The purpose of this paper is to lay out a suggested procedure for a condominium association which desires to sell its property to do so in an orderly manner that will maximize the distributions to the owners with the minimum amount of time, effort, and conflict.
A. Background/De-Conversion Phenomena.
Condominiums were first authorized in Illinois in 1963 when the Illinois Condominium Act (the “Act”) was first adopted. In the 50+ years since then, the condominium form of ownership has become the dominant form of owner/occupant home ownership of units in multifamily buildings in the Chicago area.
The housing market crash which led to the Great Recession (the “Crash”) put enormous stress on the housing market in general and the condominium form of ownership in particular. Issues unique to condominiums which were exposed by the Crash include the following:
- Presale requirements, restrictions on the percentage of units that could be owned by investors, limits on the number of delinquencies and other restrictions that lenders applied to condominium projects, made it much more difficult to obtain a mortgage on a condominium unit than on a single family home or a non-condominium townhome unit.
- The rise in assessment delinquencies created serious financial issues for condominiums and their non-delinquent unit owners. Lenders required that condominium declarations make the lien for unpaid assessments subordinate to the lien of the first mortgage on the unit. When the first mortgage on a unit was foreclosed, the foreclosure sale would result in the extinguishment of the lien for unpaid assessments, depriving the association of much needed income. Non-delinquent owners were faced with rising assessments and/or special assessments to cover the shortfalls created by delinquencies and extinguished assessment liens.
- Many condominiums were unwilling or unable to accumulate sufficient reserves for major repairs or replacements when needed, resulting in association borrowing and/or levying a special assessment to pay for needed work. In the absence of a source of funds for repairs, many condominium associations chose to defer necessary repair work, resulting in the deterioration of the property, a decline in unit values and an increase in the difficulty of its owners to sell or refinance their units.
- Restrictions or prohibitions on leasing of condominium units made it difficult for an owner no longer in occupancy of his unit to rent the unit to generate income to help pay the unit’s ownership costs until the unit could be sold.
- Large numbers of potential home buyers were shut out of the housing market because of damaged credit or large student loans. Many people who could afford to buy and who could qualify for a mortgage chose to rent rather than buy in order to keep their options open and not risk a potential diminution or loss of their equity in the event of a decline in housing values. Alternatively, they were concerned that they might be stuck in a unit they no longer were able or desired to live in. In addition, many millennials delayed marriage and family formation, and the need or desire to purchase a home. As a result, homeownership in the United States significantly declined.
As the demand for owner/occupant condominium units declined, demand for rental apartments increased, as did rental rates. As a result, demand for rental buildings which could be leased for moderate rents increased.
In recent years, investors began to look to condominiums as a source of rental units. At first, investors went after low hanging fruit in the form of recently constructed or converted condominium buildings which stalled or failed for lack of sales. The investor would acquire a significant percentage of the units in a troubled building from the failing developer or the lender which repossessed the units and then would patiently acquire the balance of the units through short sales or foreclosure sales until it owned all of the units and was able to withdraw the condominium from the terms of the Act and make it into a single owner apartment building.
As the availability of failed condominium projects decreased, investors began to focus on condominiums in which no single party owned a significant percentage of the units. However, investors found that acquiring all of the units in a condominium with multiple unit owners was much more difficult than buying the bulk of the units in one transaction and picking up the stragglers one at a time. Investors began to approach condominiums which were candidates for de-conversion—well located buildings with studio, one or two bedroom units, which were experiencing some of the problems referred to above—with an offer to buy the entire building. Investors learned, often the hard way, that acquiring a condominium building for de-conversion in Illinois is problematic, especially when there are multiple unit owners and/or underwater mortgages.
B. Statutory Basis.
There is only one way to voluntarily de-convert a condominium in Illinois: 100% of the unit owners and 100% of the holders of liens on units must consent under Section 16 of the Act. Section 15 of the Act provides for the sale of 100% of the units upon the affirmative vote owners owning not less than 75% of the percentage interests. Upon such a vote, each unit owner, even those who did not vote in favor of the sale are obligated to “deliver such instruments and to perform all acts as in manner and form may be necessary to effect such sale.” Although Section 15 does not specifically so state, it is generally presumed that if all owners cooperate with the sale without objection the net proceeds will be distributed based on the percentage interests of the units. Section 15, however, provides a mechanism whereby a dissenting owner can obtain an appraisal of the owner’s unit and possibly receive a sum which is greater than the unit’s percentage interest of the net proceeds, with the balance of the net proceeds being distributed to the remaining unit owners based on their relative percentage interests. Following the sale and conveyance of all the units to the buyer, the buyer, as owner of 100% of the units, would be able to de-convert pursuant to Section 16 of the Act.
Unfortunately, although Sections 15 and 16 are straight-forward, the implementation is not so easy, especially where there are owners who do not desire to sell, owners who will not co-operate with the sale, issues concerning the ownership of units, the relative values of the units do not correspond to the percentage interests, and there are liens on units which exceed the value of the unit, i.e. the units are “underwater”.
The presence of one or more of these issues can scuttle a proposed sale or complicate and extend the process to the point where a prospective buyer may be deterred from pursuing the sale or will need to reduce the purchase price to compensate for the time and effort required to negotiate and consummate the transaction.
Section 15 promises the prospect of the ability to force a sale with the vote of owners representing at least 75% of the percentage interests. However, as a practical matter, for the transaction to succeed requires the ultimate co-operation of 100% of the owners because, in the end, 100% of the owners need to deliver deeds to the buyer.
The recommended plan of action for a condominium which is a good candidate for sale and de-conversion is for the association to first deal with and resolve all issues and then offer the building for sale pursuant to a request for proposals or “RFP” which lays out the terms and conditions of the sale and only requires the prospective buyer to make a proposal based on price. It may take some time to resolve all the issues and it may turn out that the issues cannot all be effectively be resolved, in which case it may not be possible to sell the building. However, if the association can resolve the issues up front, it would be in a position to offer a “turnkey” sale which would maximize the sale price and the return to the owners.
C. Identify the Issues.
Following is a discussion of some of the issues which may confront, and need to be resolved by, an association which is considering selling itself:
1. Relative Values of or Relative Investment inUnits Do Not Correspond to % Interests. Although the default formula for allocating net proceeds of a sale is percentage interests, Section 15 allows for deviation from that formula where a dissenting owner claims the “value” of the owner’s unit is greater than what the owner would receive based on the unit’s percentage interest multiplied by the net proceeds of the sale. Section 15 provides for a cumbersome procedure involving a panel of three appraisers to determine the “value” of the owner’s unit, without giving any guidance of on what basis “value” is to be determined.
There appears to be at least three possible ways to approach a determination of value: (a) as an owner/occupant unit in a functioning condominium; (b) as a rental unit in a functioning condominium; or (c) as a rental unit in a non-condominium apartment building. This lack of clarity would likely result in confusion and disputes that could lead to litigation. In order to avoid this potentially fatal obstacle, the owners should agree among themselves, preferably with professional assistance, as to the basis for dividing up the proceeds of the proposed sale.
Agreement will require 100% buy in by the owners. In order to attain this buy in will require an approach which will seem fair, or at least reasonable enough, to get all of the owners to agree to the approach in order to permit a sale to occur. There may not be a simple formulaic solution to establishing relative values. For instance, owners may have different investments in comparable units and owners which have higher investments will want to at least get their money back. With respect to those units which are underwater, it may be necessary to negotiate with the lender to accept less than the outstanding debt or else allocate enough proceeds to the unit to pay off the debt.
Agreeing on how the net proceeds of the sale will be distributed is the threshold issue. If it cannot be resolved, there may be no point in continuing to pursue a sale unless the buyer is willing and able to underwrite the cost of what could be a long, drawn out and costly process.
2. Dealing with Owner/Occupant Issues
There may be owner/occupants who desire to remain in their unit as a tenant after the sale/de-conversion. If the expectation is that the building will be de-converted into a conventional rental building, the terms of sale could require the buyer to permit the owner/occupant to remain as a tenant, either short term or long term, in order to obtain the owner/occupant’s consent to a sale. Alternatively, a portion of the proceeds of the sale could be set aside to assist the owner/occupant to relocate.
3. Difficulty Identifying or Contacting Owners. There could be deceased or incapacitated owners or unresponsive owners, such as lenders who have taken title through foreclosure or foreclosures in process. The association will need to identify and resolve these issue before it can deliver clear title to all of the units.
D. Prepare for the Sale.
If the issues described above, as well as whatever other issues arise, can be effectively dealt with, the association will need to prepare an RFP which will lay out the terms of the sale, which may or may not include a minimum price. Before the RFP is publicized, it is recommended that the owners approve the RFP and all owners execute and deliver documents necessary to facilitate a sale, such as deeds and other necessary closing documents. These documents would be deposited in escrow with instructions to complete and deliver the documents in connection with the closing of the sale approved by the association pursuant to the RFP.
E. Find a Buyer.
The RFP can be sent to prospective purchasers who have expressed an interest in buying the building or disseminated by a broker. Once a qualified buyer is obtained and a contract negotiated and executed and the conditions to closing have been satisfied, the transaction can close using the closing documents being held in the escrow. F. Liquidate Association and Distribute Funds. The net proceeds of the sale would be distributed per the agreement previously established by the owners. The balance of the funds held by the association, including reserves, should, after all expenses are paid and delinquent assessments are paid, be distributed based on the percentage interests, which likely will not be the same as the percentages used to allocate the net proceeds of sale. This is because such funds were accumulated through assessments which were paid based on the percentage interests. After all funds have been distributed, the association can be terminated.
Conclusion.
A condominium association which desires to sell its building needs to spend some time, effort and money to prepare itself for sale. Following the procedure suggested above will help facilitate a sale and maximize the return to the owners, while minimizing conflicts and hard feelings.
Brian Meltzer, January 2017