining building permits, getting construction financing, finishing the project and getting it fully rented, which can take years.
In a deconversion, the turnaround from deal to fully rented can be much faster.
Scheck and Livaditis said many of the buyers have capital to invest and are looking for places to pour it.
“All they want to do is grow their inventory and marketplace,” Scheck said. The problem is that’s not so easy, especially in a hot market like Lakeview on the North Side, where Livaditis estimated as many as 40 percent of the buildings are controlled by the same group of owners.
“Those buildings are never going to trade,” he said. So when an association looks to deconvert in a bulk sale, investors get motivated.
Many of the investors also already own a number of units near the deconversions they target, meaning they can absorb the new ones and use the same management companies, maintenance fims, leasing people and other staff.
Smazal said the buyers in the deals he’s brokered have been a mix of family offices, syndicates, individual buyers and institutional investors.
“They’re attractive deals because there’s enough scale to make them profitable but not out of reach to a lot of buyers,” he said.
And buyers have been willing to sweeten the deals, in part because it takes a vote of at least 75 percent of the building’s ownership to approve a deconversion. Elmore said some buyers will give unit owners upgrade payments if they’ve recently added hardwood floors, stainless steel appliances or other amenities. Some will pay off underwater mortgages, or affordable housing loans that come due when a sale triggers them.
Many allow unit owners to remain as renters even after the deconversion closes, offering breaks on rent in some cases. And in some of the deals the buyer will let the unit owners keep whatever money has been built up in their association’s reserve funds, which can be millions.
For many condo owners, though, it’s simply a chance to get out from under a bad investment.
“Some of these buildings should have never been converted. They saw very little appreciation,” Scheck said. “This is a blessing. It’s an opportunity to get out.”
But not everyone feels that way.
“It can get very very emotional and very complex” for condo owners who may not want to sell, Scheck said.
Brokers and attorneys who’ve closed deconversions said the key is being upfront with associations from the start. In some cases, that means counseling associations against deconverting when their building doesn’t seem like a good fit for it.
Collin McKenna is vice president of acquisitions for Golub, which paid $60 million for the 292-unit Century Tower at 182 West Lake Street in the Loop and also bought two other smaller deconversions. He said looking into the future, the condo buildings that have yet to deconvert might have a harder time.
“The low-hanging fruit has been picked off,” he said.
And that might be what fuels the trend in the near term, Smazal said, because it’s not clear how long the trend will last.
“There is a sense of urgency for buildings that are doing this right now,” he said.