Lawyers Help Clients Convert Condos into Rental Property

May 10, 2011

By  Amanda Robert
Law Bulletin staff writer

In early April, Jason P. Neumark, a partner in the real estate and finance practice at Levenfeld, Pearlstein LLC, advised Waterton Residential in its purchase of 124 unsold units in the Mondial River West condo building and on its plans to convert those units into apartments.

Neumark points to Waterton Residential, a subsidiary of Waterton Associates LLC, a Chicago-based investment firm that owns and manages more than 16,000 apartments, as one of many clients who have shown increasing interest in capitalizing on the weak condo market.

"It was a project that had roughly 150 units and the developer only sold a small number of those units and ran into some trouble selling the rest," he said. "Once you get to a certain point where you can't sell the units for the price that your lender requires in order to release the mortgage, you're kind of stuck and that's when these projects get into distressed situations."

Like Waterton Residential, many investors in Chicago have noticed a steady rise in the rental market. As they consider the trend of purchasing unsold units in distressed condo buildings and converting them into apartments, they call on real estate attorneys to help guide them through the process.

Brian Meltzer , managing partner of Meltzer, Purtill & Stelle LLC, who has represented developers, lenders and investors for more than 40 years, explained that many condo projects stalled in recent years as the market died and developers walked away from their contracts.

"A number of buildings went up that either weren't able to sell any units or sold a few, but didn't make it any further," he said. "In most cases, the money that was spent to build the building wasn't repaid because the sales were not there. Some of these are in various stages of foreclosure or workouts and some of them went into bankruptcy."

Now, Meltzer said, potential investors want to acquire either buildings that were created as condos, but didn't sell any units or their remaining unsold units.

"The rental market is picking up a lot quicker than the condo market," he said. "There is a unique opportunity for someone who comes along and buys a building or the remainder of a building that is below the cost of construction or what was on the mortgage. If the price is low enough, they can rent the units out and carry a new mortgage."

Michael S. Kurtzon, a member of Dykema, Gossett PLLC, who has represented clients in the real estate industry for more than 35 years, has recently counseled several clients on various options involving these condo projects.

He explained that if the developer constructed the building as a condo project, but didn't close on the sale of any units, the building can become an apartment project.

"That's a little easier, because in that situation, when the developer or a bank takes over, they will be able to terminate the contracts and basically start all over," Kurtzon said. "The project would have never been submitted to the Condo Act, and even if the condo declaration was recorded, as long as they get rid of the contracts, they could deconvert the property and turn it into a pure rental project."

But, Kurtzon said, once residents closed on and live in those condo units, it becomes more difficult to deconvert the entire building.

If only 15 to 20 units in a large condo building are occupied by owners, developers could negotiate to buy those units, he said. If needed, they could use a provision in the Illinois Condominium Property Act, which states that if 75 percent of owners elect to sell the building, they can force other owners to sell.

"If you can't do any of that, you're stuck with a building and own a bunch of unsold condo units — but the declaration does allow a developer to lease the units," Kurtzon said. "They can keep it as a condo, leave people in there and rent out the unsold units."

When Neumark and other real estate attorneys advise their clients on the various condo projects, they often help them overcome several challenges.

An investor who takes a project that was meant to be a condo building and tries to change it to an apartment building almost always faces a distressed situation, Neumark said. They often need to work with the seller's lender to negotiate a short sale or to move through the foreclosure process.

In addition to issues like incomplete construction and improperly funded reserves, those investors must deal with existing owners in the building, he said.

"They bought into a building that now, for the most part, will be rental," Neumark said. "That decreases the market value of their unit, and it's going to make it a lot harder, if not virtually impossible, to sell their unit. You're going to have some unhappy owners."

New owners mitigate that risk by purchasing the majority of condo units, which gives them control of the board, he said.

"It seems to be a good solution for most of the players involved," Neumark said. "But there is really no good solution for the people who purchased early on."


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