The Hybrid Condominium

The Dilemma Facing Some Aging Condominiums

The housing crash resulted in dramatic declines in home values in the Chicago area. By 2017 home prices were recovering in many neighborhoods. However, in some neighborhoods, the values of condominium units, particularly those in moderate income buildings, have not recovered and may not recover any time soon. At the same time, rents have been rising to the point where the value of some moderate income condominium buildings as a rental project is greater than the sum of the values of the individual units in the condominium.

Recently, many older moderate income condominium associations have been discovering that large expenditures are needed to repair or replace deteriorating portions of the building, such as windows, risers, roofs and building exteriors. Some of these associations are discovering that they do not have sufficient reserves to pay for the necessary work. It is generally believed that associations faced with these issues have the limited options of (a) levying a large special assessment (which many owners would not be able to afford), (b) taking out a loan secured by a pledge of assessment income (which is difficult to obtain), or (c) attempting to sell the building (a process which requires the vote at least 75% of the owners and is difficult to accomplish).

I believe that there is another option which could leverage the increased value of a particular building as a potential rental project to stabilize the building and avoid many of the drawbacks of the three options mentioned above and I call it the Hybrid Condominium.

The Hybrid Condominium Concept

An existing condominium association confronted with the circumstances mentioned above could become a “Hybrid Condominium Association” as follows:

  • The condominium association would organize a new entity which would be wholly owned by the condominium association (“Newco”).
  • Newco will acquire all of the units in in the condominium pursuant to the vote of owners representing at least 75% of the percentage interests pursuant to Section 15 of the Condominium Property Act for a purchase price equal to the amount necessary to pay off all outstanding liens on the units. Each unit owner would convey the owner’s unit to Newco subject to all liens, without any payment of money by Newco to the owner.
  • Newco would borrow enough money to pay off all liens on all of the units (“Acquisition Loan”), so that Newco will own all of the units, subject only to the Acquisition Loan. Ideally, the Acquisition Loan would be a fixed rate long term, self-amortizing loan.
  • Newco would then take out a loan for the required repairs (“Repair Loan”). The Repair Loan would be a construction loan, with disbursements made as needed to pay for the work as it is being done and with interest only being payable on the Repair Loan until all the funds have been disbursed, at which time it would switch to a fixed rate long term, self-amortizing loan. Each of the Acquisition Loan and the Repair Loan would be secured by a mortgage on all of the units (each a “Blanket Mortgage” and together the “Blanket Mortgages”). Each Blanket Mortgage will, upon the satisfaction of certain conditions, permit partial releases of a unit from the Blanket Mortgage upon the payment to the holder of the Blanket Mortgage of the portion of each Blanket Mortgage which is attributable to the unit (calculated as provided below).
  • For this plan to work, the appraised value of the building as a rental project would probably need to be sufficiently in excess of the liens on all the units when they are acquired by Newco, probably by 25% or more, and the estimated increase in the value of the building after the repair work is done would need to equal or exceed the cost of the work.
  • Newco, as the owner of 100% of the units in the condominium, would amend and restate the condominium declaration to create the Hybrid Condominium which would be set up and operate as set forth below.
  • Those owners who desire to continue to own their unit would have their unit conveyed back to them by Newco, subject to the Acquisition Loan and the Repair Loan. Those units which are not conveyed to former owners would be held by Newco or conveyed to the condominium association and either (a) sold subject to the two loans or (b) leased to tenants at rent sufficient to at least cover the monthly payments attributable to the unit, as described below.
  • The monthly payments with respect to each unit would be as follows:
  1. Assessments for common expenses and reserve build-ups based on % interests; plus
  2. The portion of the monthly service on the Acquisition Loan attributable to the owner’s unit based on the relative portion of the Acquisition Loan needed to pay off the liens, if any, on the unit when it was acquired by Newco; plus
  3. The portion of the monthly service on the Repair Loan attributable to the unit, based on % interests.
  • The Hybrid Condominium Association would make the monthly service payments under each Blanket Mortgage.
  • The Hybrid Condominium Association or Newco would use the rent from each unit which it owns to pay the unit’s share of the monthly payments and the real estate taxes on the unit, with any excess going into the reserves of Newco or the Hybrid Condominium Association.
  • The members of Hybrid Condominium Association would be the unit owners from time to time, including the Hybrid Condominium Association and Newco, with respect to the units owned by each of them.
  • The Hybrid Condominium Association’s budget would include line items for reserves to cover delinquencies and to build up sinking funds to pay for major repairs and replacements. If properly funded, the reserves could help cover the hopefully brief periods when payments with respect to a unit are disrupted, avoid delinquencies on the Blanket Mortgages and obviate the need for additional borrowings or a special assessment.
  • In Illinois, a condominium association has the power of forcible detainer to deal with a delinquent owner. What this means is that if an owner of a unit in the Hybrid Condominium becomes delinquent, the Condominium Association will be able evict the occupants of the unit and rent the unit out in order to generate the cash flow necessary to pay the monthly amounts payable with respect to the unit. Although it may take some time to evict a delinquent owner or the owner’s tenant, it likely will take a lot less time than it would take to get possession in a foreclosure action.
  • In a departure from the current practice of only allowing unit owners or their designated representative to serve on the association board, tenants should be granted to right to serve on the board, at least those tenants who have been in residence at the building for a significant amount of time, say in excess of three years. Tenants should also be permitted and encouraged to serve on committees.
  • Long term, fixed rate financing, without personal liability on the unit owners, and with the right to obtain unit by unit partial releases from the Blanket Mortgages may be available from the National Co-op Bank, a local bank or another lender. Depending on the situation, a bank may earn Community Reinvestment Act credit for making the Acquisition Loan or the Repair Loan, or both.
  • If the above described financing is obtained, then after the secondary mortgage market approvals are obtained for the Hybrid Condominium and presale requirements are satisfied, it will be possible to sell or refinance a unit and use a portion of the proceeds of the sale to obtain a release of the unit from the Blanket Mortgages.
  • A unit owner, including the Hybrid Condominium Association or Newco, could (i) sell and convey a unit subject to the Blanket Mortgages or (ii) sell/refinance with the buyer/owner paying off the Blanket Mortgages and getting partial releases from the Blanket Mortgages with respect to the unit.
  • Over time, the Hybrid Condominium would become a mix of owner/occupant units, investor owned units and units owned and leased by the Hybrid Condominium Association or Newco, thus the name—Hybrid Condominium.

Conclusion

The issues facing aging condominium buildings, particularly those with smaller units (i.e. 1 and 2 bedroom units) were aggravated by the Crash. The Hybrid Condominium approach suggested in this article will enable those condominiums which are faced with the need for substantial repairs or replacements and which do not have sufficient reserves to pay for such work to leverage the value of the building as a rental project (where such value is greater than the sum of the values of the individual condominium units) in order to finance necessary repairs with a long term fixed rate loan without levying a special assessment and without selling the building. The suggested approach would also facilitate the sale of units by owners who want to sell and permit unit owners who desire to remain in ownership to do so.

Brian Meltzer, March, 2017

Thank you for your interest in MPSLaw. Please fill in the forms below.
Thank you again for your interest. We will be in touch soon.
Close